U.S. Markets closed

Edited Transcript of NPTN earnings conference call or presentation 5-Aug-19 8:30pm GMT

Q2 2019 NeoPhotonics Corp Earnings Call

SAN JOSE Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of NeoPhotonics Corp earnings conference call or presentation Monday, August 5, 2019 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Elizabeth Eby

NeoPhotonics Corporation - Senior VP of Finance & CFO

* Timothy Storrs Jenks

NeoPhotonics Corporation - Chairman, CEO & President

================================================================================

Conference Call Participants

================================================================================

* Alexander Henderson

Needham & Company, LLC, Research Division - Senior Analyst

* Jun Zhang

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

* Ku Kang

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

* Michael Edward Genovese

MKM Partners LLC, Research Division - MD and Senior Analyst

* Paul Jonas Silverstein

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

* Richard Cutts Shannon

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

* Simon Matthew Leopold

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

* Timothy Paul Savageaux

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

* Erica L. Mannion

Sapphire Investor Relations, LLC - President

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Welcome to the NeoPhotonics 2019 Second Quarter Conference Call. This call is being webcast live on the NeoPhotonics Event Calendar web page at www.neophotonics.com. This call is the property of NeoPhotonics, and any recording, reproduction or transmission of this call without the express written consent of NeoPhotonics is prohibited. The webcast is available on the Event Calendar page of the NeoPhotonics' website. I would now like to turn the call over to Ms. Erica Mannion at Sapphire Investor Relations. Please go ahead, ma'am.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the second quarter of 2019 and outlook for the third quarter of 2019. With me today are Tim Jenks, Chairman and CEO; and Beth Eby, Chief Financial Officer. Tim will begin with a review of our business progress in the second quarter and a discussion of business drivers and products. Beth will then provide financial results for the second quarter before providing the outlook for the third quarter of 2019. Beth will then turn it back to Tim for closing remarks before opening the call for questions.

The company's press release and management 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 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 at the Investor Relations section on 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, capital needs and availability, customer demand, inventory levels, economic and industry projections or subsequent events. Various factors could cause actual results to differ materially. Some of these risk factors have been set forth in our press release dated August 5, 2019, and are described at length in our annual and quarterly SEC filings.

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

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Erica, and good afternoon. NeoPhotonics recorded second quarter revenue of $81.7 million, above the high end of our revised outlook, up 3% from the prior quarter and essentially flat compared to the same quarter last year. High-speed products were 89% of revenue. This was in spite of the headwinds of U.S. government actions related to Huawei Technologies. The Department of Commerce put Huawei, historically our largest customer, on its Entities List with effect as of May 21, thereby banning them from purchasing items subject to U.S. Export Administration Regulations or U.S. EAR. As a result, we revised our financial outlook from an initial revenue midpoint of $90.5 million to a revised midpoint of $77.5 million, reflecting the immediate cessation of our shipments to Huawei.

NeoPhotonics is committed to rigorously complying with United States export regulations. Since the addition of Huawei to the Entities List, we implemented processes to evaluate each of our products against the standards set forth in those regulations. Each product must be reviewed individually in a detailed, specific and rigorous process, and these reviews are ongoing. Having consulted with our legal counsel and technical experts, we determined that certain of our products are not subject to EAR and may continue to be sold to Huawei and its affiliates. Consequently, late in the quarter, we restarted shipping certain non-EAR products to Huawei. In late June, administration guidance was that U.S. firms would be allowed to sell to Huawei with a license under certain conditions. We have applied for a license to ship certain EAR products. As a result of our cessation of shipments to Huawei for much of the quarter, our business with them declined from 46% of revenue in 2018 to 36% of revenue in the second quarter of 2019.

In the quarter, our next 4 customers were 48%, up from 37% of revenue in the last quarter. The telecom business in China continues, and we note that late in the second quarter, China Mobile announced the award of a tender for certain parts of its 5G network, of which Huawei won a significant share. Further, we see ongoing demand for deployments of existing 100-gig and 200-gig systems. In the second quarter, demand from our customers in China, other than Huawei, increased slightly but remained within the normally expected range. We do not expect significant share shifts there going forward.

