NeoPhotonics' (NPTN) CEO Tim Jenks on Q2 2014 Results - Earnings Call Transcript

NeoPhotonics Corp. (NYSE:NPTN)

Q2 2014 Earnings Conference Call

August 7, 2014 04:30 PM ET


Erica Mannion - IR

Tim Jenks - President and CEO

Ray Wallin - CFO


Richard Shannon - Craig-Hallum


Welcome to the NeoPhotonics 2014 Second Quarter Conference Call. This call is being webcast live on the NeoPhotonics event calendar webpage at This call is the property of NeoPhotonics and any recording, reproduction or transmission of this call without the express written consent of NeoPhotonics is prohibited. You may listen to a webcast replay of this call by 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 second quarter of 2014 as well as the company’s outlook for the third quarter. With me today are Tim Jenks, Chairman and CEO, and Ray Wallin, Chief Financial Officer.

Tim will begin with a review of the second quarter results, followed by a discussion of the Company’s growth and margin drivers and cost reduction plans over the next several quarters. Ray will provide a financial update including results for the second quarter and the outlook for the third quarter of 2014. We will then open 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 risks 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 August7, 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 filed on June 4, 2014, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, which we filed on June 24, 2014,and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, which we anticipate filing shortly. Listeners who do not have a copy of our second quarter 2014 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. We are encouraged by the strength in our business as evidenced by our record second quarter revenue of $77.5 million which came in at the high end of our outlook range of $73 to $78 million and represents a 13.6% increase over the prior quarter and a 3.3% increase over our second quarter of 2013. We witnessed increased strength in both our 100G products and their backlog, plus strong Access product shipments. In the June quarter we achieved a Non-GAAP gross margin of 20.8%. As we noted in our prior two calls we expected to have some decreases in sales for client side 100G modules and components as the industry moves from CFP to CFP2. In 2Q this resulted in adverse impact on volumes and utilization, and Ray will provide more details on this later. Our Non-GAAP EPS loss was 24 cents per diluted share.

Second quarter revenue attributable to our “Speed and Agility” product group was approximately 72% of our total revenue, and was up $6.4 million from the prior quarter and up $1.8 million on a year-over-year basis. Of this, revenue from our High Speed products, i.e. 100G and some 40G, was $30.2 million or 39% of total revenue in the second quarter of 2014, which is an increase of 3% over the second quarter of 2013. Our “Access” product group was strong at approximately 21% of total revenue, which was up $2.1 million over the prior quarter and up $1.2 million on a year-over-year basis.

End markets. We remain excited about the pace of 100G adoption and the dynamics in our various end-markets. 100G deployments were a significant contributor in Q2, including in China, and we are continuing to see increases in our backlog for the third and fourth quarters of 2014. 100G long-haul deployments remain strong as we have seen some North American carriers increase CapEx spending in this market. Industry discussions and design win activity related to 100G deployments outside of long-haul, including Metro, continue at an active pace and we remain enthusiastic about its adoption cycle, and we expect these products to ramp in 2015.

Within the Access market, we continue to see strength over the near-term as a result of growth in China LTE backhaul and FTTX. We view the FTTX segment as a mature market with flat or declining revenue over the mid-term while LTE backhaul is growing, giving strength to this product group.

Need for profitability. While we are encouraged by the growing opportunities ahead of us, due to the competitive nature of our industry, we are sharpening our focus on costs and the need to reach sustained profitability in the near term.

I would like to spend some time today focusing on the plan we have put in place to achieve this goal. As we have stated on previous calls, there are three main drivers which impact our path to profitability – operating cost reduction, revenue growth and shifting product mix. I will discuss each of these in greater detail.

Cost reduction. We have initiated a restructuring and cost reduction plan with the goal of reducing total operating costs in the company. In the initial phase, we expect to reduce our operating costs by approximately $10 million of annual run rate during Q3, or approximately $2.5 million per quarter. We have reduced our general and administrative expenses as we completed our restatement activities over the past several quarters resulting in a $1 million reduction per quarter which is not included in the $2.5 million per quarter I already noted. So far, we have taken actions to reduce manufacturing costs and operating expenses by staffing reductions in operations, R&D, sales, marketing and G&A, and these cost reductions will materialize during Q3.

