For second-quarter 2014, NeoPhotonics Corp of San Jose, CA, a vertically integrated designer and manufacturer of both indium phosphide (InP) and silica-on-silicon photonic integrated circuit (PIC)-based modules and subsystems for high-speed communications networks, has reported record revenue of $77.5m, up 13.6% on $68.2m last quarter and up 3.3% on $75m a year ago (and at the high end of the $73-78m guidance range).
Fiscal Q2/2013 Q3/2013 Q4/2013 Q1/2014 Q2/2014 Revenue $75m $76.8m $74.4m $68.2m $77.5m
Growth is driven mainly by 100G products. "Our new products are well positioned to continue to benefit from the rapid growth in worldwide 100G deployments," believes chairman & CEO Tim Jenks.
There were three 10%-or-greater customers, with Alcatel-Lucent falling from 13% of total revenue last quarter to 12% and Ciena falling from 14% to 13%, whereas China's Huawei Technologies rose from 35% to 39%. Correspondingly, the revenue mix by geographic region was 20% Americas (level with last quarter), 5% Japan (down from 7%) and 21% rest of the world (level with last quarter), whereas China was up from 52% to 54%.
The Speed & Agility product group contributed $56.2m (72% of total revenue), up $6.4m on last quarter. Of this, High Speed products (i.e. 100G and some 40G) contributed $30.2m (39% of total revenue), up $1.9m. The Access product group contributed $16.4m (21% of total revenue), up $2.1m.
On a non-GAAP basis, gross margin has fallen from 25.1% a year ago and 22.0% last quarter to 20.8%, due mainly to lower volumes of components (notably for client-side 100G modules as the firm transitions from CFP to CFP2) and above-average inventory reserve charges.
The transition from CFP to CFP2 in 100G client-side modules caused a decrease in certain component shipments and under-utilization in that fab. "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," says chief financial officer Ray Wallin. "With lower volumes this quarter, we had the additional issue of adverse volume variances. In addition, we took above average inventory reserve charges of $0.9m, or a 1.2 percentage point impact, for certain end-of-life low-margin products," he adds. "These impacts offset gains we made through other cost reduction and productivity efforts."
Sales, general & administrative (SG&A) expenses were $11.8m (15.2% of revenues), down from $12.4m (18.2% of revenues) last quarter. Of this, G&A expenses were $8.2m (10.6% of revenue), cut from $9m (13.2% of revenue) last quarter. R&D expenses were $12.1m (15.6% of revenue), unchanged from $12.1m last quarter (17.7% of revenue) and up on $11.1m a year ago, as NeoPhotonics continued making significant investments in 100G product development despite the restructuring.
Net loss was $7.5m ($0.24 per diluted share), cut from $9.5m ($0.30 per diluted share) last quarter but up from $3.8m ($0.12 per diluted share) a year ago.
During Q2, NeoPhotonics restructured a credit line facility with its principal lender in the USA. As a result, at the end of June it reported restricted cash and investments totaling $26.4m, as required under its $21m term loan in the USA and the remaining $5.4m under its line of credit facilities in China. Hence, on a comparable basis, combined cash, cash equivalents and restricted cash and investments was $54.4m, down from $64.3m of cash, cash equivalents, short-term investments and restricted cash at end-March. Combined notes payable and debt rose from $40.8m to $48m during the quarter.
"We are taking significant actions to address operational and profitability challenges while continuing our focus on key growth markets such as 100G," says Jenks. "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," he adds. "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," continues Jenks. "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."
For third-quarter 2014, NeoPhotonics expects revenue of $78-82m. Gross margin should rebound to 22-26%, due to the impact of restructuring changes, ongoing operational improvements and other cost reductions. Having completed its 2013 audit and restatement work, the firm expects G&A expenses to fall to $7.5-8m. Diluted net loss per share should be $0.04-0.14. CapEx is expected to be $2-3m per quarter in the next two quarters (down from $3.8m in Q2).
NeoPhotonics also expects revenue growth in the coming quarters from several of its 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," says Jenks. This product should begin production shipments later this year and ramp in early 2015.
Since product mix affects profitability (due to margins ranging from greater than 40% for some high-speed products to below10% for certain mature products), NeoPhotonics is focused on increasing the contribution from higher-margin opportunities, including certain coherent100G long-haul and 100G metro deployments in the USA, Asia and Europe. "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," notes Jenks. "We expect metro 100G, where several of our new products are targeted, to begin to ramp in 2015 and continue into 2016," he adds.
"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," says Jenks.
"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," says Jenks. NeoPhotonics has hence initiated a restructuring and cost-reduction plan with the goal of reducing total operating costs.
In the initial phase, NeoPhotonics expects to cut operating costs by $10m of annual run rate during Q3 ($2.5m per quarter). "We have reduced our general & administrative expenses as we completed our restatement activities over the past several quarters, resulting in a $1m reduction per quarter (not included in the $2.5m)," says Jenks. "So far, we have taken actions to reduce manufacturing costs and operating expenses by staff reductions in operations, R&D, sales, marketing and G&A, and these cost reductions will materialize during Q3," he adds.
In a second phase, the firm will take additional actions to reduce manufacturing and operating costs by reducing manufacturing footprint in higher-cost geographies, decreasing associated manufacturing overhead costs for these facilities, and further reducing R&D spending. It expects the split of cost reductions to be about 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," says Jenks. "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," he adds.
"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," says Wallin. "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," he adds.
"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," says Jenks. "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 about $85m per quarter."