Our business has been strong with Western customers, especially in DCI and metro markets. In fact, our top 5 Western customers were each up by double-digit percent in sequential revenue growth, with growth coming from product shipments for 400-gig and 600-gig systems. As a result, our business from Western and rest of world customers was 52% of revenue, comprised of 24% from the Americas, up from 18%; and 28% from rest of world, up from 25%. China was down, commensurate with the drop at Huawei, to 48% of revenue.

Moving to product technology. Recent industry announcements have focused attention on system approaches to increasing data rates in a single fiber and then in a single channel. To increase the information bandwidth carried by a single wavelength, optical system designers have 2 levers to work with. They can increase the basic frequency at which the system operates, called the baud rate or the symbol rate, or they can use higher order modulation to transmit more symbols -- more bits per symbol. There are trade-offs to these 2 approaches, with higher order modulation having shorter reaches and higher baud rates requiring wider wavelength channels. Indeed, most systems use some combination of the 2 approaches.

For each of these high data rates, high-performance optics is critical to achieving the required system performance. NeoPhotonics provides high baud rate modulators and coherent receivers in addition to our ultra-narrow linewidth tunable lasers. We continue to see good progress with design-ins and volume growth for our Class 40 64-gigabaud product suite, which is aimed at 400-gig and 600-gig applications, and we have announced our Class 50 receiver and modulator aimed at 800-gig applications. As we have discussed previously, with higher order modulation such as 64 QAM, the very pure light and low phase noise of our lasers becomes increasingly important. Because of this, our tunable lasers have the right performance to be the laser of choice for the higher-performance systems.

Connecting this to specific system data rates, we anticipate that 400 gig will continue to deploy while our 600-gig products ramp through this year and next. Beyond 2020, we expect 600 gig will coexist with coming 800 gig, and we will be engaged in deployments of both. Each of these approaches requires best-in-class component performance, which NeoPhotonics delivers, both with our vertically integrated indium phosphide PIC platform and our active silicon photonics platform.

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

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

With that, let me turn the call over to our CFO, Beth Eby.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Tim, and good afternoon. Our second quarter brought us both challenges and some opportunities. In May, after the Huawei ban went in place, we executed on changes in our operations to adjust to lower revenue levels. We reset our supply chain, adjusted R&D projects and reduced expenses substantively. This, combined with good news in FX, resulted in a non-GAAP Q2 EPS loss of $0.03 compared to our revised midpoint of a $0.10 loss.

As Tim mentioned, revenue was $81.7 million, slightly higher than we expected, on strength in the Western DCI market and the restart of non-EAR product shipments to Huawei at the end of the quarter. Our non-GAAP Q2 gross margin was 25.6%, at the high end of our range. Within this, product margins were approximately 32% as expected and up 5 points from last quarter on good execution of cost reductions. Other cost of sales charges of about 6.5 points were comprised of approximately 5 points of underutilization charges given the volume cuts and 1.5 points of other charges, all less than 0.5 point, the largest of which was tariff impact.

Moving to operating expenses. Total non-GAAP operating expense for the second quarter was $22.1 million. This was at the low end of expectations, down approximately $2 million sequentially on a combination of spending reductions and project pushouts. Non-GAAP operating loss for the second quarter was $1.2 million or a 1% loss compared to a loss of 8% in Q1 driven by higher gross margin and lower spending. In Q2, appreciation in the U.S. dollar relative to the Chinese yuan drove an FX gain of approximately $1 million. As a result, non-GAAP net loss in the second quarter was $1.2 million compared to a loss of $9 million in the first quarter. This translates to a non-GAAP EPS loss of $0.03 compared to a loss of $0.19 in Q1. For the second quarter, adjusted EBITDA was $6.8 million.

I will close out my discussion of the second quarter income statement with a review of our GAAP results. Second quarter gross margin was 19%, down from 20% in Q1 and flat compared to the second quarter of last year. The second quarter margin includes charges of $3.6 million related to the write-down of Huawei-specific inventory and the costs related to end-of-life of our client module of $0.9 million.

