NeoPhotonics' CEO Discusses Q1 2012 Results - Earnings Call Transcript (Prepared Comments)

NeoPhotonics Corporation (NYSE:NPTN)

Q1 2012 Earnings Conference Call

May 3, 2012 16:30 ET


Erica Mannion – Investor Relations

Tim Jenks – Chairman and Chief Executive Officer

JD Fay – Chief Financial Officer


Welcome to the NeoPhotonics 2012 First Quarter Conference Call. This call is being webcast live on the event calendar page of the Investor Relations section of NeoPhotonics' website at This call is property of NeoPhotonics and any recording, reproduction or transmission of this call without the expressed written consent of NeoPhotonics is strictly prohibited. As a reminder, today's call is being recorded. You may listen to a webcast replay of this call by going to the event calendar page of the Investor Relations section of NeoPhotonics' website. I would now like to turn the call over to Erica Mannion, Investor Relations for NeoPhotonics.

Erica Mannion

Good afternoon. Thank you for joining us to discuss NeoPhotonics' financial and operating results for the first quarter ended March 31, 2012. With me today are Tim Jenks, Chairman and CEO and JD Fay, CFO.

The call today contains forward-looking statements that involve risks and uncertainties. These include statements related to NeoPhotonics' business outlook for the quarter ending March 31, 2012, future periods and industry trends, as well as forward-looking statements that we may make in response to questions. Forward-looking statements are generally indicated by words such as "would", "believe", "should", "expect", "outlook", "estimate," "anticipate", "forecast" and similar expressions that look toward future events or performance.

Actual results may differ materially from forward-looking statements. Factors that could cause results to differ materially from these statements include those described in today's press release as well as those detailed in the section entitled "Risk Factors" of the company's Annual Report on Form 10-K most recently filed with the SEC. NeoPhotonics cautions you not to place undue reliance on forward-looking statements, and that these statements speak only as of the date they are made.

In addition, non-GAAP financial measures will be discussed today. Please visit the Investor Relations section of the NeoPhotonics Web site for a copy of the company's press release, which contains an explanation of these non-GAAP financial measures as well as a reconciliation to the comparable GAAP measures.

Before I turn the call over to Tim, I'd like to mention that NeoPhotonics will present at the B. Riley & Co. 13th Annual Investor Conference in Santa Monica on May 23rd, and at the Cowen 40th Annual technology Media & Telecom Conference in New York City late May.

Now, I will turn the call over to Tim Jenks, CEO of NeoPhotonics.


Tim Jenks

Thank you for joining us today.

I will provide a financial and business update, discuss progress in our business, and then talk about what we are seeing in the industry as a whole. In addition, I'll comment on our recently announced private placement and cooperation in the Russian market with the Russian Corporation of Nanotechnologies.

We delivered record first quarter revenue at $54.2 million, significantly above our projected range of $46-$51 million provided in our fourth quarter 2011 conference call. We experienced increased demand across a large part of our business, notably for Speed and Agility products, offset by annual price declines - the result of negotiations completed in the fourth quarter, plus normal seasonality.

NeoPhotonics, as a vertically integrated supplier of optical modules and subsystems, is not at all dependent on partners in Thailand for any part of our supply chain. Thus, the flooding in Thailand did not have any direct adverse impact on our ability to produce products. Demand in the first quarter was particularly strong for high speed products, such as, tunable laser products and other products for Coherent networks, each of which are in our Speed and Agility product group. In addition, demand from several of our largest Western customers was relatively strong in the first quarter and above fourth quarter demand as carriers accelerated their investments in high speed coherent networks. In contrast, Asia and in particularly China reflected both seasonality in the winter months, particularly for our Access business, and the fact that the Chinese New Year occurred in the middle of the quarter, making the first quarter there essentially a twelve week quarter.

We delivered Non-GAAP gross margin above our projected range. Non-GAAP gross margin was 23.9% in the first quarter, compared to our projected range of 20-22% following the acquisition of Santur Corporation that closed during the fourth quarter of 2011, and again inclusive of the effects of annual price negotiations completed during the fourth quarter of 2011. Our work to integrate Santur, to benefit from scale and procurement synergies and to "right size" overheads for operations, resulted in Santur products achieving Non-GAAP gross margins in a range comparable to our broader product portfolio. GAAP gross margin for the first quarter of 2012 was 21.0%.

