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Edited Transcript of NPTN earnings conference call or presentation 30-Apr-20 8:30pm GMT

Q1 2020 NeoPhotonics Corp Earnings Call

SAN JOSE May 14, 2020 (Thomson StreetEvents) -- Edited Transcript of NeoPhotonics Corp earnings conference call or presentation Thursday, April 30, 2020 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Elizabeth Eby

NeoPhotonics Corporation - Senior VP of Finance & CFO

* Timothy Storrs Jenks

NeoPhotonics Corporation - Chairman, CEO & President

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Conference Call Participants

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* Alexander Henderson

Needham & Company, LLC, Research Division - Senior Analyst

* Joseph Lima Cardoso

JP Morgan Chase & Co, Research Division - Analyst

* Ku Kang

B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components

* Paul Jonas Silverstein

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Richard Cutts Shannon

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Ryan Boyer Koontz

Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst

* Simon Matthew Leopold

Raymond James & Associates, Inc., Research Division - Research Analyst

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

* Timothy Paul Savageaux

Northland Capital Markets, Research Division - MD & Senior Research Analyst

* Erica L. Mannion

Sapphire Investor Relations, LLC - President

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Presentation

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Operator [1]

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Ladies and gentlemen, please stand by. Good day. And welcome to the NeoPhotonics First Quarter 2020 Conference Call. This call is being webcast live on the company's website at www.neophotonics.com on the Events page of the Investors section. This call is the property of NeoPhotonics, and any recordings, reproductions or transmission of this call without the expressed written consent of NeoPhotonics is prohibited.

I'd now like to turn our call over to Ms. Erica Mannion of Sapphire Investor Relations. Please go ahead, ma'am.

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Erica L. Mannion, Sapphire Investor Relations, LLC - President [2]

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Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the first quarter of 2020 and the outlook for second quarter of 2020. With me today are Tim Jenks, Chairman and CEO; and Beth Eby, Chief Financial Officer.

Tim will begin with a review of the company's business progress in the first quarter and a discussion of business drivers and products. Beth will then provide financial results for the first quarter before providing the outlook for the second quarter of 2020. Beth will then turn the call back to Tim for final comments before opening the call for questions.

The company's press release and management's statements during this call include discussions of certain non-GAAP financial measures and information, including all income statement and balance sheet amounts and percentages other than revenue, unless otherwise noted. These non-GAAP financial measures are not prepared in accordance with GAAP and are not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. These financial measures and a reconciliation of GAAP to non-GAAP results are provided in the company's press release and related Form 8-K being filed today with the SEC and can be found in the Investor Relations section on the NeoPhotonics website.

Material contained in the webcast is the sole property and copyright of NeoPhotonics with all rights reserved.

Certain statements in this conference call, which are not historical facts may be considered forward-looking statements that involve risks and uncertainties and include statements regarding future business results, product and technology development, customer demand, inventory levels, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially. Some of these factors have been set forth in our press release dated April 30, 2020, and are described at length in our annual and quarterly SEC filings.

Now I will turn the call over to CEO, Tim Jenks.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [3]

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Thank you, Erica, and good afternoon.

At work and at home, the global COVID-19 pandemic is at the forefront of our collective thoughts. And as a company, our first priority remains the health and well-being of our employees and those of our supply partners. Currently, our North American facilities are operating under shelter-in-place orders with some impact, while our China and Japan factories are running with full labor capacity, producing steady output. Our China suppliers have largely recovered, but there remains potential for new supply chain risks to emerge. As manufacturers around the world comply with local public health guidelines, we have teams in place to address these issues, and we're confident in our ability to support our Q2 outlook.

Moving to our first quarter results. NeoPhotonics delivered very strong revenue of $97 million, above the top end of our outlook range, with non-GAAP gross margin expanding to 31% despite normal seasonality, the extended Chinese New Year shutdown and supply chain issues due to the COVID-19 pandemic. This was revenue growth of 23% from the same quarter last year and was driven by a combination of strong end demand and customer demand in China, which represented 60% of revenue as well as strong in metro and DCI markets in the West, where we continued -- our continued leadership in 400-gig and faster solutions address the emerging needs for more network bandwidth capacity by both cloud players and carriers.

High-speed products were 92% of revenue. The continued strength in our performance reflects our focus on high-speed products, including our unique ultra-pure light tunable lasers, serving the industry leaders in coherent telecom and data center networks and the transition of cloud and hyperscale data center networks to coherent technologies.

