NeoPhotonics’ revenue rises 3% in Q2 as Huawei shipments only partially subject to export ban

For second-quarter 2019, 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) has reported revenue of $81.7m, up 3% on $79.4m last quarter and just 1% on $81.1m a year ago.

Fiscal	Q2/2018	Q3/2018	Q4/2018	Q1/2019	Q2/2019
Revenue	$81.1m	$81.7m	$91.1m	$79.4m	$81.7m

This is below the original guidance of $88-93m, given before the US Department of Commerce’s Bureau of Industry and Security (BIS) added Huawei Technologies (historically NeoPhotonics’ largest customer) to its Entities List as of 21 May, banning the sale to Huawei of products subject to US Export Administration Regulations (EAR) without obtaining an appropriate export license. NeoPhotonics subsequently ceased shipments to Huawei for much of the quarter.

However, Q2 revenue exceeded the revised guidance of $75-80m due to strength in the Western data-center interconnect (DCI) market as well as the re-start of shipments of non-EAR products to Huawei near the end of the quarter.

“Since the addition of Huawei to the Entities List, we implemented processes to evaluate each of our products against the standards set forth in those regulations,” notes chairman, CEO & president Tim Jenks. “Each product must be reviewed individually in a detailed, specific and rigorous process, and these reviews are ongoing,” he adds. “Having consulted with our legal counsel and technical experts, we determined that certain of our products are not subject to EAR and may continue to be sold to Huawei and its affiliates. Consequently, late in the quarter, we restarted shipping certain non-EAR products to Huawei.”

Huawei (including its affiliate HiSilicon Technologies) hence declined less than feared, from 49% of total revenue last quarter to 36% in Q2/2019. Demand from other customers in China rose slightly but remained within the normally expected range, so China overall fell from 57% to 48% of revenue.

After Huawei, NeoPhotonics’ next four customers contributed 48% of total revenue (up from 37% last quarter). Western and rest-of-world (RoW) customers comprised 52% of revenue, consisting of 24% from the Americas (up from 18% last quarter) and 28% from the rest of the world (up from 25%). “Our business has been strong with Western customers, especially in DCI and metro markets,” says Jenks. “In fact, our top five Western customers were each up by double-digit percent in sequential revenue growth, with growth coming from product shipments for 400G and 600G systems [to more than 10% of High-Speed Product revenue].”

High-Speed Products (for data rates of 100G-and-above) hence rose from 86% to 89% of total revenue. “Q2 was a volatile quarter for NeoPhotonics and I am proud of our team and their continued focus and execution to extend our leadership position in high-speed digital optoelectronics while making changes needed to adjust for the Huawei ban,” says Jenks. “In the case of China and Huawei, the preponderance of demand is 100-200G,” he adds. “There is certainly a decrease in demand from Huawei and China for the 400G… We took a breather on the 400G growth because of the China situation with Huawei.”

On a non-GAAP basis, gross margin has risen further, from 20.1% a year ago and 22.4% last quarter to 25.6%. This is at the low end of the original guidance range of 25-29% but at the high end of the revised range of 22-26%. Within this, product margins were about 32% (up 5 points from 27% last quarter due to good execution of cost reductions). Other cost of sales charges of about 6.5 points consisted of 5 points of under-utilization charges (given the volume cuts) and 1.5 points of other charges (all less than 0.5 point, the largest of which was the impact of tariffs).

Despite being up slightly from $21.8m (26.9% of revenue) a year ago, operating expenses were $22.1m (27.1% of revenue), cut from $24.2m (30.5% of revenue) last quarter (and at the low end of the revised expectation of $22-23m) due to a combination of spending reductions and project push-ups.

“In May, after the Huawei ban went in place, we executed on changes in our operations to adjust to lower revenue levels,” says senior VP, finance & chief financial officer Beth Eby. “We reset our supply chain, adjusted R&D projects and reduced expenses substantively,” she adds.

Driven by higher gross margin and lower spending, operating loss was $1.2m (operating margin of -1.5% of revenue), cut from $6.5m (-8.1% margin) last quarter and $5.6m (-6.9% margin).

Net loss was $1.2m ($0.03 per diluted share), cut from $9m ($0.19 per diluted share) last quarter and $6.3m ($0.14 per diluted share) a year ago, and towards the top of the revised guidance range of $0.15-0.05.

