13 August 2021
NeoPhotonics’ revenue returns to growth in Q2
For second-quarter 2021, NeoPhotonics Corp of San Jose, CA, USA – a vertically integrated designer and manufacturer of silicon photonics and hybrid photonic integrated circuit (PIC)-based lasers, modules and subsystems for high-speed communications – has reported revenue of $65m.
This is a drop of 37% on $103.2m a year ago, but that is largely due to the additional restrictions imposed on 17 August 2020 by the US Department of Commerce’s Bureau of Industry and Security (BIS) on exports to China-based Huawei Technologies (formerly NeoPhotonics’ largest customer, comprising 40% of 2020’s revenue). In Q2/2021, NeoPhotonics now has three 10%-or-more customers, and the top five comprised 77% of total revenue. In fact, year-to-date (first-half) revenue – excluding Huawei – is up by about 15% year-on-year.
The Q2 revenue of $65m is up 7% on $60.9m in Q1 (and at the top end of the $59-65m guidance range) due to strong demand for lasers and high-speed, 400G-and-above products (e.g. 400ZR and 400ZR+ modules) counteracting ongoing supply chain challenges. Revenue for 400G-and-above products in particular doubled year-on-year, comprising 46% of total revenue.
“As we said last quarter, we restarted shipments to Huawei in Q1 for a limited set of products, and we expected their quarterly revenue to be in the mid to high single-digit millions on a run-rate basis,” says senior VP & chief financial officer Beth Eby. “Q2 was somewhat higher, at $14m, given the lack of shipments in previous quarters,” she adds. “We do not expect Huawei to be a 10% customer for the year.”
On a non-GAAP basis (excluding a $3.3m end-of-life related inventory write-down, $2.3m of stock-based compensation and $0.4m of accelerated depreciation, amortization and other charges), gross margin has nevertheless fallen further, from 33.2% a year ago and 22.4% last quarter to 21.7%. However, this exceeds the expected 17-21% as a result of favorable product mix and the shift of about $1.5m from cost of sales to R&D expense for materials related to the new product introduction. The shift is an accounting timing issue. Product margin of 37.6% (down from 40.5% last quarter) was offset by the expected levels of excess capacity charges. “We expect these under-utilization charges to drop as we ramp volume and complete the consolidation of our indium phosphide production, as we announced last year,” notes Eby.
Operating expenses have risen further, from $23.6m (22.9% of revenue) a year ago and $21.5m (35.3% of revenue) last quarter to $24.4m (37.5% of revenue), higher than the expected $22.5-23.5m due to the shift from cost of sales to R&D.
Compared with net income of $8.7m ($0.16 per diluted share) a year ago, net loss has worsened from $7.5m ($0.15 per diluted share) to $11.4m ($0.22 per diluted share, although this is $0.03 better than the midpoint of the $0.20-0.30 guidance range).
During the quarter, cash and cash equivalents, short-term investments and restricted cash fell by $16m from $111m to $95m due to new product startup costs, the payment of 2020 variable compensation, and the pay-down of debt.
Net inventory was $44m, down $2m due to product end-of-life (EOL). Despite continuing to buffer critical inventory and supporting the new product ramps, days of inventory (DOI) improved from 88 days to 72 days.
“Building on our strong performance in the second quarter, we see accelerating growth in the back half of the year, driven by the initial ramp of 400ZR and related products adding to our 400G+ suite,” says chairman & CEO Tim Jenks. “We are ramping our modules and component-level products, including our Nano Tunable Laser, putting us in a good position to return to profitability,” reckons Jenks.
“Looking to Q3, we are seeing the expected increasing demand for our leading 400G-capable components, particularly our lasers and the increase in demand for our modules,” says Eby. For third-quarter 2021, NeoPhotonics expects revenue of $76-84m (representing revenue growth – excluding Huawei – from Q1 to Q3 of 25-35%).