Huawei, our largest customer, contributed 52% of total revenue, up from 41% as demand in China has returned following the pandemic onset. Revenue from our next 4 customers was 33% of revenue, which was up 10% in dollar terms from the same quarter last year. This was down sequentially, as is generally anticipated in the first quarter, and lower in percentage terms due to China's strength during the quarter.

Within China, China Mobile released their phase-13 national backbone tender results in which Huawei won the east ring network and ZTE won the west ring network. Note that these deployments are for the national backbone covering long-haul distances. We expect national backbone installations in China will be followed by additional provincial deployments in support of 5G rollouts.

We are expecting that a portion of these new China deployments will use 200-gig QPSK modulation and the Super C-band spectral window, which effectively doubles typical data carrying capacity in an optical fiber. For NeoPhotonics, the use of Super C-band leverages our C++ LASER product and related 64-gigabaud component and module solutions. This is important as combining the C++ spectrum and high baud rate together are key technology advances for speed over distance. This combination is first being deployed in China.

For high speed over longer distances, using higher baud rate is more efficient. To increase fiber capacity, you can also expand the spectral range, which is achieved using our C++ LASER, together with our 64-gigabaud components. These are designed specifically to work over the full Super C-band wavelength range. We expect that these innovations are here to stay and that ultimately these attributes will be broadly adopted.

Addressing cloud and data center markets, recently, we introduced several new DCO coherent modules. In addition to CFP2 and OSFP coherent modules for 400-gig and 400ZR applications, we now have sampled our new QSFP-DD DCO module, such that NeoPhotonics has now sampled 400-gig coherent modules in all 3 form factors to leading customers. The OSFP and QSFP-DD DCO modules offer complete optical connections over ZR distances up to 120 kilometers and form factors that plug directly into switches and routers, enabling the IP over DWDM network architecture, which greatly reduces the cost per bit of cloud and data center interconnection. Each of our DCO modules also offer ZR+ performance, extending reach to metro distances. And our CFP2 modules have the ability to operate over the wider C++ spectrum or over the C- and L-bands, increasing usable fiber capacity. These are further examples of how our tunable laser products are differentiated and how they work in tandem with our other high-speed components and modules. We believe these products will gain strong traction when they ramp in 2021.

Momentum continues to build for 5G deployments, most notably in China. As evidenced by the recent China Mobile tenders, the major carriers in China have indicated that their 5G deployments will not be delayed by the COVID-19 pandemic. In the West, with many people working from home, carriers have reported network utilization increases of 20% to 40% or more, and some carriers have proposed increased CapEx to accelerate 5G deployments, though timing will vary by region.

Deployment of next-generation networks is now underway, and NeoPhotonics products are supporting currently ramping rollouts at 200G, 400G and 600G, which provide ever higher capacities on single wavelength plus 800-gig systems that are being introduced. Each of these new high-speed systems further require customized multiplexer products having unique channel spacings and filter shapes, which we also provide.

In the current environment, drivers of our business continue to be favorable, given the increase in bandwidth needs due to remote working under the pandemic. We remain optimistic about the medium- and long-term trends in the industry, but we are also cautious about the next few quarters under the ongoing pandemic and the global uncertainties it creates.

With that, I will turn the call over to our CFO, Beth Eby.

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [4]

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Thank you, Tim, and good afternoon. Q1 was a strong quarter, resulting in non-GAAP EPS of $0.17, higher than our range on outstanding execution by our team and our suppliers in a difficult quarter.

Moving to more details on Q1 performance. As Tim mentioned, revenue was $97.4 million, well above our outlook. Our non-GAAP Q1 gross margin was 31.2%, above the midpoint of our range. Within this, product margins were 35.8%, down 1 point from last quarter on annual pricing reductions, offset by a favorable product mix. This was up nearly 9 points from the same quarter last year driven by the increasing leadership of our lasers.

Other cost of sales charges of about 4.5 points improved sequentially and were comprised of 2 points of underutilization charges mostly related to the extended Chinese New Year shutdown, just under 2 points of inventory reserves and just over 0.5 point of tax charges on products shipping from our U.S. fabs into China. This is lower than last quarter as tariffs on most of our products were eliminated in March.

Total non-GAAP operating expense for the first quarter was $20.3 million, down $4 million from Q4. $1.5 million of the reduction was a onetime license fee as a credit to R&D as expected. The remaining reductions are related to COVID-19 impacts in terms of lower travel, fewer marketing events and a temporary push of R&D project spend as some of our teams were not in the lab. The R&D spending reductions from Q1 will be added to future quarters.