In a second phase, we will take additional actions to reduce manufacturing and operating costs by reducing our manufacturing footprint in higher cost geographies, decreasing associated manufacturing overhead costs for these facilities and further reducing R&D spending. We anticipate the breakdown of cost reductions to be approximately 25% in manufacturing related costs, with the rest in operating expenses. That said, we will continue to fully support our key 100G product platforms for next generation networks. The specific components of this restructuring initiative are aimed to reduce corporate and business unit overheads, provide operating leverage in gross margins on increasing volumes, reduce total R&D spending and streamline decision making efficiency. We will update you in our next regularly scheduled earnings conference call on the status of these changes.

Revenue growth. Related to revenue growth, we are enthusiastic about the current dynamics in the market and the implications they have for our business. With the ramp in 100G deployments, including in China, we believe our customers are well positioned to win in upcoming tender awards and NeoPhotonics should benefit from this market’s growth.

While the Metro market opportunity is still in the nascent stage, we expect the overall market opportunity over time to be as much as 3x the volume of the 100G long-haul market. We expect Metro 100G, where several of our new products are targeted, to begin to ramp in 2015 and continue into 2016.

In addition, we have seen continued strength in our Access product group due to both LTE backhaul deployments, notably in China, as well as continuing FTTX volumes.

Lastly, we expect contributions to revenue growth in the coming quarters from several of our new products. For example, our micro ITLA product, which represents a step function improvement in component integration and performance, is in qualification with lead customers and we believe this product will begin production shipments later this year and ramp in early 2015.

Product mix. Product mix, as we have discussed on prior calls, also affects our profitability. Our products have a range of margins from greater than 40% for some of our high speed products, to below10% for certain mature products. To improve gross overall margins for the Corporation in the quarters ahead, a key factor is the mix of our product shipments.

We are focused on increasing the contribution from higher margin opportunities including certain Coherent100G long-haul and 100G Metro deployments in the US, Asia and Europe. Additionally the transition from CFP to CFP2 in client side 100G modules represents an opportunity both for our CFP2 modules and also for 25G lasers and drivers from NeoPhotonics Semiconductor, and we see this as a continuing trend over the next few years. In fact, we are seeing initial CFP2-related ordering and we anticipate a pickup going forward.

And while not directly accretive to overall corporate gross margins, we do benefit from the uptick in high volume markets such as 10G China transport and Access, which aids in growing our top line in order to further leverage our manufacturing utilization.

In conclusion, we continue to work on increasing our content per port in 100G systems, and we believe our key investments in next generation products, our investments in production capacity and the growing adoption of Coherent networks, plus the use of high speed modules on the client side, will fuel NeoPhotonics growth in the medium term. In the interim we believe our restructuring activities, volume growth and our ongoing product mix changes will accelerate our path to profitability such that, once completed, we are targeting break-even profitability at run-rate revenues of approximately $85 million per quarter.

I will now turn the call over to Ray Wallin, our Chief Financial Officer.

Ray Wallin

Thank you, Tim, and good afternoon. I will start with a review of the financial results for the second quarter ended June 30, 2014 and conclude with our outlook for the third quarter of 2014.

For the second quarter of 2014, revenue was $77.5 million, an increase of approximately 13.6% from the first quarter of 2014 and an increase of 3.3% from the year ago period. As Tim noted, this was within our projections and the highest second quarterly revenue in our history.

We had three 10% or greater customers in the second quarter of 2014: Alcatel-Lucent at approximately 12%; compared to 13% in the first quarter; Ciena comprised approximately 13%; compared to 14% in the first quarter; and Huawei Technologies comprised approximately 39% of our total revenue compared to 35% in the first quarter.

Geographically, our revenue mix for the second quarter was 20% in the Americas, which is the same as the prior quarter, 54% in China compared to 52% in the first quarter, 5% in Japan compared to 7% in the prior quarter, and 21% in the rest of the world, which is the same as the first quarter. Note that these figures are based on shipment destination and not end use destination.

GAAP gross margin for the second quarter of 2014 was 18.8%, a decrease of 1.4 percentage points sequentially from the 20.2% reported for the first quarter of 2014 and a decrease of 2.0 percentage points from the second quarter of 2013. Non-GAAP gross margin for the second quarter was 20.8%, within our projection of 20% to 25%, and represents a decrease of 1.2 percentage points versus the previous quarter’s Non-GAAP gross margin of 22.0% and a decrease of 4.3 percentage points from the prior year period.

The decline in gross margin from the previous quarter was primarily due to lower volumes of components, notably for client side 100G modules as we transition from CFP to CFP2, and above average inventory reserve charges.

