Some Positives And Negatives From NeoPhotonics
Summary
- NPTN took some big hits in Q4 with the absence of Huawei, but it also scored gains as it embarked on life without the latter.
- The positives from NPTN were offset by negatives, which included revising down the growth outlook due to softening demand and the prospect of more weakness ahead.
- NPTN has recently benefited from acquisitions sweeping through the optical industry, but it's anyone's guess whether that will prove to be justified.
- There are arguments to be made for or against NPTN, clouding the road ahead for NPTN.
The latest quarterly report from NeoPhotonics (NPTN) stood out for one particular reason. It was the first in a long time without any contribution from Huawei, NPTN's biggest customer until very recently. Losing your biggest customer is never easy for any company, so it was not surprising that NPTN took some big hits in Q4. However, there were some positives to be found besides all the negatives. Why will be covered next.
Q4 FY2020 quarterly report
As mentioned before, Q4 did not have any contributions from Huawei due to sanctions imposed by the U.S. government. In the first three quarters of FY2020, Huawei accounted for 52%, 52% and 44% of revenue. So it stood to reason that NPTN would experience a major drop off in Q4, which is ultimately what happened.
Q4 revenue fell by 34% YoY to $68.2M. Operating income, net income and EPS, whether it's GAAP or non-GAAP, were all in the red. For instance, non-GAAP EPS went from $0.10 the year before to a loss of $0.14 per share in Q4. Margins dropped by several hundred basis points. The table below shows the numbers for Q4.
However, the numbers start to look better when comparisons exclude Huawei. For instance, Q4 revenue increased by 18% QOQ if revenue from Huawei is left out. Q4 growth was led by strong demand for 400G+ products, which grew by 153% YoY to account for 46% of total revenue. Overall, high-speed products for 100G and above grew by 18% YoY and accounted for 92% of revenue in Q4. All positive signs that NPTN is making headway in replacing some of what it has lost with Huawei, even if there's ways to go. It also reaffirms the soundness of NPTN's strategy of growing the company by focusing on solutions for the highest speed over distance.
(GAAP) | Q4 FY2020 | Q3 FY2020 | Q4 FY2019 | QoQ | YoY |
Revenue | $68.19M | $102.40M | $103.36M | (33.41%) | (34.03%) |
Gross margin | 22.7% | 23.8% | 30.2% | (110bps) | (750bps) |
Operating income (loss) | ($7.88M) | ($2.55M) | $4.35M | - | - |
Net income (loss) | ($11.50M) | ($4.90M) | $2.07M | - | - |
EPS | ($0.23) | ($0.10) | $0.04 | - | - |
(Non-GAAP) | |||||
Revenue | $68.19M | $102.40M | $103.36M | (33.41%) | (34.03%) |
Gross margin | 24.7% | 33.6% | 30.9% | (890bps) | (620bps) |
Operating income (loss) | ($6.88M) | $9.92M | $7.62M | - | - |
Net income (loss) | ($7.24M) | $6.24M | $5.26M | - | - |
EPS | ($0.14) | $0.11 | $0.10 | - | - |
Source: NeoPhotonics Form 8-K
The release of the Q4 report means that the final numbers for FY2020 are also available. FY2020 revenue increased by 4% YoY to $371.2M and non-GAAP net income jumped from $0.44M to $16.7M. Of course, all of these numbers include the contributions from Huawei in the first three quarters of FY2020.
The FY2020 numbers are therefore less representative of the current state of NPTN than those of Q4. What they do make clear is how much of a difference Huawei made when it was able to contribute. Note how much the non-GAAP numbers improved due to Huawei going on a buying spree in anticipation of being cut off. A previous article delves deeper into this issue.
(GAAP) | FY2020 | FY2019 | YoY |
Revenue | $371.16M | $356.80M | 4.02% |
Gross margin | 27.8% | 24.9% | 290bps |
Operating income (loss) | $3.57M | ($14.54M) | - |
Net income (loss) | ($4.37M) | ($17.08M) | - |
EPS | ($0.09) | ($0.36) | - |
(Non-GAAP) | |||
Revenue | $371.16M | $356.80M | 4.02% |
Gross margin | 31.3% | 27.3% | 400bps |
Operating income (loss) | $23.84M | $4.35M | 448.05% |
Net income (loss) | $16.74M | $0.44M | 3704.55% |
EPS | $0.31 | $0.01 | 3000.00% |
Guidance calls for Q1 revenue of $57-62M, a decrease of 12.8% QoQ and 38.9% YoY at the midpoint. The forecast expects a non-GAAP loss per share of $0.10-0.20, flipping from the $0.17 EPS of a year ago.
(GAAP) | Q1 FY2021 (guidance) | Q1 FY2020 | YoY (midpoint) |
Revenue | $57-62M | $97.4M | (38.91%) |
Gross margin | 16-20% | 30.5% | (1250bps) |
EPS | ($0.18-0.28) | $0.12 | - |
(Non-GAAP) | |||
Revenue | $57-62M | $97.4M | (38.91%) |
Gross margin | 18-22% | 31.2% | (1120bps) |
EPS | ($0.10-0.20) | $0.17 | - |
Q4 FY2020 earnings call
Demand for 400G+ high-speed products is expected to remain robust in Q1. From the Q4 earnings call:
"in the first quarter, we expect the growth of our 400-gig and faster revenues to continue to more than double versus the previous year's first quarter."
A transcript of the Q4 FY2020 earnings call can be found here.
NPTN also expects to resume shipments of some products to Huawei in the coming quarters. The outlook calls for a return to operating profit in Q3.
"as a result of our efforts to develop products which comply with the most recent BIS restrictions for Huawei, we expect a modest level of shipments to Huawei in forward quarters. With these changes, we still expect to return to operating profit in Q3."