Non-GAAP operating profit for the first quarter was $10.1 million or 10.4% compared to 7.4% in Q4. In Q1, depreciation of the Chinese yuan relative to the U.S. dollar drove a foreign exchange gain of approximately $1.3 million. As a reminder, the functional currency of our China operations is the yuan. The FX gain is driven by the revaluation of China balance sheet items to the end-of-quarter exchange rate. As we have said before, we regard any FX gains and losses as largely temporary.

As a result, non-GAAP net income for the first quarter was $9.1 million compared to an income of $5.3 million in the fourth quarter and a loss of $9 million in the first quarter of 2019. This improvement reflect -- in our results is a reflection of the increased value-add of our products and continued strong execution.

I will close out my discussion of the first quarter income statement with a review of our GAAP results. First quarter gross margin was 30.5%, up slightly from Q4 and up 11 points compared to the first quarter of last year, driven by an increase in volume and improved product mix. Operating expense was $22.3 million, down $4.5 million on a onetime license credit and lower spending related to the impacts of COVID-19. Operating profit for the first quarter was $7.4 million, which included $2.5 million of stock-based compensation expense and approximately $0.2 million of amortization of acquisition-related intangibles. Net profit for the quarter was $6.3 million compared to a profit of $2.1 million in the prior period.

Turning to the balance sheet. As you know, over the last couple of years, we have put a heavy emphasis on cash, cash flow and paying down debt. This focus has positioned us well with $109 million in cash, investments and restricted cash. Long-term debt paid down to $41 million, lean inventories at 61 days and good free cash flow at $22 million.

That said, we are taking steps to ensure that we can withstand a variety of potential scenarios that may emerge through the rest of the year, both positive and negative. As part of this, we are working to build inventory to buffer supply chain volatility.

Before I discuss our earnings and revenue outlook for the second quarter of 2020, I would like to remind everyone of our public filings with the SEC and our safe harbor statement included in our press release that discusses the risks and uncertainties that could affect future performance causing actual results to differ materially from our forward-looking statements.

While we believe there is immediate demand to increase network bandwidth capacity to handle the increased traffic, we continue to see supply chain risks. We have included approximately $10 million of impacts to Q2 revenue in our outlook due to concerns about supplier shutdowns as they comply with their local public health orders. We expect the supply chain risks to continue into the second half of the year.

But given that, the company's expectations for the June 2020 quarter are: revenue in the range of $94 million to $102 million; GAAP gross margin in the range of 29% to 33%; non-GAAP gross margin in the range of 30% to 34%; GAAP diluted earnings per share in the range of a $0.02 loss to an $0.08 profit; and non-GAAP diluted earnings per share in the range of a $0.05 to $0.15 profit. These numbers are reflective of approximately 54.2 million fully diluted shares.

We remain confident in the long-term demand trends for our industry. We are pleased with the progress that we have made to become a consistently profitable business with exciting products and continued strong execution in a volatile environment.

With that, I will now turn the call back to Tim.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [5]

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Thank you, Beth. We are pleased to deliver another profitable quarter, notably through our seasonally low first quarter in spite of headwinds from trade, bands and the pandemic. Needless to say, we're optimistic about our future.

Through the pandemic, China was shut down for only a short period and came back strong. Now they are accelerating deployments. This is a favorable supply environment for us as our high-performance and high-speed products bring even greater value in the systems they enable.

Our new product launches, including our new and differentiated nano and C++ tunable lasers and our strong lineup of new 400-gig and 400ZR DCO high-speed coherent modules plus high-speed modulators and receivers position us well with competitive product offerings as the world's cloud, data center and telecom markets drive for more bandwidth capacity in their networks. Moreover, these trends align well with new large customer demands that we see and in our expanding TAM serving data center and 5G markets.

As we look forward, the industry continues to move in our direction with higher and higher performance requirements. As this transition occurs, high-speed and high-performance optical components will increasingly be the differentiator. And we believe that NeoPhotonics is positioned to capture more of this value going forward.

This concludes our formal comments. And now I would like to ask the operator to open up the line for questions. John?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Mr. Richard Shannon from Craig-Hallum.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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Congrats on a very nice start to the year. If I may ask a question first on the results from the first quarter. When you gave guidance, you had imputed a $10 million impact from COVID. You beat the midpoint by roughly $10 million. Does that mean you didn't see any risks there? Or were there some issues still with COVID and you were able to beat the numbers by other means?

