NeoPhotonics’ Q3 revenue growth in North America and China offset by declines elsewhere

For its third-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 $71.1m, down 2.9% on $73.2m last quarter and 31.2% on $103.3m a year ago. However, the latter was before NeoPhotonics divested its Low-Speed Transceiver product line in January.

Sales of High Speed Products rose further, from 81% of total revenue last quarter to 84%. Sales of Networking Products & Solutions comprised the other 16%.

Sequential growth of 14% in North America and 5% in China was offset by declines in other regions. Of total revenue, China rose from 53% last quarter to 57% and the Americas from 20% to 23%, while Europe, the Middle East & Africa (EMEA) fell from 24% to 18% and Japan from 3% to 2%.

There were three 10%-or-greater customers: US-based Ciena (the largest customer outside China) fell back to 14% of total revenue (after strong growth last quarter), China’s FiberHome Technologies was at 11%, and China’s Huawei Technologies and its affiliate HiSilicon Technologies collectively (consistently NeoPhotonics’ largest customer) rebounded somewhat to 39%, with revenue growing by 2% to almost $30m. The four largest customers after Huawei comprised 41% of revenue, compared with just 35% a year ago.

“We are focused on growth initiatives in telecom, data-center and cloud markets, as well as operational execution to lower our breakeven level as China continues with steady though muted demand [with the lingering impact of excess customer inventory],” says chairman & CEO Tim Jenks. “We are seeing continued traffic growth in China and customer inventory levels returning to normal ranges, and we are seeing success in our 400G product introductions as well as continued growth in our laser products,” he adds. Laser revenue is up 25% year-on-year to almost half of total revenue. “Despite a challenging market due to the China inventory overhang, our suite of laser solutions (including transport, inter-data-center and intra-data-center solutions) has grown steadily over the year,” says Jenks. “Growth drivers in our markets include metro deployments across the globe, China high-speed build-outs in advance of 5G wireless, and data centers and Big Data applications that are embracing our higher-speed technologies and leverage NeoPhotonics’ core strengths.”

On a non-GAAP basis, gross margin has fallen further, from 27.6% a year ago and 23.9% last quarter to 18.6% (below the 24-27% guidance), driven by: about 4 percentage points of increased under-absorption charges as the firm reduced factory loadings in order to limit inventory; and about 3.5 percentage points of increase in period costs (primarily for inventory write-offs and a warranty charge). These were partially offset by 2 points of improvement in product margin.

Operating expense (OpEx) were $24.7m (34.7% of revenue), slightly higher than $24.2m (33.1% of revenue) last quarter, driven by an increase in R&D associated with new products.

Driven primarily by factory under-absorption, net loss has worsened from $6.6m ($0.15 per diluted share) last quarter to $10.9m ($0.25 per diluted share, worse than the $0.17-0.07 guidance), compared with net income of $2.9m ($0.06 per diluted share) a year ago.

Cash used in operations was $25m (compared with cash generation of $2m last quarter). Capital expenditure (CapEx) was $7m (cut from $17m last quarter). Free cash flow was hence -$32m. During the quarter, cash and cash equivalents, short-term investments and restricted cash fell from $79m to $73.7m, while restricted cash fell from $3.3m to $2.9m.

NeoPhotonics also entered into a new five-year $50m revolving credit facility with Wells Fargo Bank (effective 8 September). On closing, NeoPhotonics drew $30m under the new facility to pay off its prior credit facility with Comerica Bank (under which it borrowed $20m) as well as to add cash to the balance sheet for working capital needs and general purposes.

NeoPhotonics’ existing CITIC Bank loan of $17m in China is drawn through early January. It is in discussions about renewal of the larger underlying credit line. In addition, NeoPhotonics has about $20m of unused credit with Shanghai Pudong Bank that remains available until July 2019.

“We believe that we have sufficient liquidity to meet business needs for the next year. Additional risks can and will be mitigated with already identified actions,” says chief financial officer Beth Eby.

“As a part of our continuing actions to improve profitability and cash flow, in the third quarter we implemented restructuring actions to focus on key growth opportunities and to lower our breakeven revenue,” notes Eby. These included a reduction in force, real-estate consolidation, a write-down of inventory for certain programs and a write-down of idle assets. “We have reduced risk to the balance sheet and lowered our operating expenses going forward,” she adds. The actions will reduce quarterly operating expenses by about $2m and manufacturing spending (or under-absorption) by about $0.6m when fully realized at the start of fiscal year 2018. Implementation costs should be about $5.8m ($2.3m in real-estate consolidation and fixed asset-write off, $2m in inventory write-downs related to end-of-life projects, and $1.5m in severance costs). The firm incurred about $5.1m of these costs in Q3, with the remainder to be incurred in Q4. “Our actions balance the need for a sustainable level of operating expenses with long-term growth goals,” says Eby. “Once we complete amortization of under-absorption charges we will have lowered our breakeven revenue from approximately $100m to the mid-eighties, and we are continuing with actions to further reduce that breakeven point,” she adds. “There is more work to be done and in process to balance our infrastructure and operations against the joint goals of growth and profitability.”

For fourth-quarter 2017, NeoPhotonics expects revenue of $69-74m, with gross margin rebounding to 20-23%. Operating expenses should be cut to $23-24m, with loss per share reduced to $0.23-0.13.

NeoPhotonics expects cash used in operations to be about -$10m. CapEx should rise to about $10m. “We anticipate partially financing these cash requirements [of $20m] with our existing unused credit facilities,” says Eby.

“Customers [in China] are suggesting that inventories are less than one quarter for most products at this point,” says Jenks. “While it is our expectation that recent tender awards such as those by China Mobile and China Unicom should create a more normalized demand environment in 2018, our discussions with China carriers indicate that network traffic continues to grow at a robust pace, necessitating continued network capacity adds.”

“In the short-term, while the overall activity levels of our China customers may overshadow metro growth and 400G wins, we believe that the mid- and long-term market drivers for our business are compelling, as China continues to build out national backbone, provincial and metro networks, and as they advance in data-center deployments and prepare for 5G wireless,” says Jenks.

“We have initiated a series of actions to focus our strategic direction on high-speed components and coherent solutions, recognizing the explosion of optics in the cloud, together with transitioning our product development to focus on some newer markets and opportunities that include next-gen components for data-center interconnects, the expanding market in cloud and converged edge and the impact of disaggregation, especially in data center and cloud. At the same time, a very bright spot for us is the growth of our laser business,” Jenks continues.

“With the continued traffic growth in China and now that customer inventory levels are approaching normal ranges, together with our success in 400G product introductions, we anticipate returning to top-line growth in 2018 and profitability by mid-year,” concludes Jenks.