NeoPhotonics’ Q1 revenue down 28% year-on-year to $71.7m after sale of Low-Speed Transceiver product line

For first-quarter 2017, 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 revenue of $71.7m, down 28% on $99.1m a year ago and 35% on $109.8m last quarter

“The first quarter of 2017 marked a milestone with our transition to a purely High-Speed company with our focus on 100G and above as networks move to 400G and 600G,” says chairman & CEO Tim Jenks. “We completed the sale of our Low-Speed Transceiver product assets [in January] and we tightened our focus on continuing the growth of our global high-speed component and modules businesses.”

Sales of high-speed products were $58.7m (82% of revenue) and networking products were $13m (18% of revenue). Excluding $1.5m from two weeks of low-speed product shipments (prior to sale of the product line), revenue was $70.2m (84% high-speed products; 16% networking products).

Geographically, of total revenue, 54% came from China (down from 65% last quarter), 17% from the Americas (down slightly from 18%), 5% from Japan (up from 4%), and 24% from the rest of the world (up from 13%). Revenue from China fell significantly due to the sale of the Low-Speed Transceiver product line. Excluding low-speed products, shipments to the China region were down about 40%, compared with business outside China growing by nearly 10%.

There were two 10%-or-greater customers. US-based Ciena comprised about 14% of revenue (level with last quarter). However, China’s Huawei Technologies and its affiliate Hi-Silicon Technologies collectively comprised 41% of revenue (down from 53% last quarter, or 50% excluding low-speed products).

“Demand was very strong in China, with overly optimistic forecasts entering 2017,” notes Tim Jenks. “A leading customer there accumulated significant inventory as a result. But demand dropped precipitously as they moved to rapidly adjust their outsized inventory to align with their production, given that expected China tenders had not materialized. Coupled with these demand dynamics, our revenue performance in Q1 additionally reflects the seasonal impact from pricing, Chinese New Year and other factors,” he adds.

“Some products with elevated levels of inventory are also among our higher-margin products, such that during the period of burning off this inventory our margins are being adversely affected,” explains Jenks. On a non-GAAP basis, gross margin has fallen further, from 32.8% a year ago and down from 29.9% last quarter to 26.3% (below the forecasted 28-31%). Of this drop, about a quarter is due to a mix shift from the China customer inventory, about half is due to unfavourable direct material procurement costs from a major contract manufacturing partner, and a quarter is due to under-utilization as a result of the lower volumes in NeoPhotonics’ own plants.

Operating expenses have risen from $23m a year ago and $26.6m last quarter to $30.2m, reflecting some periodic costs and higher annual audit costs in the first quarter.

Net loss was $10.7m ($0.25 per diluted share), compared with net income of $6.3m ($0.13 per diluted share) last quarter and $7m ($0.15 per diluted share) a year ago. Adjusted EBITDA was a loss of $5.2m (compared with a gain of $12.5m last quarter and $12.3m a year ago).

In addition to the cash loss of $5m, working capital changed by about $14m (principally from build-up in inventory). So, cash outflow from operations was -$19m. Capital expenditure (CapEx) was $17.6m (down from $21.7m). So, free cash flow was about -$36m in cash burn. However, during the quarter, NeoPhotonics received about $22m in cash from the sale of the Low-Speed Transceiver business. So, cash and cash equivalents, short-term investments and restricted cash fell overall by $14.1m, from $105.6m to $91.5m.

“The inventory overhang and customer actions to reduce it reduced our Q1 outlook and will similarly impact our Q2,” says Jenks. For second-quarter 2017, NeoPhotonics expects revenue of $68-74m (up only modestly after excluding low-speed product revenue). Gross margin should fall to 23-26%, due mainly to the temporary adverse mix impacts (with low volumes on higher-margin products, largely the result of China’s inventory overhang). Operating expenses are expected to fall to $26-27m. Net loss per share should be $0.19-0.26, with cash loss cut to $3m. However, the change in working capital is expected to rise to about $16m. CapEx should fall to $16m.

“We saw both the build of inventory and the coming China market softness in early March,” notes Jenks. “We now anticipate continuing China softness through Q2 as they consume inventory, followed by a stronger China market in the second half of the year as new provincial tenders are awarded and our Chinese customers increase their pulls on both our production and are higher than normal in order of finished goods inventory. This will lead to a normalized product mix and gross margin,” he adds. Overall, demand is expected to grow late in Q2.

Due to both the sale of its Low-Speed Transceiver product assets and the continued slowness seen in first-half 2017 in the China market, NeoPhotonics is implementing several cost-saving measures, including thinning R&D in legacy areas and restructuring actions to reduce sales, general & administrative (SG&A) expenses (rationalizing the number of product lines, reducing its real-estate footprint, and making certain staffing reductions). This should yield $6-9m in annualized operating cost savings. The firm is also looking further for areas to increase savings as the year progresses. The full quarterly impact of cost-reduction actions should be realized by third-quarter 2017. The firm will record a pre-tax charge of $0.7-1m for severance costs in Q2. However, it is seeking to continue (with limited critical hiring) to ensure that key R&D developments progress and that it maintains production capabilities to respond to any upside.

“We are very well along in our previously announced capacity expansion plan [about 80% of the way through the CapEx program] and, to this end with both progress to date and with China overhang, we anticipate returning to our normalized CapEx of 6-8% of revenue in the second half,” says chief financial officer Ray Wallin. “Demand for 100G-and-beyond products will be stronger in the second half of 2017 than in the first half. The market dynamics driving growth in the optics market remains very robust,” adds Jenks.

“The China market is a timing issue related to the transition from national backbone deployments to provincial backbone and metro deployments and related to the accumulated inventory overhang,” he adds. “Worldwide metro and data-center interconnect 100G coherent deployments continue to grow and now exceed long-haul levels by ports. 100G is now standard, and all line-side and client-side applications and networks are moving rapidly to 200G and 400G, with 600G on the horizon for data-center interconnect fat pipe applications,” continues Jenks. “We are well positioned to serve these growing markets with both our high-capacity production and our new solutions focused on 400G-and-above coherent and data-center products,” he believes.