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [3]

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We absolutely did see some of the risks, but largely mitigated and increase in demand as well, some -- just some new business.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Okay. And let's take that into the second quarter with your sales guide here. At the midpoint, it's a modest growth here. Was this because you had such a strong first quarter? Are you building in, again, some of these risks here from the supply chain and others? Are there inventory build in the first quarter that you're worried about? If you could help us unpack kind of that trend in the second quarter that's a little bit lower than normal, especially in what looks like a favorable environment for you.

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [5]

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The -- again, having a $10 million risk in the second quarter is related to COVID. It's a little bit higher risk than I would say that we saw in the first quarter because what we saw in the first quarter was just we were waiting for companies to start up in China. Now we're dealing with a much broader set of suppliers that are potentially impacted by COVID-19, and some of them had periods of shut down. And they're trying to come back up.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [6]

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I'll just add to that, Richard, is that in the first quarter, it was risks, and that played out over time. In the second quarter, we've actually seen some of them actually impact. So it's not just risk. And all of it hasn't been mitigated, though we're working hard on all of it.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [7]

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So Tim, would you say the supply chain risk there are very specific and you're watching it closely? Or is this more of a generic cover-all statement for...

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [8]

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No. No. No. They're actually very specific. And the comments that we made about local public health orders in certain countries of the world that they'll impose a shutdown and shutdown plans. And then even when those plans sometimes come up, if they come up at 20% or 30% capacity, you have a problem. And we've seen that play out a number of times over the last 2 months, and we expect that it will continue to play out. So it's very real and very specific.

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Operator [9]

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Our next question comes from Tim Savageaux of Northland Capital Markets.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [10]

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Congrats on the results. We should lock you guys down more often. Spectacular. I wonder if -- well, I guess first question with regard -- well, first, very quickly, and this isn't kind of the question. I missed your China percentage number. I got the Huawei at 52%, but what was China overall again?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [11]

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China overall was 60%.

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [12]

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And just to finish that, China was 60%, Americas was 19%, the rest of world was 21%. But as you know, it's -- that's just where we ship to as opposed to end customer demand.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [13]

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Yes. Thanks for that. Okay. Well, looking at China, in particular, it's pretty clear. And we've got a lot of strength there. And I wonder if you could talk to the various drivers of that strength. You mentioned the backbone award. I don't know if you can tell whether you've seen that in your backlog yet? Obviously, a lot of this is connected to 5G in terms of front-haul or mid-haul. And we've heard some unique and positive comments about DCI in China from Nokia this morning. So as you look at this range of drivers and you absolutely feel free to extend this across your total business, but at least starting with China, in terms of the strength that you're seeing, I wonder if you could talk about it in those various categories.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [14]

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So in China, the first part of your question said, is it forward-looking or are we seeing it? And the answer is, yes, we are seeing it and it is reflected in our guidance for the second quarter. We've -- in the prepared remarks, I talked about the phase-13 and the expectations we have on provincial follow-on. In addition, these are supporting the overall 5G rollout. So they're -- depending on the carrier, they have created certain time frames within this calendar year to deploy the tenders that have been awarded. So we would -- while the phase-13, for example, wasn't expressly a large tender, it is one that we expect to play out during 2020 and then to be followed by provincial. This is all carrier telecom and not DCI.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [15]

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Right. And following on that kind of provincial commentary, historically, you've seen provincial deployments or perhaps significantly larger in the sort of regional backbones that were just awarded. And I guess I ask this with an eye toward your feeling on the continuation of this sort of strength throughout the year. And would you expect provincial awards to impact later in 2020 or into '21? And what sort of magnitude would you expect for those relative to what you've seen here in the first half?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [16]

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Well, the pattern has been that provincial awards follow a national backbone. So that is the primary reason for -- or having such expectations. Until we actually see it though, we really can't know either the timing or the magnitude, and I'd rather not speculate.