Appreciation of the US dollar relative to the Chinese yuan drove a foreign exchange (FX) gain of about $1m. Also, NeoPhotonics made a $0.82m gain on the sale of its Russia manufacturing operation (as part of its ongoing process to align business with product lines that are strongest and most profitable) - Dmitry Akhanov, representing RUSNANO, subsequently resigned from NeoPhotonics’ board of directors. “We remain focused on managing the business for cash and profitability,” says Eby.

Cash generated from operations was hence $0.7m (down from $8.7m last quarter). Although down from $5m last quarter, free cash flow was a better-than-expected $0.3m. However, due mostly to a $3.6m write-down of Huawei-specific inventory, net inventory fell by about $5m, from $54m (76 days) to $48.8m (67 days). During the quarter, cash and cash equivalents, short-term investments and restricted cash hence fell by about $5m, from $78.9m to $74m, due to the repayment of debt.

“Demand signals from our global customers are positive for the year,” says Eby. “As a result, revenue for Q3 is expected to be solid. The supply chain constraints that we have seen for the last 6-9 months have ameliorated,” she adds.

For third-quarter 2019, NeoPhotonics expects revenue to rise to $87-93m, driven by Western customers (with strong order backlogs for the firm’s five largest Western customers) as well as DCI applications, despite Huawei revenue falling (although most Huawei shipments are not subject to EAR and are hence continuing, via businesses acquired in China and Japan, and development centers established there). Gross margin should be 25-29%. With OpEx of $22-23m, diluted earnings per share should range between a $0.03 loss and a $0.07 profit.

For fourth-quarter 2019, NeoPhotonics expects revenue in a similar range to Q3, and OpEx to remain at $22-23m.

“We continue to monitor changes in the Department of Commerce and BIS rules related to Huawei and their affiliates. We have not included any benefit for shipment under pending licenses in our forecast,” says Eby. “However, products that we have determined are not subject to US EAR are included. These products represented a majority of our shipments to Huawei in 2018,” she adds.

“In late June, administration guidance was that US firms would be allowed to sell to Huawei with a license under certain conditions,” notes Jenks. “We have applied for a license to ship certain EAR products,” he adds.

“Late in the second quarter, China Mobile announced the award of a tender for certain parts of its 5G network, of which Huawei won a significant share. Further, we see ongoing demand for deployments of existing [legacy] 100G and 200G systems,” says Jenks.

“Overall, the drivers for the markets we serve are well aligned with our advanced technologies, high-speed capabilities and strong presence in high-speed components. These trends transcend the current Huawei ban and, coupled with the beginning of 5G wireless infrastructure deployments and continued demand with hyperscale data centers, we are optimistic about NeoPhotonics’ new product prospects,” says Jenks.

“We continue to see good progress with design-ins and volume growth for our Class 40, 64Gigabaud product suite, which is aimed at 400G and 600G applications, and we have announced our Class 50 receiver and modulator aimed at 800G applications,” notes Jenks.

“With higher-order modulation such as 64 QAM, the very pure light and low phase noise of our lasers becomes increasingly important. Because of this, our tunable lasers have the right performance to be the laser of choice for the higher-performance systems,” he reckons. “Connecting this to specific system data rates, we anticipate that 400G will continue to deploy while our 600G products ramp through this year and next. Beyond 2020, we expect 600G will coexist with coming 800G, and we will be engaged in deployments of both. Each of these approaches requires best-in-class component performance, which NeoPhotonics delivers both with our vertically integrated indium phosphide PIC platform and our active silicon photonics platform,” he adds.

“On the pluggable side of the business, we continued to make good progress with design wins and shipments of our ClearLight CFP DCO modules. At the OFC trade show in March, we demonstrated our CFP2 DCO module. Also at OFC, we demonstrated our 64GigaBaud silicon photonics-based COSA or coherent optical subassembly which, together with our already shipping nano tunable laser, provides all of the optics required for a 400 ZR pluggable module.”

See related items:

NeoPhotonics cuts Q2 revenue guidance from $88-93m to $75-80m after Huawei export ban

NeoPhotonics’ Q1 revenue grows 16% year-on-year to $79.4m

NeoPhotonics’ revenue grows 11% in Q4 to $91.1m

NeoPhotonics’ Q3 revenue up 15% year-on-year to $81.7m

NeoPhotonics’ revenue grows 18% in Q2 to $81.1m

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