“We have a new chip shortage due to a supplier timing decommit that has an $8m adverse impact on revenue in Q3,” notes Eby. “We have widened our range to allow for the possible outcomes, meaning we have confirmed supply and inventory to meet the low end of the range. We have confidence in the actions to reach the midpoint and are working on mitigation actions that could allow us to reach the high end of the range,” she adds.
Gross margin should rise to 25-30%, while operating expenses should fall slightly to $23-24m. NeoPhotonics hence expects diluted earnings per share to improve to between a $0.10 loss and breakeven.
“While we have sufficient demand to achieve non-GAAP breakeven in Q3, the supply chain limitations are extending the timing to reach operating profit to Q4,” notes Eby.
“Looking forward to the rest of the year, we expect to grow revenue at an accelerated rate approaching the levels of one year ago [returning to about $100m per quarter in Q4/2021], consistent with our growth target of 25-35% excluding Huawei. This reflects the continued high demand for 400G-and-above-capable products,” says Eby. “Over the longer term, market size estimates for 400ZR and 400ZR+ pluggable modules continue to increase. As we gain confidence in the strength and size of our module ramp, we may review our capital structure to ensure that we maintain the flexibility to be able to support customer forecasted ramps,” she adds.
“Last year, we lost significant revenue following tightened BIS restrictions on Huawei. In parallel, we accelerated our pivot to Cloud-focused customers. As we embarked on this new path, we said the number of 400G-and-above coherent ports being shipped each year is approximately doubling; we would have new 400ZR module products that would ramp in 2021. And we expected to get back to non-GAAP operating profit in Q3,” recalls Eby. “Even with the supply chain issues, we are on track to meet those goals for the second half. Our 400G-and-above-capable revenue grew 100% year-over-year in Q2, and we expect total year-over-year growth to be 100% or higher,” she notes. “We are in late-stage qualification with target hyperscale customers for 400ZR. And we expect to achieve non-GAAP operating profit breakeven now in Q4. We are pleased with our company performance over the last year and are excited about our path forward and our additional growth vectors in the hyperscale market.”
“Our core coherent components for 400G-and-above applications have driven most of our 400G-and-above revenue to date. We expect to see cloud hyperscalers and telecom carriers increase their CapEx spending and deployment rates for these products and our 400G coherent modules,” says Jenks. “We’ve been sampling our 400G coherent module solutions to cloud and hyperscale data centers. We expect cloud data centers to begin deploying 400ZR coherent links in the fourth quarter; we believe we are at the beginning of a broad market expansion for 400ZR- and 400ZR+-based networks and applications. This expansion has started with adoption of coherent interconnects into cloud service provider metro networks. Rapid adoption of 400ZR and 400ZR+ in cloud metro applications will be followed by cloud content providers similarly adopting 400ZR and 400ZR+ for longer-distance interconnects, significantly expanding our served market,” he believes.
“The cloud and hyperscale interconnect market is expected to soon rival the telecom market in high-speed Internet connect. AI-enabled applications such as autonomous vehicles (AVs) and machine learning will rapidly expand traffic and bandwidth requirements in the edge cloud market. These are huge mega trends that we believe will expand ZR applications and deliver accelerated growth, with each overlapping cycle for at least several years,” Jenks continues. “Our high-speed component products for 400G, 600G and 800G are used by virtually all leading network equipment manufacturers in cloud and hyperscale networks. Also, our ultranarrow-linewidth tunable lasers are the laser of choice for 400G-and-above, such that we are designed into several other customers’ 400ZR modules; these products are beginning to ramp now ahead of module deployments in late 2021 and 2022.”
“Our 400ZR modules are in later qualification phases with leading hyperscalers. Our target customers have wide-ranging volume plans. We believe that our 400ZR and 400ZR+ modules are industry leading in performance and in maturity, and we expect initial deployments toward the end of 2021,” says Jenks.
“The strong demand we’re seeing for 400G-and-above solutions suggests that growth in 2022 could be higher than in past years,” reckons Jenks. “Accelerating demand for our 400G-and-above products is still in the early innings. As the market continues to move to these higher speeds we believe we are entering a new era of growth.”