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Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [17]

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Fair enough. Well, then you probably won't answer this one then, but we'll give it a try. It's been a while since we've seen kind of normal seasonality sort of overwhelmed to some degree, and probably it would have been up without your COVID impacts in Q1. I think that was 2016, which is a pretty big year for this industry. And I wonder if you can compare kind of what you're seeing now to what you saw then? And from both a demand standpoint and maybe a pricing standpoint as well, given the consolidation we've seen, did that play a role in your better-than-expected Q1 results?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [18]

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Yes. The -- a couple of things there. Going back a few years, we certainly saw in 2016 a strong year but recall that, that was also followed by a very soft 2017. And we did express in our last 2 quarterly calls that we had some customers in China and in the West who were increasing their procurement and perhaps risk mitigating their go-forward plans. So I think for these reasons of potential customer inventory as well as the supply chain risks, I think we need to be a little cautious about how it might prove out.

Now with the pressures of the U.S.-China trade situation as well as BIS rules on EAR, we have seen a pricing environment that was not quite as aggressive as it has been in prior years. So I think that has been more stable in the recent -- most recent quarter and certainly in the first quarter and the fourth quarter. So in those situations, yes, it is a bit favorable.

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Operator [19]

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We'll take our next question from Paul Silverstein of Cowen.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [20]

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So I just -- before I ask you the question, just to make sure I understood your response to the previous question. Expected pricing, historically, you and a lot of other vendors have been citing 10% to 15%. And I think the common frame has been that it was on the more benign side of that, if I recall correctly. With respect to the price resets that you just referenced, what -- can you give us any quantification? You mentioned that it's more stable, more benign than it was previously. Do I understand that...

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [21]

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Well, no, but your memory is precise, Paul. And it was at the -- with that range, it was at the lower end of that range.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [22]

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And so it's consistent. It's not -- it's still on the more benign side of that 10% to 15%. Or have you changed that?

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [23]

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Yes. And -- but the other thing that I mentioned, Paul, is that we are moving to higher mix of higher performance parts as well. So that does -- that helps offset some of that, just more benign than the historical average.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [24]

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All right. So I'm glad you raised that. Here's the 2 questions. One, with respect to that issue, right, I assume it is without saying that as the linewidths go up to 600-, 800-gig and beyond, the number of competitors that can make ultra-narrow linewidth tunable lasers and other critical components that are critical -- either extremely critical to achieving those linewidths as opposed to lower linewidths where customers may not want to pay off and they don't need that performance. I assume there are far fewer competitors by definition, and therefore, pricing is relatively better.

The other question is beyond China, outside of China, we get the rest of the world, can you now offer us more insight in terms of what you're seeing in terms of demand trends from a product market, DCI, long haul, et cetera, as well as from the regional Asia Pac, non-China, EMEA market, et cetera? Any color you could add? Appreciate it.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [25]

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Yes. The first part, on the product mix, Paul, the -- in the prepared remarks, I mentioned a couple of things. So if we think about in order, lasers, coherent components and coherent modules, certainly, our lasers are differentiated, and we have several new versions. So the ability, for example, to provide a laser product into the Super C-band or our C++ LASER product is different. And then I think it's true that the number of players at 64-gigabaud at the higher symbol rates is a relatively smaller number. So that does certainly matter in this domain.

With respect to the products such as modules, the launching of 400ZR modules has happened, but they're not into production volumes yet. So they're not really impacting at this point the discussions about pricing. Because of the fact that we sell a lot of components into line cards, it's a little more difficult to differentiate between say, DCI and long haul for western customers, although we have noted that in -- some customers are doing proportionately more of their business from data center. And that no doubt, reflects in our mix as well. I hope that helps.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [26]

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Yes. Can you answer from a regional perspective? Can you tell where you're shipping to? But when you look at demand in Asia Pac ex-China, Europe, North America, what are you seeing? Any incremental color you can add?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [27]

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Well, let's see. In China, what we certainly saw was that at the end of 2019, we were concerned about China inventory build. Now we're seeing tenders released and so that will work through the system reasonably. But China has been strong in our last 2 quarters, and so we're going to be cautious about how it looks later in the year in China. The U.S. has generally been just strong and consistently so, particularly at the higher speeds. EMEA is relatively stable. Japan, too, some positive notes in Japan. But I would say China is the strongest, followed by North America, followed by rest of the world, which really means EMEA and Japan.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [28]

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All right. I appreciate that. And so one quick clarification for you, Beth. With respect to your business by revenue mix, now I know you don't break it out this way, but is there any insight you're showing up in terms of what percentage of revenue is lasers in particular? And I trust your module business is still now -- is still very, very small, still dominated by components overall revenue. But any sense you'd give us what lasers specifically are in terms of the overall allocation?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [29]

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Yes. Recall that we have several different types of lasers. And so the sum of all of our lasers approaches about half of our total revenue. And that means lasers for data centers that are fixed wavelength as DSPs. That means lasers that are generally used, for example, in 5G mid-haul and front-haul links, those are generally EML lasers. And then tunable lasers, which are used in coherent systems and are used in conjunction with our coherent components. So lasers are an important part of our company, but it does have 3 different broad types of lasers.