The transition from CFP to CFP2 in 100G client side modules that Tim noted and as we mentioned on our last two calls caused a decrease in certain component shipments and under-utilization in that fab. It is important to remember we have a vertically integrated manufacturing model and as such, we must continue to focus on improving and optimizing production processes to increase yields and lower manufacturing costs. With lower volumes this quarter we had the additional issue of adverse volume variances. In addition, we took above average inventory reserve charges of approximately $0.9 million, or a 1.2 percentage point impact, for certain end-of-life low margin products. These impacts offset gains we made through other cost reduction and productivity efforts in the quarter.

SG&A spending for the second quarter was $11.8 million, or 15.2% of revenues, down from $12.4 million, or 18.2% of revenues, in the first quarter. Of this, G&A expenses in the second quarter were $8.2 million, or 10.6% of revenue, down from $9.0 million, or 13.2% of revenue in the prior quarter. Having completed our 2013 audit and restatement work, we anticipate quarterly G&A costs will be approximately $7.5 to $8.0 million in the current quarter.

The GAAP diluted loss per share for the second quarter reflects a 12 cent, or $3.9 million gain recorded in the operating expenses relating to the escrow settlement for our 2011 acquisition of Santur.

Research and Development expenses were $12.1 million, or 15.6% of revenue, which was unchanged from $12.1 million, or 17.7% of revenue in the prior quarter and prior to our restructuring actions. We continued making significant investments in 100G product development in the quarter.

Operating loss for the second quarter of 2014 was $5.8 million, or 7.5% of revenue, compared to an operating loss of $11.0 million, or 16.2% of revenue for the first quarter of 2014. The effective tax rate for the second quarter of 2014 was 1.5%, as the company made a provision for taxes related to NeoPhotonics Semiconductor in Japan and for our operations in China. We expect that our full year effective tax rate will be approximately 8%.

GAAP net loss for the second quarter of 2014 was $6.8 million, compared with a net loss of $12.6 million in the first quarter of 2014. Diluted loss per share for the second quarter of 2014 was 21 cents which is lower than the loss of 40 cents per share in the prior quarter and is also lower than the diluted loss of 27 cents per share in the second quarter of 2013 primarily due to the 12 cents benefit from the escrow settlement gain of $3.9 million mentioned earlier.

Non-GAAP net loss for the second quarter of 2014 was $7.5 million as compared to a net loss of $9.5 million in the first quarter of 2014 and a net loss of $3.8 million in the second quarter of 2013. Non-GAAP diluted loss per share for the second quarter of 2014 was 24 cents as compared to a loss of 30 cents per share in the preceding quarter and 12 cents per share in the year ago period. Adjusted EBITDA was a loss of $2.6 million in the second quarter of 2014, a decrease from loss of $4.2 million in the first quarter and lower than the gain of $1.4 million in the second quarter of 2013.

Now turning to the balance sheet. During Q2 we restructured a credit line facility with our principal lender in the U.S.As a result, at June 30, 2014, we reported restricted cash and investments totaling $26.4 million as required under our $21.0million term loan in the U.S. and the remaining $5.4 million under our line of credit facilities in China. On a comparable basis, combined cash, cash equivalents, and restricted cash and investments was $54.4 million, down from $64.3 million of cash, cash equivalents, short-term investments and restricted cash at March 31, 2014.And total debt at June 30, 2014 was $48.0 million, a net increase of approximately $7.3 million from the first quarter of 2014.

Accounts receivable balances increased by $8.6 million in the second quarter to $79.2 million, and days sales outstanding were 87 days at the end of the second quarter compared to 89 days at the end of the first quarter. The increase in accounts receivable reflects our record revenue of$77.5 million in the second quarter with shipments heavily weighted toward the end of the quarter. Our accounts receivable balances were decreased by approximately10% for payments received in the first five days of the third quarter. We do not have any significant collection issues.

Net inventory decreased approximately $4.0 million during the second quarter to $64.0 million while days of inventory on hand decreased to 94 days from 110 days in the first quarter as we began to ship the inventory built in the first quarter in anticipation of expected demand increases.

Capital expenditures totaled $3.8 million in the second quarter, up from $2.1 million in the prior quarter. We expect our capital expenditures to be in the range of $2.0 million to $3.0 million per quarter in the next two quarters. And, second quarter depreciation and amortization was $5.9 million, up $0.4 million from the prior quarter.

