NeoPhotonics’ revenue grows in Q2 despite sale of Low-Speed Transceiver product assets

For its second 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 $73.2m (towards the upper end of the $68-74m guidance range). This is down 26% on $99.1m a year ago but up 2% on $71.7m last quarter (or up 4% on $70.2m after excluding $1.5m from the Low-Speed Transceiver product line, which was divested in January). Growth was driven by strength in 100G-and-above shipments to North America as well as modest sequential growth in China despite the inventory overhang there.

Sales of High-Speed Products rose slightly from $58.7m last quarter to $59.4m (81% of revenue, up from 66% a year ago).

Sales of Networking Products & Solutions rose from $13m last quarter to $13.8m (19% of revenue, down from 34% a year ago).

There were again two 10%-or-greater customers: US-based Ciena (the largest customer outside China) grew by $3m from 14% to 19% of total revenue, while China’s Huawei Technologies and its affiliate HiSilicon Technologies collectively fell by $1.4m from 41% to 37% of total revenue as they continued working through their inventory build-up.

However, apart from Huawei, NeoPhotonics saw growth at each of its Chinese network equipment customers, resulting in China revenue growing by $1.6m (4%) sequentially. Consequently, of total revenue (excluding Low-Speed Transceiver product revenue from Q1), China fell only slightly overall from 54% last quarter to 53%, as the Americas rose from 17% to 20%. Japan fell from 5% to 3%, and the rest of the world from 25% to 24%.

On a non-GAAP basis, gross margin has fallen further, from 29.3% a year ago and 26.3% last quarter to 23.9%, reflecting excess and obsolescence charges on discontinued products plus continued under-absorption in NeoPhotonics’ manufacturing facilities (given the softness in China and hence the lower-than-planned shipment volumes).

In light of both the disposal of the Low-Speed Transceiver assets and the soft business levels in China, NeoPhotonics implemented cost-saving measures including limited restructuring actions, reducing sales, general & administrative (SG&A) expenses, and thinning some R&D spending and manufacturing overheads for legacy products. Although still up on $21.8m a year ago, operating expenses have been cut by nearly 20% from $30.2m (42.1% of revenue) last quarter to $24.2m (33.1% of revenue) – beyond the targeted $26-27m – driven by the cost savings plus a reduction in audit-related costs (which were higher than normal in Q1).

Net loss was $6.6m ($0.15 per diluted share), cut from $10.7m ($0.25 per diluted share) last quarter (and better than the targeted $0.19-0.26 per diluted share), although this compares with net income of $6.9m ($0.15 per diluted share) a year ago.

Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was breakeven, an improvement from a loss of $5.2m last quarter but down on +$12m a year ago.

During the quarter, cash and cash equivalents, short-term investments and restricted cash fell from $91.5m to $79m.

Over the last two years NeoPhotonics has been adding significant capacity to its production facilities, and these projects are nearing completion. Total capex was planned to be about $100m over two years. Cash capital expenditure in 2017 is estimated to total $57m. “On an operating level, we have scaled our production levels to reflect current demand forecasts, and we continue to closely monitor our operating expense levels,” says interim chief financial officer Sandra Waechter.

NeoPhotonics’ existing $30m credit facility with Comerica Bank (under which it borrowed $20m) expires on 31 August and a $39.2m credit line with China’s CITIC Bank (under which it borrowed $17m) expires on 30 September. NeoPhotonics also has additional capacity of about $17.7m from Shanghai Pudong in China. “We are currently working through the due diligence process with a potential new lender that would provide increased flexibility in borrowing, and we are hopeful this will come to completion this quarter,” says Waechter. “We have mitigation plans in place to conserve our cash including a combination of expense and inventory controls. However, without any recovery in China, there would be doubt that our existing cash would be adequate for the next full year if we did not extend at least one of these credit lines or secure equivalent financing,” she adds. “In line with this effort, we borrowed $17m in China subsequent to the end of the second quarter that will remain in place until early Q1/2018,” she adds. “In the near term, while we continue to deal with this softer China market, we are tightening expenses as we closely manage inventory and production levels, and drive further cost savings measures.”

For third-quarter 2017, NeoPhotonics expects revenue of $70-76m. “While China softness has continued into the third quarter, we believe we are seeing relative stability in demand,” says Waechter. “However, there is limited visibility, given the inventory overhang, the move to provincial deployments and customer inventory management changes. As a result, we anticipate only modest changes in existing inventories and in gross margins, and our factory under-absorption will continue through the remainder of this year,” she adds.

“We continue to operate our production facilities with a focus on efficiency and with lower overhead, and we expect to be able to expand gross margins as finished goods inventory depletes with higher production and shipment volumes,” says chairman & CEO Tim Jenks. Gross margin should rise to 24-27% in Q3, with operating expenses of $23-25m. Net loss should be $17-0.07 per diluted share.

Cash used in operations should be about $18m, inclusive of changes in working capital. Cash capital expenditure is targeted to be down to $12m. “We anticipate financing these cash requirements with debt, inclusive of our $17m debt financing in China,” says Waechter.

“While we believe the business is on a good footing to realize increased operating leverage when demand levels return, we continue to see near-term challenges with China visibility and forecasts,” says Jenks. “Within China, it is too early to predict how the full year will unfold with the transition from primarily national backbone to primarily provincial deployments. Our near-term growth may continue to be restricted by the China inventory overhang, as certain customers are driving their inventories lower across the board. In addition, the inventory situation may impact some of our customers who also sell to customers in China as they are similarly pressured by the inventory-related actions,” he adds. “While these issues may overshadow metro growth and 400G wins and related early shipments in the near term, we believe that the mid- and long-term market drivers for our business remain compelling. China is committed, through the China Broadband 2020 and newer initiatives, to continue to build out the national backbone network and expand buildouts of 100G provincial and metro networks. Our OEM customers in China expect these actions to increase the number of 100G ports in China in 2017 and again in 2018,” notes Jenks.

“We continue to see strong demand in regions outside of China driven by North American carriers,” says Jenks. “We anticipate robust growth in the medium and long term, driven by metro, data-center interconnect, a normalized China market, and the emergence of 400G and above.”

NeoPhotonics expects to be positive on an adjusted EBITDA basis for both Q3 and Q4/2017, concludes Waechter.