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Operator [30]

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And our next question comes from Alex Henderson of Needham.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [31]

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I was hoping we could just talk a little bit more about the supply chain side of things and to what extent that might be causing people to be building -- trying to build more inventory the same as you're trying to build more inventory downstream from you. Do you have any sense of whether the rate that you're shipping into the Chinese, for instance, is consistent with the rate that they're shipping out to their service providers? Or do you think that there's some inventory build? I realize that there was a concern at the end of the year, but do you think that's continuing build as we go forward? Or do you think that alternatively that they're, in fact, shipping the product through as fast as you're shipping it to them, given they're also rebounding in terms of demand? Which dynamic do you think is more prevalent?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [32]

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Well, let's see. In the first quarter, I think we're probably seeing more shipments to them than their shipments out. However, as we talked about in response to an earlier question, during Q1, we saw these new tenders and so those -- I specifically referred to China Mobile, but now there are additional things being done by China Unicom and China Telecom. And so in second quarter, we expect more balanced or even potential more use than accumulation. So I think Q1, the sum of all China customer inventory was probably increasing. And in the second quarter, I think it will probably be flat to down.

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [33]

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I do think, Alex, if we were able to get to our -- the full unconstrained revenue, that there would have been some inventory build in there, but we're constrained on supply chain.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [34]

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Right. So I would assume that, that reflects back to you by your customers calling you and pushing you to ship more product and being very concerned about product availability timing. Is that an accurate assessment that you're hearing frequently from your customers about when will you get the constraints behind you?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [35]

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Well, they're not asking when. They're just -- it's much more that they ping us daily and sometimes hourly. So -- but they understand the situation in the pandemic. They're wrestling with the same kind of supply chain issues. We're all in the same storm, though we're in different boats. And so they're -- everybody's wrestling with it.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [36]

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If you were to flip that from China to focusing on western accounts, is there any difference in the -- your sensibilities towards those accounts?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [37]

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No. Not really.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [38]

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So no inventory?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [39]

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I don't think I can really tell you much. We haven't -- we actually haven't heard enough from the whole ecosystem with this quarter and kind of the aftermath of living through a couple of months of the pandemic. I don't know enough yet.

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Operator [40]

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And our next question comes from Samik Chatterjee of JPMorgan.

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Joseph Lima Cardoso, JP Morgan Chase & Co, Research Division - Analyst [41]

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This is actually Joe Cardoso on for Samik. So my first question, I kind of wanted to dive in into your gross margin guidance. Obviously, very strong relative to your historical performance. And obviously, this quarter, you guys performed well on the gross margin line as well. I just wanted to kind of dive into the high end of that guidance and kind of get an understanding of what's driving that high end and how you guys would get to that high end as the quarter progress.

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [42]

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So one of -- the things that impact our gross margin, product volume particularly swings us on the underutilization. It also impacts our cost, product mix. Different products in different markets have different levels of margin. And the ASP reductions are pretty well baked in, also cost reduction. One thing that is unusual this quarter, and I alluded to it in my remarks, is that as of March, the tariffs in China that's been running in any given quarter for the last few quarters between 0.5 point and 1 point of gross margin. The tariffs on our U.S. products going into China have been eliminated. So the bulk of the difference, frankly, between this quarter and next quarters is that elimination of those tariffs. And we'll see what product mix ends up doing and that will swing us to the high end or the low end of the range.

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Joseph Lima Cardoso, JP Morgan Chase & Co, Research Division - Analyst [43]

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And then on the OpEx side, last quarter, you guys mentioned expecting maybe a slight increase in OpEx on the new product launches that you guys are having this year. And obviously, OpEx, in your prepared remarks, you said that it was a little bit down, but you expect it to layer in some of the expenses as we go through the year. So kind of few clarifications on that. One is, do you still expect OpEx to be higher this year? And then the second one being, how do you expect the cadence of layering on these R&D investments as we go through the year?