Reflecting our strong revenue and expanding margins, and inclusive of our "delta" research and development investment we started in the third quarter of 2011, we reported Non-GAAP diluted loss per share from continuing operations of $0.22 compared to our projected range of a loss of $0.25 to $0.35 [cents].

Broadly speaking, NeoPhotonics' core business is in providing photonic integrated circuit, or PIC, based modules and subsystems for bandwidth-intensive high-speed communications networks. Our products enable cost-effective, high-speed data transmission and efficient allocation of bandwidth over these networks. We sell our products to the leading network equipment vendors globally.

Our direct customers, the network equipment vendors, supply their systems to global telecom service providers. During the first quarter of 2012, these network equipment vendors and their service provider customers continued to spend on the growth of traffic, supporting the rapid expansion of bandwidth demand driven by video, mobile video, the proliferation of network-attached devices, social networking and other elements of mobility and virtualization, that are enabling consumers to access bandwidth-intensive content anytime and anywhere over fixed and wireless, including 3G and LTE, networks.

Our largest customers are the leaders of network equipment - Huawei Technologies, Alcatel-Lucent and Ciena Corporation together accounted for more than 60% of our revenue in the first quarter. Huawei represented approximately 36% of our first quarter 2012 revenue. Alcatel-Lucent and Ciena each contributed more than 10% of our revenue. In total our top 10 customers for the quarter represented approximately 91% of total revenue, up from 88% in the fourth quarter. These increases in major customer revenue contributors were achieved while Huawei decreased to 36% of revenue, down from 47% of revenue in the fourth quarter.

Demand for our products is seasonal, with our first quarter usually the lowest of the calendar year. I mentioned strong demand for Speed and Agility products. In particular these products include devices used in Coherent networks for 40G and 100G transmission, including narrow linewidth tunable lasers and integrated coherent receivers. These were strong in the first quarter and we expect that these products will be important contributors to NeoPhotonics results in the quarters ahead. Demand for our Access products, meaning GPON and GEPON fiber to the home, or FTTH network products, was sequentially lower largely due to this seasonality, albeit stronger than we had originally forecast.

Our product groups support critical system capabilities provided by our customers. Within our product groups in the first quarter of 2012, revenue attributable to our "Speed and Agility" products was approximately 58% of our total revenue, up from 52% in the fourth quarter. Revenue attributable to "Access" products was approximately 29% of total revenue, slightly down from 31% and reflecting seasonality; and for our "Other Telecom" products (which are legacy products such as DWDM, Sonet and SDH products) revenue was approximately 13% of total revenue, down from 17%. The first quarter decline for Other Telecom products was due primarily to decreasing demand for transceivers used in legacy systems at data rates below 10 Gbps, particularly in China, where the region was softer in the first quarter. Revenue attributable to our 40G and 100G high-speed products was 16% in the first quarter of 2012, up from 11% in the fourth quarter of 2011.

Geographically, demand from customers in China was broadly softer in comparison to other parts of the world in the first quarter of 2012. Revenue from China represented 51% of total revenue in the first quarter, down from 63% in the fourth quarter. The Americas, Japan, EMEA and Rest of World were, as regions, each up in the first quarter, both absolutely and in percentage terms, as compared to the fourth quarter.

Demand levels for our products were "normalized" throughout the quarter. I mention this as we saw some significant variations in demand patterns throughout 2011, in part due to natural disasters -- the tsunami in Japan and the flooding in Thailand -- that affected our industry last year. In our first quarter of 2012 we experienced the "normal" pattern; that is general strength in the back end of a month, and in the third month of the quarter.

Demand on our hub-based vendor-managed inventory, or VMI, is key to understanding our revenue build during a quarter. When a customer takes a unit of product from the VMI hub, we record revenue for that product. This system facilitates our customers' just-in-time inventory and lead-time management.

By supporting this model, we believe we are favorably viewed by these customers, and that we earn a larger share of the customer demand for these products.

Our VMI revenue typically builds in a relatively steady fashion month-by-month during a quarter; and it is typically weaker during the first weeks of each month, and can be stronger in the back half of each month. Our first quarter demand pattern fit our view of normalized VMI demand, and our end of quarter VMI inventory was approximately $3.7 million, down from approximately $4.4 million at the end of the fourth quarter. The end of quarter VMI balance fluctuates quarter-to-quarter as customer forecasts vary.

