Nov 2, 2015
Executives
Erica Mannion - Sapphire Investor Relations Timothy S. Jenks - President, Chief Executive Officer, Director and Chairman Clyde Raymond Wallin - Senior Vice President & Chief Financial Officer
Analysts
Alex Henderson - Needham Simon Leopold - Raymond James Richard Shannon - Craig-Hallum
Operator
Welcome to the NeoPhotonics, Third Quarter 2015 Conference Call. This call is being webcast live on the NeoPhotonics events calendar webpage at www.neophotonics.com.
This call is the property of NeoPhotonics and any reproduction without the written consent of NeoPhotonics is prohibited. You may listen to the webcast replay of this call by visiting the event calendar page of the NeoPhotonics website.
I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations, Investor Relations for NeoPhotonics.
Erica Mannion
Good afternoon. Thank you for joining us to discuss NeoPhotonics operating results for the third quarter of 2015, as well as the company’s outlook for the fourth quarter of 2015.
With me today are Tim Jenks, Chairman and CEO, and Ray Wallin, Chief Financial Officer. Tim will begin with a review of the third quarter, Ray will review the financial results for the third quarter and provide an outlook for the fourth quarter of 2015 and then Tim will provide closing comments before opening up the call for questions.
We may make statements in this conference call which are not historical facts. These statements may be considered forward-looking statements that involve risks and uncertainties.
Various factors could cause actual results to differ materially from what is set forth in such forward-looking statements, including those that have been set forth in our press release sent out today, November 02, 2015 and our most recent Annual and Quarterly Reports on Forms 10-K and 10-Q, all of which have been filed with the Securities and Exchange Commission. Listeners who do not have a copy of our third quarter 2015 earnings press release may obtain a copy of the press release by visiting the Company’s website.
Now, I will turn the call over to CEO, Tim Jenks.
Timothy S. Jenks
Thank you for joining us today. NeoPhotonics had a good third quarter.
We recorded quarterly revenue of $83.6 million, which was above our projected range of $77 million to $83 million, and represents year-over-year growth of 2%, this in spite of our having pruned products representing $23 million in 2014 annual revenue. Our gross margins continue to expand year-over-year recording a non-GAAP gross margin of 30% which was 3 percentage points above the third quarter of 2014.
On an earnings-per-share basis we continue to make significant progress towards our target model as a result of our continued growth, margin expansion and operating cost discipline we delivered non-GAAP earnings of $0.11 and GAAP earnings of $0.03 per diluted share, which includes the impact from shares issued in our May equity offering. We generated $10.2 million of EBITDA and continued to drive positive cash flow from operations during the third quarter.
Over the past four quarters we have generated $43.1 million of EBITDA. Our goals are to be a leader in the high speed 100G and beyond products solutions and to deliver sustained profitability.
Our third quarter results continue to demonstrate our strong execution towards these goals as we achieved 56% revenue from 100G and above products, once again achieving well over half of our revenue from high-speed products. As a result of our continued strength in 100G products and ongoing operational discipline, we delivered year-over-year increases in both non-GAAP and GAAP profitability.
I am pleased with our results and our continued progress against our objectives and I thank all of our employees for their hard work and dedication. Turning to the outlook for our business in the markets we serve, in the near-term we see positive indicators in China both for accelerated development of their networks and our strong position to capture this growth.
Investment activities in the region continues to increase as witnessed by increases in order rates from each of our largest direct network equipment customers in China, in particular our customer input anticipates upward of 20,000 100G lines likely to be awarded during this quarter. With this uptick in our 100G demand within China and the continued 100G strength we see in the U.S.
and EMEA offset by lower pricing in the fourth quarter and likely by a decrease in Network Products and Solutions demand within China, we are projecting fourth quarter revenues to be in the range of $82 million to $86 million with expanding gross margins and a solid non-GAAP profitable bottom line. Beyond the fourth quarter, as we look to the growth drivers of our business through 2016 High Speed 100G and beyond coherent developments and deployments including in China will remain a primary contributor.