Operating expense was $23.9 million, down from $27.7 million in the preceding quarter on lower spending and a $0.8 million gain on sale of our Russia assets. Operating loss for the second quarter was $8.2 million, which in addition to the charges I already mentioned, included $3 million of stock-based compensation expense and approximately $0.3 million of amortization of acquisition-related intangibles and restructuring charges. Net loss for the quarter was $7.3 million compared to a $14 million loss in the prior period.

Turning to the balance sheet. We finished the quarter with $74 million in cash, investments and restricted cash, down $5 million from the prior period on the repayment of debt. Net inventory was $49 million or 67 days, down $5 million from the first quarter, mostly on the write-down of Huawei-specific inventory. Free cash flow was approximately $0.3 million, better than expected as we made the needed changes in our spending.

Before I discuss our revenue and earnings outlook for the third quarter of fiscal 2019, 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 risks and uncertainties that could affect future performance, causing actual results to differ materially from our forward-looking statements. We continue to monitor changes in the Department of Commerce and BIS rules related to Huawei and their affiliates. We have not included any benefit for shipment under pending licenses in our forecast. However, products that we have determined are not subject to U.S. EAR are included. These products represented a majority of our shipments to Huawei in 2018.

Demand signals from our global customers are positive for the year. As a result, revenue for Q3 is expected to be solid. The supply chain constraints that we have seen for the last 6 to 9 months have ameliorated. Given that, the company's expectations for the September 2019 quarter are: revenue in the range of $87 million to $93 million, GAAP gross margin in the range of 24% to 28%, non-GAAP gross margin in the range of 25% to 29%, GAAP diluted earnings per share in the range of a $0.09 loss to a $0.01 profit and non-GAAP diluted earnings per share in the range of a $0.03 loss to a $0.07 profit. These numbers are reflective of approximately 48.6 million fully diluted shares. Looking forward to the fourth quarter, based on what we know at the moment, we would expect revenue in a range largely similar to Q3.

In summary, while we continue to monitor the evolving status of the Huawei ban and U.S.-China trade, we have executed well to reset our business and remain focused on managing the business for cash and profitability. I'll now turn the call back to Tim for closing remarks.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Beth. We are looking at Western customers and DCI for continued growth, and we expect to benefit from growing deployments at 400-gig and 600-gig data rates. As Beth noted, we exited our Russia operations and Dmitry Akhanov, representing RUSNANO, subsequently resigned from our Board of Directors. We appreciate his contributions as a Director of the company. Moreover, we are pleased that Dr. Yanbing Li, a seasoned engineering executive from the cloud services industry, joined our Board of Directors, as we announced on July 9, 2019.

As we have communicated over the last year, our focus has been on profitability as we ramp our newer high-speed products. We have also remained focused on execution to extend our leadership position in the high-speed digital optoelectronics market with 64-gigabaud and moving to 100-gigabaud and above product introductions as well as seeing some adjacent market opportunities developing for our high-speed technologies.

This concludes our formal comments, and now I'd like to ask the operator to open up the line for questions. Cody?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) We'll take our first question from Alex Henderson with Needham & Company.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [2]

--------------------------------------------------------------------------------

I'm very impressed. You did a great job of managing through a very difficult situation. My hats off to you guys. I was hoping you could give us a little bit more granularity on a couple of the key pieces of the puzzle here. Specifically, what portion of your revenues to Huawei are not covered by the EAR requirements? And to what extent or what portion has been requested of the government for exemptions? In particular, those are the 2 key pieces that we don't really have full granularity on.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

So let's see, taking that in part. As we've said, we do have a lot of our products that are not EAR, in fact, the majority of the products sold in the course of 2018. Just recall, we've been acquisitive over our lifetime. We've acquired businesses in Japan, China and we have development centers in those countries as well. And so we have a number of products and technologies that are not subject to EAR. So it is the majority of our Huawei shipments.