I would now like to talk further about our acquisition of Santur Corporation, which closed in October. Santur was a private company located in Fremont, California, and focused on commercializing PIC-based laser array and high density PIC-based packaging technologies for communications networks. We believe that core innovations in our industry in recent years include photonic integration and coherent transmission. And this acquisition enhances our leading position in PIC-based modules and subsystems based on photonic integration and in particular for 100G coherent and cloud computing markets.

I should note that our acquisition of Santur contributes almost exclusively to our Speed and Agility products. Revenue from these former Santur products was approximately $8.7 million for the quarter which is largely in line with historical full-quarter run rates. We made substantial progress through the fourth and first quarters in the integration of Santur into our global company; the integration is now substantially completed. We have combined the organization, consolidated certain operations, combined our ERP systems, eliminated redundancies, and fully trained and engaged our sales channels to support the expanded product offering. As our integration activities are largely implemented and we are operating as an integrated company, we will not be separately mentioning Santur product revenues going forward in our quarterly calls.

We have noted that our Speed and Agility products generally have higher than corporate average gross margins and Access products generally have lower gross margins. The spread in margins between these two groups narrowed in the fourth quarter of 2011 with the Santur integration, but with integration largely completed and Santur's business growing sequentially, we are seeing the margin spread between these two product groupings return to more historical levels.

With this acquisition we are now able to leverage indium phosphide as an integration platform for 40G, 100G and beyond PIC-based products, thereby expanding our potential total available market and expanding our direct range of applications as well as improving our cost position for these important elements in our modules and subsystems. Examples include PIC-based tunable lasers, arrays of lasers, modulators for 10G and 100G transmitters, and components for coherent transmitters and receivers. The combination complements and extends our PIC technologies and expands our spectrum of key technologies, product opportunities and materials expertise.

A key example of this is the importance of narrow line width tunable lasers, used as both the signal and reference in Coherent transmission systems, and therefore on both the transmit and receive sides. During the fourth quarter of 2011 there were critical shortages of these components in the industry and in response to urgent customer requests, we more than doubled our capacity for producing these key devices and have since continued ramping our volumes. In addition, we have achieved many new customer qualifications since we closed the acquisition of Santur last October.

Finally, on our November conference call we indicated that we believed that we could return to profitability in five to seven quarters, which is now three to five quarters, and we continue to believe we are well on track to achieve this goal. If the industry rebounds sooner or faster, then we could achieve this goal sooner.

In our prior three conference calls, we noted that we would make a "delta" investment in research and development of $1 million per quarter for 4 to 6 quarters to leverage our PIC technology platform in next-generation network opportunities in switching and high speed devices. We increased staffing at our development center in Wuhan, China and we opened a design and sourcing center in Tokyo, Japan. We further developed and introduced a Multicast Switch product to augment current Reconfigurable Optical Add/Drop Multiplexer, or ROADM, technology to enable next generation "colorless, directionless and contentionless", or CDC, networks.

We are now starting to sample our multicast switch to initial customers. It is designed to expand the flexibility of the node to enable any port to drop any wavelength (making it colorless) from any direction (making it directionless) and to allow two identical wavelengths from different directions to be dropped through the same switch (making it contentionless). This is important because it achieves enhanced flexibility and efficiency of the network by directing a wavelength to a port where a transponder has already been deployed without any further manual intervention. In addition, our Multicast Switch product is designed to be most efficient in coherent optical networks, where the final optical filtering can be performed by, for example, our integrated coherent receiver.

With the integration of the Santur R&D activities into the broader NeoPhotonics operations and consolidations resulting from this action being largely completed, we do not plan to comment separately on the "delta" investment initiative as it is now similarly integrated into the broader R&D activities of the company.

Earlier this week, we announced a strategic investment by Rusnano, the Russian Corporation for Nanotechnologies, a $10 billion sovereign investment corporation located in Moscow. RUSNANO acquired 4.97 million newly-issued common shares of NeoPhotonics stock in a private placement transaction at a price of $8.00 per share for proceeds of $39.8 million before costs. The purchase price represents a 78% premium over the Company's $4.49 per share closing trading price on April 27, 2012.