To ensure NeoPhotonics is best positioned to take advantage of these technology transition cycles we continue to introduce new products and solutions. Our 100G solutions include new compact receivers and ultra-narrow linewidth tunable lasers and address both high baud rate and higher order modulation approaches to 400G.
For datacenter applications we joined with Inphi the European Conference on Optical Communications or ECOC in September to demonstrate a 100G PAM4-10 km link and we believe our capability here will further compliment NeoPhotonics' existing line of client-side transceivers, including CFP2-LR4, CFP4-LR4. We see the metro market as the next significant opportunity for 100G Coherent solution growth in 2016 and beyond.
On our last earnings call I highlighted the colorless-directionless-contentionless or CDC network architecture which may likely represent the future of metro optical networking. Our Multi-Cast Switches leverage our core strength in complex photonic integrated circuits and highly dense architectures to reduce overall CDC network build-out costs while increasing the flexibility in deployment approaches.
We are now shipping MCS blades commercially and expect continued volume growth over the next year. In addition, our compact low-power, narrow linewidth lasers and our next-generation small form factor receivers meet the density and power requirements of 100G Coherent Receivers meet the density and power requirements of 100G coherent metro systems and are currently shipping into coherent pluggable or ACO applications as well as dense linecard solutions.
The datacenter interconnect market which consists of very high capacity fat pipes between data centers located tens to thousands of kilometers apart represent a further distinct market segment and one which has been growing very rapidly. It is similar requirements in the metro market for high density and lower electrical power.
Our next-generation compact coherent optical components will be beneficial here and we expect this market be a growth driver for the next several years. I'll now turn the call over to Wallin Ray our Chief Financial Officer.
Ray?
Clyde Raymond Wallin
Thank you Tim, and good afternoon. As Tim mentioned earlier, revenue for the third quarter totaled $83.6 million representing an increase of 2% from the year ago period and a decrease of 2% from the second quarter of 2015.
Overall we generated non-GAAP earnings of $0.11 per fully diluted share up from 4% of non-GAAP earnings in the prior year period. This was above our outlook range of non-GAAP earnings of $0.01 to $0.09.
Our non-GAAP gross margin was 30% which included inventory related charges from discontinuing certain products. Independent of these charges our non-GAAP gross margin for the quarter would have equaled the midpoint of our projected range of 29% to 32% despite the higher-than-expected mix from Network Products and Solutions in the quarter and total non-GAAP operating expense for the quarter was $20.7 million representing a 2% increase compared to the prior year period and a 2% decrease versus the June 2015 quarter.
Our quarterly non-GAAP operating expense run rate continues to reflect the vigilant management and controls we established for the year to be consistent with our target model and as we drive for increased profitability. And for the last five quarters we have operated at our target model 25% for operating expenses and non-GAAP operating income for the third quarter was $4.2 million or 5% of revenue up from 2% in the year ago period and below the 8% reported in the prior quarter.
Now interest expense during the quarter decreased from the prior quarter to $0.2 million due to lower average debt outstanding. We recorded a tax provision of $1.2 million in the third quarter and we anticipate our Q4 2015 non-GAAP effective tax rate to be at 22.5% driven by our profits in foreign jurisdictions and non-GAAP net income was a solid $4.6 million in the third quarter or 6% of revenue.
And this is compared to non-GAAP net income of $1.4 million or 2% of revenue in the prior year period an income of $5.3 million or 6% of revenue in the prior quarter. In the third quarter of 2015 China cut their RMB exchange rate against the dollar by about 4% which resulted in a foreign exchange gain of $1.9 million or approximately $0.03 per share on a non-GAAP after-tax basis.
Based on a fully diluted share count of 42.9 million shares these results translated to earnings of $0.11 per share. For the third quarter EBITDA was $10.2 million or 12% of revenue as compared to EBITDA of $7.3 million or 9% of revenue in the year ago period and EBITDA of $11.4 million or 13% of revenue in the second quarter of 2015.