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [44]

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We don't guide more than one quarter. Welcome to Neo. That said, the -- we said straight out in Q1 that we guided midpoint of $22.5 million and we had a $1.5 million unusual credit gives you a pretty good idea of the stable run rate. There'll be some variability around that.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [45]

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And we -- as Beth said in the prepared remarks, Joe, we did have lower spending in the first quarter with the pandemic, and we expect that to be added to the subsequent quarters. We get the same amount of work done.

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Joseph Lima Cardoso, JP Morgan Chase & Co, Research Division - Analyst [46]

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Yes. Got it. Understood. And then if I could, just one more from my end. Relative to your C++ products, obviously, you guys have been seeing strong interest in China or from Chinese customers there. I'm just curious what would drive -- or what are you guys expecting will drive interest outside of China from the rest of the world? And I guess, to that point, [what guide] your Chinese customers finding that or finding the interest into that product?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [47]

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Well, let's see. The -- it's an interesting situation to be in the middle of this pandemic with people working from home and availing themselves of cloud services. People are talking about higher bandwidth utilization or bandwidth demand, and that all means that you want to increase the data carrying capacity of the fibers that are already installed. That is what C++ does.

And in China, work has been going on over the last year around these kinds of technologies with the Super C-band and the use of Super C-band with QPSK as a modulation, which I talked about in my prepared remarks. So they've been at it for a year. And now that they have these new tenders awarded, we expect it to deploy. But other parts of the world, it will take them a similar amount of engineering time to assess the value proposition and decide if it works. It's interesting to see that, that initial deployment is going to be starting just as we've all gotten adjusted to this need for more bandwidth capacity through the pandemic.

It also depends to some extent on available fiber capacity because if there are available channels on existing fibers, then that has to fill first before the next structure or the next technology is applied to increase that capacity further. But ultimately, it is a solution set that solves a particular problem, and that problem has gotten more current in recent months.

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Operator [48]

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Okay. Our next question will come from Simon Leopold of Raymond James.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [49]

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First, I wanted to get a quick maybe clarification or added color here. You did highlight the Huawei business being very strong. Did you have any other customers that exceeded 10% of revenue in the quarter?

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [50]

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We had one other customer that exceeded 10%.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [51]

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Do we know how much they exceeded 10% by?

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [52]

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As we've discussed a number of times, they have asked us to not cite their percentage.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [53]

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Okay. And then I just wanted to follow-up with the 400-gig opportunity, understanding it's still early, but having products available gets us started. What do you view as the timing for when that business becomes material for you? And how do you think about the total market opportunity in 2021?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [54]

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Well, let's see. The 400-gig opportunity, I have to describe 2 parts of it. It's more than 10% of our business right now, but there are 2 parts of it. The first 400-gig part that is driving the more than 10% is the fact that we have a wide range of 400- and 600-gig capable components that go into line cards and that are being sold in volume today.

For the DCO modules, which is, for us, we have 3 different form factors. We have a CFP2-DCO module, which is the favorite form factor for the telecom carrier space. And then for data center, we have both an OSFP and a QSFP-DD DCO modules. Each of these are 400-gig DCO modules. These, we expect to ramp in 2021. And frankly, we expect that through the course of the last few months, things have moved a couple of months to the right. So what might have been early 2021 now might move to the second quarter or even midyear in 2021. I hope that answers your question.

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Operator [55]

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And our next question comes from David Kang of B. Riley FBR.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [56]

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Can you give us an update on the Japan and Thailand production status?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [57]

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Sure. They're both running full throttle.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [58]

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So no impact from local currencies at this point? And you're not taking in -- they're not part of the $10 million impact for this current quarter -- second quarter?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [59]

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Yes. Our production is running fine. It's running full throttle. This is true not only in Thailand and Japan, but also in China. In our last quarterly conference call, it was just after China returned from an extended China New Year period and we were light on our labor. But over the next few weeks, the labor force returned from other provinces in China as they were able so that we were running full speed. Now...

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [60]

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The $10 million, Dave, is pure supply chain in multiple locations in the world.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [61]

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Yes. The other thing I just wanted to say was that in each of our locations, we have impacts from COVID-19. And we're running with practicing protocols of social distancing and low-density working, et cetera, et cetera. So there are impacts everywhere, but we're well into it. We've gotten used to it. We're getting all the work done and things are moving right along, but in terms of production only, it's all running just fine.

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Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [62]

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Regarding the supply chain issue, is there any kind of a key component that could cause some kind of a component imbalance, more bottleneck that could hold things up?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [63]

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Well, the answer is, yes, there are about 10,000. Essentially, every component is -- every subcomponent in a component is key and every component is key in a module. So...