The license pertains to specific products that are subject to EAR and not surprisingly, it's a minority and it's fairly modest overall. So our outlook for Q3 reflects the majority of product shipments to Huawei continuing. And as they are non-EAR and as Beth said, we haven't included any EAR shipments in our forecasts and she gave comments for both Q3 and potentially for Q4.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [4]

--------------------------------------------------------------------------------

So just to be clear, the demand from Huawei hasn't slackened for the products that would then go into systems that might be unable to produce because they were missing other products? So there've been no drawdown in demand from Huawei at all in that context?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Well, as I said in my prepared remarks, we're seeing a fair amount of demand for 100-gig and 200-gig systems. So these are a bit more legacy. And this is essentially where the preponderance of demand is rather than in, let's say, 400 gig or more state-of-the-art technology.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [6]

--------------------------------------------------------------------------------

I see. And just one question for Beth, if I could. Can you give us some sense of what the trajectory on OpEx will look like for the next couple of quarters since obviously you're taking a pretty good shot at bringing those down as much as you can? That would be very helpful.

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [7]

--------------------------------------------------------------------------------

We took a -- we absolutely took a haircut, and if everything goes as expected, I would expect us to remain in Q4 at $22 million to $23 million as our ranges for Q3.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

We'll now move on to our next question from Simon Leopold with Raymond James.

--------------------------------------------------------------------------------

Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [9]

--------------------------------------------------------------------------------

Certainly relieved by these results. So certainly a difficult time for you guys, so imagine it's been stressful. So just a little bit of help in terms of understanding this licensing process. What's your sense of how long it takes to get through? And would you anticipate that if you were to get a response back, would it be the kind of thing you would provide an interim update? Or is it not material enough to your guidance?

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [10]

--------------------------------------------------------------------------------

So let me start, Alex, by saying we did not put anything...

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Simon.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Simon, sorry. But we did not put anything in the guidance. So it -- I wouldn't expect it to be a huge upper.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [13]

--------------------------------------------------------------------------------

Yes, the -- so as we previously said, after the ban hit, is that we talked about non-EAR products and the fact that we -- 2 things have to happen. One is you have to have products that you can ship, and second is you have to have demand. And so the process that is done here is there are pretty clear guidelines from BIS as the process for applying for a license. As we've said in our prepared remarks, we have done that, and we have received clarifying questions back from BIS. We're not aware of other companies having been granted, at this point, licenses. So therefore, we actually don't know how long it will take.

Because of the fact that the revenue from these products is a minority and they're not in our guidance, the longer it takes, the less expectation we have for uppers because of the fact that we have to generate demand for products if we're given a license. And so at the moment, we don't know how long it will take. We don't know if there's going to be ongoing demand. Therefore, we don't really know what level it could be an upper. So we haven't included anything in the forecast.

--------------------------------------------------------------------------------

Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [14]

--------------------------------------------------------------------------------

Okay. And you did mention Huawei, I believe, was 36% of sales in the quarter. Can you offer us any other color? Were there additional 10% customers? How big were they, if so?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [15]

--------------------------------------------------------------------------------

We have -- we had one other 10% customer.

--------------------------------------------------------------------------------

Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [16]

--------------------------------------------------------------------------------

How material?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [17]

--------------------------------------------------------------------------------

Well, yes, certainly as -- above 10%.

--------------------------------------------------------------------------------

Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

--------------------------------------------------------------------------------

(technical difficulty)

something more specific. I assume it means you don't want to tell us today.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [19]

--------------------------------------------------------------------------------

Well, we -- so in our 10-Q, we'll file on 10% customers. And as we said, we did put the next 4 in our 48% of revenue.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [21]

--------------------------------------------------------------------------------

Slightly different perspective. Tim or Beth, is it -- is there risk that Huawei -- I assume by definition there's risk that Huawei has double, if not, triple ordered in order to stock up in case the administration expands the definition of what's prohibited. And is there also corresponding risk of the other key supplier -- key customers having also done some degree, if not double and triple, some degree of over-ordering in connection with what had been tight supplies in order to secure what they needed and therefore true demand is not quite as robust as what the numbers would indicate? I don't know if it's the quality of your insight, but anything you can share with us would be appreciated.