On a GAAP basis third-quarter gross margin was 28.4% up 4 percentage points versus the prior year period and down 2 percentage points sequentially. Our GAAP operating expenses of $22.9 million was 27% of revenue versus the prior year of $22.5 million or 28% of revenue and $23.4 million in the second quarter of 2015 or 27% of revenue.
Now we achieved GAAP operating income of $0.8 million for the third quarter which includes approximately $1.4 million of amortization of acquisition related intangibles, inventory and fixed asset step-up costs, $1.4 million in equity-based compensation and $0.6 million of acquisition related charges, impairment and restructuring costs. Now these charges are excluded from our non-GAAP results.
On a GAAP basis in the third quarter we again generated positive earnings achieving net income of $1.4 million in the quarter up from a $1.9 million loss in the prior year period and down from $1.8 million net income in the prior quarter. Now demonstrating our continued leadership position in the market our high-speed products that is products designed for use in 100G and above systems represented 56% of total revenue in the third quarter.
Network Products and Solutions represented 44% of total revenue where sales of products for access [ph] networks demonstrating strength in China and we continue to view the majority of this product group as a mature business. Geographically, our revenue mix for the third quarter was 30% in the Americans compared to 28% in the second quarter of 2015.
China was 49% compared to 50% in the second quarter. Japan and the rest of the world was approximately flat sequentially at 4% and 18% respectively.
Note that these figures are based on shipment destination not the end use destination. We had two 10% or greater customers in the third quarter of 2015.
Ciena was 26% of our total revenue compared to 22% in the prior quarter and Huawei Technologies was 41% of our total revenue compared to 40% in the prior quarter. A full reconciliation of our GAAP to non-GAAP numbers for the quarter is included in our press release.
Turning to the balance sheet, we ended the third quarter with $103.6 million in cash and cash equivalents, short-term investments and restricted cash. Accounts receivables decreased by $1.6 million in the third quarter ending at $77.8 million with days sales outstanding at 84 days which is flat compared to the second quarter.
And during the third quarter, we collected approximately $85 million of receivables compared to $92 million in the second quarter of 2015 when we reduced overdue balances in that period. And during the quarter we recorded a write-off of $0.4 million in connection with the bankruptcy of a customer in Israel.
Net inventory increased $1.1 million during the third quarter to $70.7 million to support anticipated 100G China awards in the fourth quarter and our days of inventory on hand was unchanged from the second quarter of 106 days. Capital expenditures totaled $5.4 million in the third quarter compared to $3.5 million in the prior quarter and in line with our annual CapEx projections.
Now third quarter depreciation and amortization was $5.5 million a decrease from the $5.7 million in the prior quarter. Turning now to our outlook for the fourth quarter of 2015, the following statements are based on expectations as of today and include forward-looking statements.
Actual results may differ materially. We do not plan to update nor do we take any obligation to update this outlook in the future.
We continue to expect steady growth in China market over the next two years. The 100G long-haul buildout in China will span upwards of 30 provinces.
Fiber-to-the-home rollouts continue along with 4G wireless installations albeit at a reduced pace versus the past year and adding new data center construction. In particular, we have seen some uptick in demand over the past four to six weeks which gives us more confidence in these forecasts.
Now taking into account these facts, our customer forecast and our product pruning efforts this year, trimming products representing $23 million in 2014 annual revenue and normal price negotiations that take place, the company's expectations for the fourth quarter are revenue in the range of $82 million to $86 million, non-GAAP gross margin in the range of 30% to 34% and diluted GAAP net income loss per share in the range of $0.03 loss to earnings of $0.04 and non-GAAP diluted earnings per share in the range of $0.05 to $0.13 which is reflective of approximately $0.08 of after-tax non-GAAP adjustments and approximately $45 million fully diluted shares. Now I would like to provide more color on our outlook.