Moving on to our updated outlook for the third quarter of 2014. We anticipate revenue for the third quarter ending September 30, 2014 to be in the range of $78 million to $82 million, which is consistent with the increasing demand we are seeing in the market; non-GAAP gross margin will be in the range of 22% to 26%, an increase of 320 basis points over Q2 at the mid-point of the range due to the impact of restructuring changes, ongoing operational improvements and other cost reductions; diluted loss per share from operations will be in the range of 14 to 24 cents, and on a Non-GAAP basis will be in the range of a loss of 4 to 14 cents per diluted share; the share count assumption used to estimate the third quarter is approximately 31.8 million diluted shares.

Looking at the full year of 2014, we continue to believe demand is favorable for NeoPhotonics products, with continued potential in high speed and Coherent products in 100G around the world, as indicated by our outlook for continued growth for Q3 over Q2 of 2014 and following the 13.6% growth we have reported for Q2.We expect that this continued revenue growth, combined with the restructuring actions we are doing, will put NeoPhotonics on stable footing by year end. That is, we plan to exit 2014 with a business right-sized for our 100G opportunity, and with a cost structure in line with our size, plus new products able to deliver strong profitable growth in 2015 and beyond.

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 Instructions) And Mr. Wallin, we have no questions in the queue, I'll go ahead and turn - I beg your pardon, we do have Richard Shannon with Craig-Hallum. Please go ahead.

Richard Shannon - Craig-Hallum

Hi guys. I guess a couple of questions from me. Let's see here. Ray, did I catch your comments about the breakeven model after restructuring here, and breakeven $85 million in revenues?

Ray Wallin


Richard Shannon - Craig-Hallum

Okay. And based on your comments about the restructuring and the components of that, I would guess that looks like the OpEx to be around $22 million and implying a gross margin expectation on a pro forma basis about 26%. Is that roughly right?

Ray Wallin

Yes, that's pretty close.

Tim Jenks

Yeah, I think it's in the ballpark there, yeah.

Richard Shannon - Craig-Hallum

Okay. How do you feel about being able to reach that in the fourth quarter from what you can see right now? It sounds like your backlog is improving for the fourth quarter. So I want to get your sense of possibilities of that happening in the fourth quarter.

Tim Jenks

Sure, Richard. This is Tim. The backlog is strong, and so I think we will continue to see strong revenue. It's not our expectation that we would be in the $85 million range though in the fourth quarter. However, I think we'll continue to move up. So as we noted there are a number of actions that we've already taken and we do expect to see the benefits accrue financially in the third quarter. But we will be continuing to work through the fourth quarter and beyond on operating changes and cost improvements. The ability to - on a sustaining basis recognizing that we do see price changes generally in the first quarter we are working on how to be well prepared for that as well.

Richard Shannon - Craig-Hallum

Okay. Your comments I think in closing remarks around getting to - having profitable revenue growth the next year, are you giving a statement or a hope or a guidance or anything like that to think that you're going to be profitable on a full year basis next year? Is that your goal and will you in - additional restructuring if that's what it takes, how should we think about your [inaudible]?

Tim Jenks

I think that's an accurate interpretation, Richard, yes.

Richard Shannon - Craig-Hallum

Okay, fair enough. Maybe a couple of blocking and tackling questions. What was your book-to-bill in the second quarter?

Tim Jenks

Actually, the second quarter book-to-bill was quite strong. It was in the range of - fairly close to 1.5.

Richard Shannon - Craig-Hallum


Tim Jenks

1.2, fairly close to 1.2.

Richard Shannon - Craig-Hallum

Okay, fair enough. And in terms of your revenue guidance for the third quarter, can you give us a sense of what kind of a growth you are expecting from 100 gig and also from access?

Tim Jenks

For our revenue guidance, what we've seen in the last, in the period thus far, it's been relatively stable in terms of our speed and agility product, as well as our 40 and 100 gig. So I think we would expect on a percentage basis things to be in line just with the change of revenue. But on a percentage basis we would expect it to be consistent.

Richard Shannon - Craig-Hallum

Okay, fair enough. I will jump out of line here guys. Thank you very much.

Tim Jenks

Thank you, Richard.


(Operator Instructions) And Mr. Wallin, with no additional questions, I'll go ahead and turn the floor back over to you, sir.

Tim Jenks

This is Tim Jenks, and in closing I would like to thank, everyone for taking time to join our call today. We look forward to updating you on our progress on our next quarterly call. Have a good day. Bye.


Thank you. And ladies and gentlemen, again, that does conclude today's conference. Thank you all again for your participation.

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