- Revenues increased 3% Y/Y and 13.6% Q/Q, however, margins continued to decline and cash reserves continued to decrease.
- The risks in the thesis materialized and the stock continued to fall and a successful, lasting turnaround remains an unlikely outcome.
- Because of a deteriorating cash position, further restructuring costs on the way and expensive or unavailable downside protection, I cannot recommend a NPTN purchase now.
NeoPhotonics, Inc. (NYSE:NPTN) reported improving Q2 2014 results (SEC filing, press release, earnings call). Revenue was $77.5M, at the high end of the company's guidance range and represents a 13.6% increase Q/Q and 3.3% Y/Y. NPTN witnessed increased strength in both 100G products and their backlog, plus in access product shipments. Gross margin was 18.8%, down from 20.2%. As expected, sales for client side 100G modules decreased, which negatively impacted volumes and utilization. Non-GAAP loss was 24 cents per diluted share. GAAP loss was $0.21 per share, an improvement from $0.40 Q/Q and $0.27 a year ago. Speed and agility product group accounted for 72% of total sales and was up Q/Q and Y/Y. Of this, high speed products (100G and some 40G) were 39% of total revenue, up 3% Y/Y. Access product group accounted for 21% of total revenue, up Q/Q and Y/Y. 100G deployments were a significant contributor in Q2, including in China, and backlog continued to increase. 100G long-haul deployments remain strong as North American carriers increase CAPEX. Metro deployments remain an interesting opportunity for 2015 and 2016. LTE backhaul is growing while FTTX as a group remains a mature market with declining sales. To achieve profitability, NPTN plans to focus even more on three areas: cost cutting, revenue growth and shift of product mix. NPTN initiated a restructuring plan, with OPEX planned to be slashed by $2.5M quarterly beginning with Q3. In the second phase, NPTN plans manufacturing capacity reductions in the high-cost regions and R&D spending cuts. Overall, 75% of the cuts should affect OPEX only in order to remain leveraged for future sales increase. The company will also focus on higher-margin products. However, this initiative has to be balanced with keeping capacity utilization high. Overall, NPTN is targeting break-even profitability at the level of $85M quarterly revenues. Non-GAAP diluted net loss per share was $0.24, a decrease from a diluted net loss per share of $0.30 in the first quarter of 2014 and up from a diluted net loss per share of $0.12 in the second quarter of 2013.
In an important development, NPTN negotiated an amendment to its term loan agreement with the U.S. lender that waived the testing of certain financial covenants for compliance, provided the Company maintains restricted cash equal to outstanding amounts under the agreement. As of June 30, restricted cash and cash/cash equivalents were $54.4M, down from $64.3M in the previous quarter and the cash position keeps deteriorating. Combined notes payable and debt was $48.0M, up from $40.8M at March 31, 2014. For the third quarter, NPTN guides for revenues of $78M to $82M, non-GAAP gross margin in the range of 22% to 26%, diluted net loss per share in the range of $0.14 to $0.24 and a net loss of $0.04 to $0.14 on a non-GAAP basis.
Since I first covered NPTN last year, a lot has changed to the worse. As I wrote in the conclusion of my updated thesis a few weeks ago: "the company's turnaround prospects are greatly diminished from last year on weak margins and increasing competition" and "should the losses accelerate, the company could start facing a risk of problems to meet its basic financial obligations. In such case, investors' losses could be substantial despite the seemingly low price. The stock is a speculative investment, even riskier than last year". Unfortunately, this thesis materialized and the stock kept falling substantially in the last few weeks. Although there are signs of rising sales, it is still at the expense of margins and the financial position keeps deteriorating despite the near-term risk of bankruptcy being averted by the renegotiated covenants. Due to the fact that it is very hard to protect the downside (the lowest strike options are at $2.5), it is very expensive to protect the downside, making the NPTN speculative investment even more risky. Due to this fact, I don't recommend a purchase of NPTN until financial conditions improve or until better downside protection is available.
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