For revenue our outlook reflects the typical ASP impacts from negotiations that take place in the fourth quarter including with our largest customers and while we anticipate solid fourth quarter volume growth in China for 100G products we also expect the demand to carry into the first quarter of next year. For gross margin, recall that our results can be impacted by a variety of factors including ASP changes, pruning of low-margin products, product mix, volume and manufacturing utilization and ongoing manufacturing process improvements all of which are reflected in our outlook.
In addition, we expect some increases in our fourth quarter R&D spending as key new products are moving towards general availability. Now, I will turn the call back to Tim to wrap up.
Timothy S. Jenks
Thank you, Ray. With the ongoing strength in 100G long-haul deployments and growth in 100G metro and datacenter interconnect deployments, we are excited about the opportunities in 2016.
With our internal developments we are increasing our content per 100G port and we believe our 100G business will continue to accelerate as we see metro deployments expand and include the addition of colorless, directionless and contention switching. While we are excited about our growth opportunities we recognize the need to remain disciplined with our operational structure to ensure we deliver on continued progress towards our target operating model and generate earnings growth to complement our topline.
This concludes our formal comments and now I would like to ask the operator to open the line up for questions. Operator?
Operator
[Operator Instructions] Your first question comes from the line of Alex Henderson of Needham.
Alex Henderson
Yes, hi could you just give me a couple of things here, one I wasn’t sure what you said on the gross margin kind of mainly because you went through so fast I think I was still taking a note on the other thing. What was the gross margin guide for the next quarter?
Clyde Raymond Wallin
Yes, so Alex, this is Ray. So the non-GAAP gross margin is guided in a range of 30% to 34% the midpoint being 32%.
Alex Henderson
Yes, got it, okay I wasn’t sure that was GAAP or non-GAAP that you had said there. So can you just talk a little bit what happened in China during the quarter?
You know obviously there was push out of timing that caused the issues around the 3Q it sounds like it came back in, in the last four to six weeks. But you also seemed to be very confident that there is going to be bleed of that into 1Q it sounds a little different than your normal seasonal pattern.
Am I right in hearing that?
Timothy S. Jenks
Well there are multiple things going on. In our prior call Alex as you'll recall we said that we expected to see some SKU of demand to the fourth and first quarter.
Again we believe that is what we have seen. The fourth quarter is indicative of that we do see increasing demand from customers and increasing forecast.
The fact is with two months to ago in the quarter and the amount of demand we would expect that things can pick up rapidly, but we would expect some of the demand to span into the first quarter. So now the strength that we've seen is both in the 100G deployment and demand forecast, but also in the access and wireless, but our expectation based on forecast is that will be a little bit softer going forward.
And so each of these trends reflect our forward-looking view.
Alex Henderson
So just so I can be clear, the historical pattern of seasonal weakness in 1Q sounds like it has some offsets this year and I know you don’t want to give guidance out more than one quarter, but you're implying that that would be evident in the strength rolling into the 4Q, but I would assume that you also have a full impact of the price reduction. So is it reasonable to think that given those parameters that we might actually see it flatter even up quarter or is it still prudent to be assuming a decline in the quarter?
Timothy S. Jenks
I think it would be prudent to see a decline in the first quarter because we have the seasonality, we have the ASP decline, we have the outdoor impact on the Access business and we have Chinese New Year which is a shorter quarter. So, all those things generally cause the first quarter to be seasonally lower than the third or fourth quarter.
This year we will have all those impacts, but we have a growth 100G market and Metro deployments. They offset each other, but I think we would expect to see a lower first quarter in total revenue.
Alex Henderson
That's great, thank you very much on that. And then just going back to the comment around the [indiscernible] and the multi-cash switch market, I would assume that that's still a very slow ramp into the back half and then picking up as the year progresses, is that the right way to think about it in 2016?
Timothy S. Jenks
Yes, it is. The situation for multi-cast switch and the CDC deployment is, it is primarily one telecom carrier in North America for the start and we expect that while it has started and that it will accelerate its starting from a zero position and there is a big pipeline to fill so it will be a slow ramp.
Alex Henderson
Okay, great. I’ll cede the floor, thanks.
Timothy S. Jenks
Thank you, Alex.