We welcomed this investment as it aligns with our strategy to accelerate deployment of our PIC technologies, to grow globally, with particular emphasis on fast growing and emerging markets, including Russia and the Commonwealth of Independent States, or "CIS" countries. Industry analysts have estimated the telecom equipment market in Russia was approximately $5 billion in 2011, of which 10% is estimated to be the share of optical telecommunication equipment - and we believe the market for optical equipment is growing approximately 8 to 10% annually. Not only are these markets deploying high speed, agile and fiber-to-the-home networks but we are also seeing some of our customers target service providers and invest locally in Russia and more broadly in Eastern Europe. We started to see and investigate this growth opportunity several years ago; we added sales capability in the region and have since been engaged with and supplying several customers in Russia. Over time, we will be investing in our Russia presence, which would align with our future plans for expanded capacity to serve our customers. This project is expected to take several years, thus we do not expect it to materially impact our results of operations in 2012.

Now I would like to comment on what we see in the industry as a whole. China remains a very active market with continuing volume demand, albeit competitive commercially. We are seeing projections for increasing capex in China as well as with certain key carriers in North America, in particular. Our largest customers are forecasting growth for 2012 after experiencing muted demand levels in some markets during 2011. Capex for investments in 40G and 100G coherent transmission systems, FTTH access network growth and investments in data centers appear healthy.

In summary, we are pleased with our progress in developing our customer diversification, and also with the favorable response of our customers to our new, coherent and other high speed products, as well as their response to our having added the strength and capabilities of Santur products to our technology and product portfolios. We believe that our multi-quarter trends of broadly growing revenue from our top 10 customers and 40G and 100G products are positive leading indicators, particularly as the momentum for deploying high-speed line-side and client-side networks leveraging coherent and PIC technologies gains momentum. We continue to believe we are in a strong position today given our design win and market share awards earned with our Tier 1 and other customers, with the strength of the products and technology added through the Santur acquisition, and with the new qualification engagements underway.

At this point I'll turn the call over to JD to review our first quarter 2012 financial performance and second quarter 2012 financial projections.


JD Fay

Thank you, Tim, and good afternoon.

For the first quarter of 2012, revenue was $54.2 million, which was approximately 12% higher than the midpoint of our projection and the highest revenue for a first quarter in our history. As a reminder the first quarter is typically our seasonally lowest quarter given the Chinese New Year holidays, the impact of new pricing negotiated toward the end of the fourth quarter, and lower levels of outside deployments during the winter in the northern hemisphere.

Compared to the year ago period, our first quarter 2012 revenue increased approximately 8% from $50.0 million in the first quarter of 2011.

GAAP gross margin for the first quarter of 2012 was 21.0%. Non-GAAP gross margin for the first quarter of 2012 was 23.9%, above both the top end of our projection and the previous quarter's Non-GAAP gross margin of 23.5%. Non-GAAP gross margin for the first quarter of 2012 excludes amortization of purchased intangibles and other assets relating to the acquisition of Santur of $1.4 million, and stock-based compensation expense of $0.2 million.

Loss from continuing operations for the first quarter of 2012 was $11.8 million, as compared to losses from continuing operations of $22.8 million in the fourth quarter and $2.1 million in the first quarter of 2011. Diluted loss per share from continuing operations for the first quarter of 2012 was $0.47.

Non-GAAP loss from continuing operations for the first quarter of 2012 was $5.4 million, an improvement compared to the loss of $6.4 million in the fourth quarter of 2011 and compares to break-even in first quarter of 2011. Non-GAAP diluted loss per share from continuing operations for the first quarter of 2012 was $0.22, which was better than the midpoint of our projection, and $0.04 better than the $0.26 loss per share in the fourth quarter of 2011.

Non-GAAP loss from continuing operations and Non-GAAP diluted loss per share from continuing operations for the first quarter of 2012 exclude stock-based compensation of $1.1 million, amortization of purchased intangibles and other assets of $2.3 million, acquisition- and integration-related costs of $1.1 million, the fair value adjustment to contingent consideration relating to the Santur acquisition of $1.9 million, and the income tax effects of these adjustments.

Adjusted EBITDA in the first quarter of 2012 was a loss of $2.4 million, an improvement compared a loss of $3.0 million in the fourth quarter of 2011 primarily due to improved sequential operating performance, and compares to Adjusted EBITDA of $3.1 million in the first quarter of 2011.