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [22]

--------------------------------------------------------------------------------

Well, I think I'll start and Tim can pile on, is I think it's absolutely normal behavior for them to get some inventory in if they can. But as I said, the supply chain constraints have ameliorated. They have not gone away. So it's not clear that they have or are building inventory on the products that we have. Now that said, as you know, we always look back at the quarter after the quarter's over and say what did they ship out versus what did we ship to them and do a check, but it's backward-looking.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [23]

--------------------------------------------------------------------------------

Paul, I would say though the risks that you expressed do exist. And I'll just agree with you, those are all risks. It's hard to say to what extent or what volume, but certainly, the risk exists.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

And Tim, historically, I think you and Beth have made observations in terms of your ability to track how much is actually being consumed, how much inventory is actually being built up. Is the quality of your insight different today, for better or worse?

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [25]

--------------------------------------------------------------------------------

I think it's a little worse actually because we don't know who's able to ship what at the moment. So...

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [26]

--------------------------------------------------------------------------------

Also, under the ban, we have fewer interactions with Huawei. So we actually have less information than we might have had in prior quarters and years.

--------------------------------------------------------------------------------

Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [27]

--------------------------------------------------------------------------------

Tim, not trying to bias the argument, but at the risk of stating the obvious, I assume the worst-case scenario would be that they are limited, to one extent or another, on what they can ship out to customers by virtue of missing one or another component. And what components they can obtain from folks like yourself, they're buying all they can so that when they have all the components required, they'll have a big inventory buffer. I mean I assume that would be the extreme worst case.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [28]

--------------------------------------------------------------------------------

Again, it's within the realm of possibilities. But again, we have seen certain tenders. We've seen the onset of the 5G. We do see that their focus is actually more on the legacy systems at the lower data rates, where they do, in fact, have more second and third sources for components. So I think that's in the realm of possibilities, but time will tell. I think they have -- they've said that their business may be down 25% on the year, but that still means they'll do $100 billion of business.

--------------------------------------------------------------------------------

Operator [29]

--------------------------------------------------------------------------------

We'll now take our next question from Richard Shannon with Craig-Hallum.

--------------------------------------------------------------------------------

Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [30]

--------------------------------------------------------------------------------

A couple questions. Tim, you noted some very strong growth from outside of China to, as you described, at your Western customers. Can you give us a sense of what you baked into your guidance for the growth of that customer set in your third quarter guidance?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [31]

--------------------------------------------------------------------------------

Well, what we've said is that the 5 largest Western customers were all up in double digits. And collectively, they all have strong backlogs with us. And so in our forward-looking guidance, we have expected a smaller percentage of total revenue from Huawei, not surprisingly. And we've expected continued strength from the largest of our Western customers. I can't quite quantify it in terms of what percent of revenue, and I don't think our forward-looking view or forecast accuracy is good enough to do that. But it is forecasting continued growth from the West and rest of world vis-à-vis China.

--------------------------------------------------------------------------------

Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [32]

--------------------------------------------------------------------------------

Okay. That's helpful to get some perspective. Tim, also in your remarks and answers to some questions, you talked about trends between the slower speed, 100, 200, and then the higher speed, 400 and 600, or I know you have gigabaud relationships there, too. But what's the sense of whether 400, 600 is anywhere near -- half of that high-speed category right now?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [33]

--------------------------------------------------------------------------------

No, actually it's not. What we did say is it's more than 10%, but it's not half of it.

--------------------------------------------------------------------------------

Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [34]

--------------------------------------------------------------------------------

Okay. That's helpful. And last question for me and I'll jump out of line here...

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

I'm sorry, Richard. Just remember also that we did say that, for example, in the case of China and Huawei, the preponderance of demand is on 100 gig, 200 gig. So it's not on 400 gig. So there is certainly a decrease in demand from Huawei and China for the 400 gig. So that affects -- that's factored into my saying it is still more than 10%, but we kind of took a breather on the 400-gig growth because of the China situation with Huawei.

