For second-quarter 2016, NeoPhotonics Corp of San Jose, CA, USA (a vertically integrated designer and manufacturer of hybrid photonic integrated optoelectronic modules and subsystems for high-speed communications networks) has reported record revenue of $99.1m, level with last quarter but up 16.1% on $85.4m a year ago. This was driven by robust demand for 100G-and-above products but offset by revenue for passive optical network (PON) products for fiber-to-the-home (FTTH) in China declining faster than expected (by $4m, which had not been factored into the firm's outlook). "These two points mark some key transitions in our business and in the industry," says chairman, president & CEO Tim Jenks.
"We commented on last quarter's call that Q2 revenue would be generally in line with Q1 revenue as we worked through our capacity expansion plans and we absorbed deferred ASP [average selling price] declines," notes chief financial officer Ray Wallin. Without the impact of the unforecasted PON decline, revenue would have been above the high end of the $97-102m guidance range.
Of total revenue, Network Products and Solutions (lower-speed transceivers, <100Gb/s) fell slightly to 34%, while High Speed Products (100G-and-above) products rose further to a record 66% of revenue.
Of NeoPhotonics' top 10 customers, nine were sequentially up, reflecting continued strength for 100G products. There were two 10%-or-greater customers: US-based Ciena comprised 16% of total revenue (level with last quarter), and China's Huawei Technologies 45% (more in line with full-year 2015's 44% rather than last quarter's unusually high 54%). Of total revenue (compared with last quarter), 60% came from China (down from 62%), 20% again came from the Americas, 5% again came from Japan, and 15% came from the rest of the world (up from 13%).
"Globally, we continue to see the overall environment for 100G-and-beyond products very robust across both telecom and data-center applications," notes Jenks. "In spite of PON market softness, we delivered solid financial results."
On a non-GAAP basis, gross margin is down from 32.8% last quarter to 29.3% (at the lower end of the 29-31% guidance range). This reflected a reduction of about one percentage point from taking additional reserves on certain end-of-life laser products, as well as PON under-recoveries and additional ramp-up costs.
Operating expenses (OpEx) were $21.8m, down from $23m last quarter but up from $21.1m a year ago. However, as a percentage of revenue, operating expenses have been cut further, from 24.8% a year ago and 23.2% last quarter to 22%. This is slightly below the guidance range due to lower-than-anticipated expenses for development materials and higher-than-expected recognition of non-recurring engineering (NRE) payments for certain developments, which benefited R&D expenses.
Net income was $6.87m ($0.15 per diluted share, at the top end of the $0.08-0.15 guidance range, reflecting focused expense control). This is up from $5.34m a year ago but down slightly from $6.95m last quarter. This represents the firm's eighth consecutive non-GAAP profitable quarter. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was $12m (12.1% of revenue), up from $11.4m a year ago but down slightly from $12.3m last quarter.
"We delivered strong free cash flow of $8m through efforts on managing operating expenses and working capital efficiencies, including strong collections and inventory management," notes Wallin. NeoPhotonics added about $13m in capital equipment. During the quarter, cash and cash equivalents, short-term investments and restricted cash rose by $9.7m from $103.8m to $113.5m.
"We are accelerating our high-speed product growth and we have announced the end of life of our declining and lower-margin PON products [to be phased out within a year]," states Jenks. For the last four quarters, PON revenue was $43.9m and gross margins were 15-20%. (Excluding PON, company revenue would have been $87.2m in Q1 and $91.3m in Q2/2016.) For second-half 2016, NeoPhotonics expects PON revenue to be less than $10m (down from $19.8m in first-half 2016), with gross margin of 10-15%, following further declines of over $4m in both Q3 and then Q4.
Despite this, for third-quarter 2016 NeoPhotonics expects revenue to rise by 1-7% sequentially to $100-106m, with gross margin of 29-31%. OpEx should rise to a more normal $23-25m (due to slightly higher R&D spending). The firm expects earnings per share of $0.09-0.17. Excluding PON, revenue should rise by 6-11% sequentially from Q2's $91.3m to $96-102m.
"We are experiencing an unprecedented level of demand for our 100G products, which we're seeing as a major and sustaining mid-term trend in China as well as in the West," notes Jenks. NeoPhotonics has hence raised and narrowed the range of its full-year 2016 revenue forecast from 20-25% to 22-25% growth (including the impact of the lower PON forecast).
NeoPhotonics has hence also increased its capital expenditure to support the growth of its production capabilities. "We have been increasing our 100G production capacities throughout the year, to a large extent to support the transition to pluggable modules, notably to DCO coherent pluggable modules in China," says Jenks. NeoPhotonics now expects $30-35m of capital spending in second-half 2016, aggregating to 12-13% of revenue for full-year 2016.
"While we've been adding capacity, we have been volume constrained by supply bottlenecks as we ramp our supply chain to support increasing volumes," notes Jenks. "This situation is now being resolved, so with solid bookings and forecasts through the end of the year and into 2017, we believe demand will continue to strengthen and this industry expansion will be directly reflected in our revenue growth as 100G deployments globally for both telecom and data-center applications are expanding, and are in sync," he adds. "In Q3 our investments in production, assembly & test operations are resulting in continued volume growth."
"With the capacity we have added and as we accelerate 100G shipments, we anticipate gross margins will expand by 2-3 percentage points in Q4," reckons Wallin. The gross margin forecast includes ongoing ramping costs as well as under-recovery due to PON revenue declines.
"In China, our 100G product demand in the second quarter was up substantially year over year, and we expect it to increase markedly over the next few quarters in support of the China deployment strength," says Jenks. "This will happen as Chinese carriers continue to build out backbone network capacity, continuing their nationwide network deployments, but also in anticipation of moving from 4G/LTE eventually to 5G wireless rollouts expected in a few years. This is a major trend and a driver for the medium term," he adds. "Nearer term, we anticipate awards for approximately another 30,000 100G ports for the second half of the year and into 2017... The total for next year is looking more like 60,000 ports, and essentially we will see a lot of this get filled by the DCO pluggable."
Pluggable DCO modules have rapidly emerged in China as the preferred approach for 100G coherent deployments. "We expect DCO modules to dominate in the China market and to be considerably higher in volume there than ACO modules for the foreseeable future," notes Jenks. "NeoPhotonics is seeing a significant benefit from this ascending industry trend as our compact ultra-narrow-linewidth tunable laser and our micro coherent receiver are specially designed for use in CFP and CFP2 modules, and we are designed in with several of the leading volume module vendors," he adds. "By the end of this year, we will have essentially tripled our capacity for these module component products versus the second half of last year, and we expect that about half of our added capacity will be devoted to supplying into CFP-DCO applications, and eventually to CFP2-DCO modules."
Also, as 100G coherent transmission is the technology of choice for long-haul, metro and DCI connections, the use of contentionless switching architectures in coherent networks is expanding, and is critical for software-defined networks for content providers' data-centers, which is driving increases in our switching products. "Our multi-cast switch product expands NeoPhotonics' product line in the 100G metro ROADM [reconfigurable optical add-drop multiplexer] market, and shipments into the North American market continue to accelerate," notes Jenks. "Moreover, contentionless architectures are being trialed in several cities in China that could drive rapid volume increases in 2017 and beyond."