To offer additional qualitative color on our first quarter, our strong revenue compared to our projection primarily resulted from increased demand for our products that are designed to address traffic bottlenecks in high speed and coherent communications networks, as the demand for bandwidth continues to grow and carriers expand their network capabilities in response. Further, while our revenue from Access products for fiber-to-the-home were lower sequentially, it declined less than expected, which also helped to offset most of the impact of seasonality that we expected for the first quarter of 2012.

Total operating expense in the first quarter of 2012 was $22.9 million, a significant reduction compared to $35.1 million in the fourth quarter, and an increase compared to $13.8 million in the first quarter of 2011.

Within operating expenses, all of the key line items declined quarter to quarter as we contained costs and started to see the benefits of the integration of Santur initiated in the fourth quarter. Specifically, research and development was $10.5 million, a sequential reduction of approximately 5%, primarily on lower personnel-related expenses; sales and marketing was $3.0 million, a sequential reduction of approximately 10%, primarily relating to good cost containment; and general and administrative was $7.1 million, a sequential reduction of approximately 17%, primarily on lower combined costs post-integration.

Amortization of purchased intangibles was roughly flat sequentially at $0.4 million. Included in the foregoing operating expenses is $1.0 million of stock-based compensation expense and $0.9 million of acquisition-related expenses.

On the balance sheet, we ended the first quarter of 2012 with cash, cash equivalents and short-term investments of $83.8 million, down slightly from $86.4 million at the end of the fourth quarter of 2011. This decrease in cash was driven primarily by our net loss, the building of inventory to meet anticipated demand of approximately $4.7 million, and capital expenditures of approximately $2.0 million, offset by a reduction in accounts receivable of approximately $9.2 million, as we stepped up collection efforts.

Total bank debt at March 31, 2012 was $25.9 million, down from $27.2 million at December 31, 2011, reflecting scheduled debt repayments.

As Tim discussed earlier, we received an equity investment of $39.8 million, before issuance costs, after the end of the first quarter. As a result, our total shares outstanding are now approximately 29.9 million shares. When the proceeds of the equity investment are combined with our cash and short term investments balance at March 31, 2012, our cash and short term investments per share is currently approximately $4.14 per share.

Inventory at March 31, 2012, was $39.0 million, up approximately 10% from the prior quarter's balance of $35.3 million, reflecting improving demand and higher production in anticipation of seasonally higher second and third quarters.

Accounts receivable at March 31, 2012 were $59.7 million, a decrease of approximately 13% from the prior quarter's balance of $68.9 million, reflecting improved collections in the quarter. Days sales outstanding rose modestly to 106 days from 100 days.

Now, I will provide our outlook for the second quarter of 2012.

As Tim conveyed, we continue to believe demand is building after a volatile 2011. We believe that the optical module and subsystem market will perform better in 2012 on a relative basis. We also expect continued growth in demand for high speed and coherent technology products, and Access products, with the potential for Asia and North America to be stronger than other regions on a relative basis. Accordingly, we anticipate revenue for the second quarter ending June 30, 2012 to be in the range of $55 million to $61 million.

Non-GAAP gross margin is anticipated to be in the range of 23% to 25%, which is primarily dependent on volume and product mix and considers our expectations for semi-annual pricing negotiations for some of our products planned for later in the quarter.

Non-GAAP loss per share is anticipated to be in the range of $0.14 - $0.22, which suggests that we continue to expect improvements in our operating leverage, the Santur business, and progress toward profitability as Tim discussed earlier. We continue to believe that we will achieve profitability in the previously discussed timeline, which is in the next 3 to 5 quarters.

The Non-GAAP outlook excludes the expected amortization of purchased intangibles and other assets of approximately of $1.6 million and the anticipated impact of stock-based compensation of approximately $2.2 million. Of these amounts, approximately $1.2 million is estimated to relate to cost of goods sold.

The share count assumption used to estimate the second quarter is approximately 29.9 million. This estimate can change based on stock and option activity in the period.

This concludes our formal comments for the first quarter 2012 conference call. Now I will ask the operator to open up the line for questions.

Question-and-Answer Session


Tim Jenks (Closing Comments)

Thank you for joining us today.

Before we conclude, I would like to thank our shareholders for their time today and their continued interest in our company, and our customers and our employees for their dedication. We look forward to our next update with you regarding our progress.

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