Up to this point, NPTN did not really reveal anything out of the blue. Yes, there were big declines in revenue and earnings, but that was expected with Huawei no longer there. What was surprising was NPTN's revelation of softening demand. NPTN is therefore lowering its outlook for 2021. Revenue is forecast to grow by 25-35% in FY2021. Note that this is significantly lower than the previous forecast of 40-50% growth.
"we have seen several changes in recent months. Notably, we have begun to see softness at the start of the year from network equipment companies serving the North America market. We believe this is due, in part, to the timing of bandwidth deployments related to the pandemic.
Current customer indications are that some demand has moved to later in 2021 due to travel restrictions limiting deployment of new systems. This leads us to estimate full-year revenue growth, excluding Huawei, of 25% to 35%."
In addition, NPTN is leaving open the possibility of even more downside as a shortage of certain semiconductor chips could affects its customers and NPTN by extension.
"we are now kind of in the current quarter, we're hearing more concern about chips, as I indicated previously, that hasn't impacted us at this point. But to the extent that it impacts customer's ability to do something with our products, it may have an impact."
NPTN had previously given a very optimistic assessment of its ability to mitigate the loss of Huawei in the second to last earnings call. But it now seems to be backtracking by adjusting its forecast downwards. The market did not respond well to these latest developments as quite a few people seems to have been taken by surprise. However, not everyone was caught off-guard. There were those who had cautioned that NPTN may be underestimating the pitfalls ahead. A previous article covers this issue in greater detail.
Why NPTN could go up despite encountering headwinds
There is one other issue worth mentioning. According to the latest Form 10-K, excluding Huawei, NPTN's biggest customers are Ciena Corp. (CIEN) at 29%, Acacia Communications (ACIA) at 17% and Nokia (NOK) at 11%.
Note that Acacia is also one of NPTN's closest competitors in optical communications, and by extension Cisco (CSCO) since the former has been acquired by the latter. Another close competitor is Inphi Corp. (IPHI), which Marvell (MRVL) has agreed to acquire. Other notable competitors in the market for lasers and coherent products are II-VI (IIVI) and Lumentum Holdings (NASDAQ:LITE). These two together with MKS Instruments (MKSI) are currently embroiled in what looks like a bidding war for Coherent Inc. (COHR).
All these moves seems to have had a positive impact on NPTN's stock. It's probably no coincidence that the stock appreciated by over 100% from late October to the middle of February. In doing so, the stock broke out of the range it had been stuck in since late 2017 as shown above. Marvell and Inphi announced their deal on October 29th. Cisco raised its bid for Acacia in January, which is also when the bidding war for Coherent started.
What's eye popping about all these transactions are the valuations. For instance, Marvell agreed to acquire Inphi for $10B, valuing the latter at 16 times sales. In comparison, NPTN has a market cap of $468M with annual revenue of $371M, Huawei included. NPTN is thus valued at 1.26 times sales.
NPTN looks like a bargain compared to what direct competitors have gone for. It's possible someone may try to acquire NPTN for some unspecified premium, which could increase if others join the fray. Something most welcome for anyone long NPTN.
Source: Wikimedia Commons
Investor takeaways
NPTN was expected to take a big hit in Q4 and that's precisely what happened. Q4 revenue fell by 34% YoY and guidance calls for revenue to decline by 39% in Q1. Profits that were there with Huawei have been replaced by losses. On the other hand, NPTN did manage to lessen the impact of losing Huawei. Revenue grew if Huawei is taken out. NPTN may also resume some sales to Huawei. Pockets of strength exist. For instance, revenue from 400G+ products doubled and that is forecast to remain the case in Q1.
However, progress was outweighed by revelations of demand weakening and the prospect of more softness due to a semiconductor shortage. The stock dropped by about 22% after the Q4 report. But NPTN remains up by 41% since late October, which coincides with the recent flurry of acquisitions in the optical industry. NPTN remains a player in the optical space, with or without Huawei. One that some would argue is undervalued in comparison to what competitors have gone for.
There's reason to believe long-term trends favor a company like NPTN. The COVID-19 pandemic has increased the need for bandwidth due to the need to work from home or stay at home. Changes that are likely to remain in some form even if COVID-19 passes. That should benefit NPTN as a supplier of lasers, receivers and modulators needed for high speed applications. It's quite telling that NPTN's revenue from 400G+ products grew by 97% in FY2020.
An argument can be made for or against NPTN. NPTN looks like a bargain when a direct competitor was acquired for 16 times sales. On the other hand, there's no guarantee that NPTN will be acquired. Going long NPTN based on the assumption that it will be bought out is risky. A stock may rally in anticipation of a possible offer, but it could just as well sell off if no offer is forthcoming.
While NPTN has made big strides in terms of making up for Huawei, there is no telling if or how long this will last. The sales windfall from non-Huawei customers in 2020 may not solely be due to end-user demand. Companies could have brought forward orders to mitigate against possible supply chain disruptions with lockdowns in many places. Real demand may be much less than what NPTN has been counting on.
Recent signs of an industry-wide slowdown as reported by companies like Ciena, NPTN's biggest customer with the departure of Huawei, give credence to this possibility. NPTN has already lowered its outlook for 2021 growth from 40-50% to 25-35%. It's also worth reminding that NPTN does not have a great track record when it comes to profits as mentioned in a previous article. It took massive sales growth from Huawei for NPTN to get rid of quarterly losses and that's no longer there.
I am neutral on NPTN. While there are some solid arguments to be made in favor of long NPTN, there are just as many arguments to be made against it. Long NPTN could pay off, but it could also backfire given current circumstances. When in doubt, the best move may be to not move at all.
This article was written by
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