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Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [64]

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If you can't get a nail or some glue or a widget, you're going to be -- you're going to have problems.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [65]

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So we have -- there are -- broadly speaking, there are 2 issues. We have -- we try to have multiple suppliers for most things that we buy, but oftentimes, there's a large one and a small one. And if the large one is unable to produce at the same rate, that causes us a problem. If someone is a sole supplier, that also causes us a problem. And when -- if a larger one has a problem and we go pull on the smaller one, the smaller one may be being pulled on -- by multiple companies at the same time.

So daily, this has been part of our daily conversation really since we learned how to spell COVID. And it's just that -- it's the reality with a global supply chain and different local public health requirements that, in some cases, we've had vendors that they'll have a public health ordinance. They'll shut down and they'll be back up 3 days later. Others, it takes a few weeks. So it varies widely, and it requires our full attention every day.

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Operator [66]

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And our next question comes from Tom Diffely of D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [67]

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First, kind of following on the last line, I was wondering if COVID has had an impact on your R&D labs. Have you had to limit the people in those labs and delay some projects?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [68]

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Well, it has had an impact. And I'll comment about it in a couple of ways. We have R&D locations in several places in the world. We have R&D in the U.S., Canada, Japan, China. And in China, we have R&D in both Shenzhen and we have R&D in Wuhan. So certainly, the most impact and the earliest impact was with our colleagues in Wuhan. All that said, they're all back at the office. They're running strong, and they've done a great job.

By the same token, our R&D is generally done around the world in a collaborative way. So when one organization is a little bit light, the others can pick it up to some extent. So we've continued to be able to get the job done, but we've had to be pretty innovative and flexible in making sure that we can do that. So far, it's worked out well.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [69]

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Okay. Great. And then as far as the data center goes, do I understand that you're saying that you think that COVID has actually accelerated plans to build the coherent in the data center?

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [70]

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No, I don't think that that's an accurate statement, but I do think that there is a need to deal with bandwidth capacity. And there are very, very good ways of leveraging coherent technology in increasing bandwidth capacity, which I talked about. And these are things, for example, having a wider spectrum, more channels of light. This is the C++, running with higher baud rate, I said that, that is efficient. That's a way of dealing with it. Actually having higher order modulation, that's a way of dealing with it. All of these require very pure lasers, which we supply. So the ways of actually using coherent technology to increase capacity certainly are strong suits of NeoPhotonics. But I think the general trend of adopting in the data center, more coherent technology, that's a big picture topic that takes considerable time.

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Operator [71]

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Our next question comes from Ryan Koontz of Rosenblatt Securities.

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Ryan Boyer Koontz, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [72]

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Congrats on the strong quarter, and thanks for the transparency in the business. Given kind of the upcoming disruption that's impacted -- certainly impacted the DCI market from ZR, how do you expect the fulfillment model to work, given there's a lot of different players and a handful of buyers there? You got the DSP suppliers, the optics guys, the systems guys, all kind of coming together here.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [73]

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Well, that's what you would might call the $200 million question. The industry is a global industry. And oftentimes, competitors are also each other's suppliers, and there's a good level of collaboration at every level of the food chain.

I think there are a couple of things to consider. First one is the fact that in the cloud and data center world, there are a dozen players around the world that are the preponderance of ultimate demand. By the same token, the same is true right now with the network equipment companies that we supply. There are a dozen that make up the vast majority of the industry. So it's incumbent on people trying to launch new technology products in volume to compete with your technical and production capability for those design opportunities -- design win opportunities. I think for the 400ZR market, that will be playing out over the next several quarters. My crystal ball isn't quite clear enough to say precisely how it will end up, however.

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Operator [74]

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And at this time, we are out of time for any additional questions. We will now turn the call back over to Tim for closing remarks.

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Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [75]

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Thank you, John. Thank you, everyone, for dialing in today, and thank you very much for your interest in NeoPhotonics. We appreciate the diligent work of our employees and of our suppliers to drive progress, especially in light of the current environment. Everyone will stay safe. We look forward to updating you in the future and meeting with shareholders again on the other side of the pandemic. Have a good evening.

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Operator [76]

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Ladies and gentlemen, that does conclude our call. On behalf of NeoPhotonics, we do appreciate your participation. Please have a great weekend. And at this time, you may disconnect.