--------------------------------------------------------------------------------

Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [36]

--------------------------------------------------------------------------------

Okay. That's helpful, Tim. My last question, I'll jump out of line here. Some of your products that are not subject to EAR, are they not subject to that specifically because they are sourced from outside the United States? And kind of correlated to that question, if that's so, is there a possibility you see any risk of those becoming EAR even if they are made internationally and a potential downside risk for you?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes, as we said in our prepared remarks, we're following the regulations. We're studying the regulations, and the regulations are certainly subject to change. Products that are developed outside the U.S., manufactured outside the U.S., certainly are non-EAR. There are certain products that are U.S. products that are EAR. In between, it's the detail of examination within the boundaries of the regulations. I think to the extent that the regulations are consistent, they're quite clear as to what the rules are, and we will rigorously follow the rules.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

We'll take our next question from Jun Zhang with Rosenblatt Securities.

--------------------------------------------------------------------------------

Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [39]

--------------------------------------------------------------------------------

So I have 2 questions. One, you mentioned there's a strength coming from non-China market. Is that more from DCI market? Or is it more from the 5G-related products? That's one. The second, as U.S. put another 10% tariffs on the $300 billion product, does that include the optical module? And how do you see the impact on the Q3?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [40]

--------------------------------------------------------------------------------

So the preponderance of our strength is actually DCI and metro, and I think I said that in my prepared remarks, rather than 5G per se. We do see demand in 5G, but today, it's relatively modest for NeoPhotonics.

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [41]

--------------------------------------------------------------------------------

Tariffs, as I mentioned, we were subject to tariffs, but the tariffs we're subject to are the tariffs in China coming from U.S. products. Those are the ones that impact us more. We ship very little directly from China to the U.S. We ship very little to the U.S. at all. When we cite the Americas, most of that's going to contract manufacturers in the Americas outside the United States. The additional $300 million (sic) [$300 billion] does not impact us at all.

--------------------------------------------------------------------------------

Jun Zhang, Rosenblatt Securities Inc., Research Division - MD & Senior Research Analyst [42]

--------------------------------------------------------------------------------

Okay. Got it. And one more follow-up on the DCI and metro. Do you see -- like, we talked about in the, I think, in the first half about a little bit of slowing down of your -- one of your major clients in the U.S. Is that -- anything changing right now? And do you see this demand is sustainable in the next few quarters?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [43]

--------------------------------------------------------------------------------

So as I noted, our 5 largest Western customers were all up sequentially in double digits. So to the extent that a Western customer is going down, it would not be among the top 5.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

We'll take our next question from Tim Savageaux with Northland Capital Markets.

--------------------------------------------------------------------------------

Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [45]

--------------------------------------------------------------------------------

I want to follow up on the, to beat a dead horse, on the non-, I guess we'll look at it, non-Huawei strength. It looks like that was up almost 30% sequentially in the quarter, in line with your double-digit commentary, which is pretty extraordinary. And I wonder -- you've talked about DCI, but do you see that as pretty broad-based? Or is that strength driven by 1 or 2 of your bigger Western customers? Or how would you characterize that growth? And did that come in stronger than you might have expected in the quarter?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [46]

--------------------------------------------------------------------------------

So as noted, it kind of goes across -- actually, probably the top 10 customers for the most part. We do have a couple of larger customers in the West that frankly just -- we have fairly concentrated customer groups. So big changes are usually done by the big customers, and I don't think that's different this time. So it is strongest with the strongest, yes.

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [47]

--------------------------------------------------------------------------------

But Tim, on your 30% number, remember, we had -- we were only, frankly, a little bit above the high end of our range, and that's as we started to ship again to Huawei at the end of the quarter. So we -- 30% feels a little frothy.

--------------------------------------------------------------------------------

Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [48]

--------------------------------------------------------------------------------

Just doing the math. And maybe this leads to my next question, which is -- and Tim, you mentioned you expect Huawei down as a percent. Do you also expect Huawei down on an absolute basis in the quarter? It sounds like you're kind of looking at flattish or something like that.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [49]

--------------------------------------------------------------------------------

I think on a percentage basis, I would expect that Huawei will actually decrease. On a dollar basis, I'm not sure I know whether they'll increase or decrease. But because of the fact that we're expecting reasonable growth in the third quarter and we're not necessarily expecting much growth from Huawei, they'll decrease on a percentage basis.