Operator
Your next question comes from Simon Leopold of Raymond James.
Simon Leopold
Great, thank you very much. First I just wanted you to remind us the timing of when you made the exits of products in the networks the non-100G just so when we think about modeling, when do you start facing different year-over-year comparisons?
Timothy S. Jenks
Sure Simon, we started that activity in the middle of 2014 and it took a year. So the $23 million of pruning impacted mostly the second half of 2014.
We said that it was approximately $5 million in the first half of 2014 and is zero from Q3, 2015 onward.
Simon Leopold
Okay, that’s helpful and I’d like to try to keep a conversation in English as much as we can, but I – we get a lot of questions about the transition in the optical market of different form factors and I think your best exposure to your customers of whey they assemble their own cards or their own blades made up of components from you. And we get a lot of noise about transitions to plugables or CFP2.
Can you help us understand how this transition may occur, what your perspective is and what it means for your business?
Timothy S. Jenks
Certainly, certainly and it’s an important question. The most important thing to first say about pluggables is that, pluggables are expressed in terms of form factors, size of module and all of them have names.
So the names for the 100G modules are the acronym CFP, C standing for 100G and FP standing for form factor plugable and there are three different flavors of that, there is a CFP, CFP2 which is half size and a CFP4 which is a quarter size. These are so smaller and smaller units.
What goes in the module can vary, so there are line side versions which today are referred to for example the CFP, ACO or CFP2 ACO and client side versions which can be for example CFP2, LR4 and SR4, these are the points were you’re talking about the language I know. The statement about CFP or CFP2 it needs to be expressed whether its line side in which case it is generally coherent or client side in which case it is not coherent and we are exposed to both of those So the next point is that we have long haul transport which is essentially all done with line cards and discrete components and it's not done at all with pluggables today and then in the metro space, the majority essentially all of it today is also done with discreet and line cards and we would expect the majority to continue as discretes but increasingly using some pluggables.
Now the issue with pluggables is that to some extent, pluggables are made up with principally components including a laser and a modulator and a receiver and so the pluggable module that has a transmitter with a laser and modulator and a receiver, the performance of each of those components determines whether it can be transported long distance or not long distance. And so this is why the vast majority of the line side are done with discrete components because it is the highest performance and there are applications now with some pluggables being used in the shorter distances principally for metro or data center interconnect.
Does that answer your - address your question, Simon?
Simon Leopold
It does and it’s very helpful and I appreciate it. It could be a complicated topic and I guess what I’d like to get is your perspective also on the timing of when pluggables become advanced that we do see a transition in the industry, when we would expect to see it in operator networks in volume, particularly CFP2?
Timothy S. Jenks
Okay. So having first said that CFP2 refers to a form factor and can be line side or client side, I’ll first say that the client side is being used now, but this is not coherent, this would be for example the CFP2-LR4 meaning it’s a long reach four times 25G client side.
For the line side meaning the transport networks, this we would expect to see in the second half of 2016 and 2017. Generally we are speaking about CFP2-ACO is the acronym, it will slowly ramp up through 2016.
Thus far CFP2-ACOs are really limited to samples only, so there really isn’t any volume thus far in the market and as indicated in our comments, we are selling into CFP2-ACO modules with the components that we sell. So we’re participating both in the discrete part of the market selling into line cards as well as into pluggables in the ACO modules.
Simon Leopold
And when these markets develop like we have an expectation that metro will be a ramping market for 100G, do you typically see line side as the leading indicator to client side, is that normal?
Timothy S. Jenks
Yes the Metro what we’re referring to here is also coherent, so you’re dealing with 100G transport as a leading – is a head of the 100G coherent metro. And then the 100G metro is initially predominantly discretes and line cards and then over time can go to some level of pluggables initially with large modules referred to as maxponders and then they go to pluggable transceivers.
So yes, the line side transport is a leading indicator and initially it’s really all done with line cards.
Simon Leopold
Great, I appreciate that. Thank you for taking my questions.
Timothy S. Jenks
Thanks Simon.
Operator
[Operator Instructions] Your next question comes from the line of Richard Shannon of Craig-Hallum.
Richard Shannon
Hi Tim and Ray.
Timothy S. Jenks
Hi Richard.
Richard Shannon
Thank you for taking my questions and congratulations on your nice results, thanks. I guess my first question maybe for you Ray, I’m not sure if I caught your prepared comments regarding gross margins in the fourth quarter, did you say that that guidance encompasses some element of pricing negotiations historically have happened in the first quarter but are impacting this fourth quarter?
Clyde Raymond Wallin
Yes the guidance that we gave 30% to 34% non-GAAP gross margins for the fourth quarter that does incorporate negotiations we’ve had with both Asian and non-Asian customers and some of that price negotiation will be reflected in our results in the fourth quarter pretty much on schedule with previous years.
Richard Shannon
Okay. Okay.
Fair enough then second question any thoughts as you can give as to how you expect 100G and above high speed to contribute to your fourth quarter revenues at least at the mid-point?
Clyde Raymond Wallin
So we have had in all of the last four quarters we’ve been between 56% and 60% of revenue, so are you asking us to predict what the product mix will be between the product groups?
Richard Shannon
Yes. Will it be outside that range as an example Tim?
Timothy S. Jenks
No I think it will be – it will still be in that range, I don’t expect it to be materially different.
Richard Shannon
Okay. I wasn’t expecting, I just want to make sure that I wasn’t missing anything there.
So thanks for that. If I may follow-up on some of the last few questions here regarding CFP2-ACO, obviously you’ve had very strong share in 100G coherent in over the last couple of years in covering one of your competitors, how do you see the overall transition as you start learning in CFP2-ACO obviously more of a metro contribution, how will that impact your overall revenue growth?
Is there any shift there from your discrete business to that, will that impact you to the negative in anyway, Tim can you help us think about that?
Timothy S. Jenks
Well I would say that overall for 2016, we would see in the entire coherent market, we would see the pluggable module version in the range of 10% to 15% of the market through the course of 2016. And so overall the impact it would have on our business is in that range.
And we are selling into certain pluggable market, certain pluggable ACOs ourselves. So we provide components into other people’s pluggables.
So the much bigger effects for our business, for the growth in the market and the fact that as the market grows and deploys additional metro those volume growth, that volume growth is large and there were additional players in the market, so I think those are the bigger factors the small percentage of the total that is pluggable ACOs is perhaps a third order effect.
Richard Shannon
Got it, okay. I figured it was but just wanted to make sure.
Maybe one last quick question kind of following up on that topic Tim on CP2-ACO it was my understanding that the market is interested in 200 gigabits per second versions of that. Is that technology and speed that you can support or expect too soon?
Timothy S. Jenks
Yes it is and in fact the 100G and 200G versions are from an optics point of view are essentially the same. So our components are being supplied into for 100G and 200G and in fact now we’re also supporting the initial 400G deployments and in many cases we’re dealing with slightly different modulation approaches between these.
So they are in many cases implemented by software suppose to hardware changes, so ultimately large scale deployment of 200G is a bit later than the 100G, 400G is later than 200, but nonetheless their activities supporting all of these today. And then when you think about the market that you use and the performance matters, so attributes such as linewidth for lasers or high bandwidth for receivers become the important attributes for performance when we are talking about things like 200G and 400G.
Richard Shannon
Okay, great. I appreciate the perspectives.
I think that’s all my questions. Thank you.
Timothy S. Jenks
Thank you, Richard.
Operator
[Operator Instructions] We have no further questions. I would now like to turn the floor back over to Mr.
Tim Jenks for any closing remarks.
Timothy S. Jenks
Thank you, operator. In closing I would like to thank everyone for taking the time today to join our call and thank our employees for their dedication and helping us to achieve our goals.
We look forward to updating you on our progress on our next call. Thank you and have a good evening.
Operator
Thank you. This concludes today’s conference.
You may now disconnect.