--------------------------------------------------------------------------------

Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [50]

--------------------------------------------------------------------------------

Right. So at the very least, you expect a continuation of that kind of pretty solid double-digit growth across the rest of the business?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [51]

--------------------------------------------------------------------------------

Yes. And so -- and a lot of that does reflect in demand for 400-, 600-gig products, and we're fortunate in the timing of that growth and that demand in volume, given the Huawei situation. But it's also -- in my prepared remarks, I said we are looking to those Western customers and DCI as the sources of growth going forward, and our resources and focus have to be that way.

--------------------------------------------------------------------------------

Operator [52]

--------------------------------------------------------------------------------

We'll now move on to our next question from Dave Kang with B. Riley FBR.

--------------------------------------------------------------------------------

Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [53]

--------------------------------------------------------------------------------

My question is on 56-gigabaud EML. Can you tell us the number of customers and percentage of revenue right now?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Generally speaking, we've said that on a components basis, it runs in the range of 10% of revenue, and we don't detail the number of customers.

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [55]

--------------------------------------------------------------------------------

He said 56-gigabaud EML.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [56]

--------------------------------------------------------------------------------

Oh, okay. My number is the components [part]. 56 gigabaud EML is heavy in the design phase. We're not -- our shipments are actually quite small in 56 gig today.

--------------------------------------------------------------------------------

Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [57]

--------------------------------------------------------------------------------

I see. Just to be clear, that's for 400 gig for intra-data center applications, correct?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [58]

--------------------------------------------------------------------------------

Well, the applications are both intra-data center and 5G backhaul, mid-haul, single gig -- single-lambda 100-gig PAM4. And our expectations are that the 5G front-haul, mid-haul applications will probably -- that's kind of 2020 growth rather than right now.

--------------------------------------------------------------------------------

Ku Kang, B. Riley FBR, Inc., Research Division - Senior Analyst of Optical Components [59]

--------------------------------------------------------------------------------

And who's your competitor there?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [60]

--------------------------------------------------------------------------------

Well, everybody else who makes EMLs.

--------------------------------------------------------------------------------

Operator [61]

--------------------------------------------------------------------------------

We'll now move on to our next question from Michael Genovese with MKM Partners.

--------------------------------------------------------------------------------

Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [62]

--------------------------------------------------------------------------------

The last time you guys gave guidance, I think you suggested that 3Q run rate would be about $65 million. So today, with the $90 million guidance, my question is, is 100% of that explained by the difference of your view previously and now, explained by the Huawei non-EAR products? Or versus that time, are you also raising your outlook for these top 5 or 10 Western vendors as well?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Well, when we said $65 million, we also said that is if there is no further demand for non-EAR products. We subsequently did say that we do have non-EAR products, and it is the case that there has been ongoing demand. But at the time that we cited the $65 million number, we said if there is no further demand from Huawei for these non-EAR products.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

The majority of it is Huawei coming back, but there is some strength from other customers as well.

--------------------------------------------------------------------------------

Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [65]

--------------------------------------------------------------------------------

Great. And Tim, based on that same conversation, I think you talked about that it could take time for redesigns to -- the customers do redesigns that would benefit these non-EAR products. Do you think that you've seen the impact of redesigns? Or do you think that that's in front of us and that could still happen and drive demand for these products, sort of see like older products, till we get to the higher level than what we're seeing now?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [66]

--------------------------------------------------------------------------------

Yes, your -- it's an insightful question, but it's one where our visibility is limited. Essentially, the fact that Huawei appears to be having more demand for the legacy systems does suggest that with certain customers, perhaps the domestic customers, there's a continuing need for capacity in the network. There's a continuing need for them to invest in their infrastructure. And therefore, they're fulfilling that perhaps with more of the legacy systems.

And for some of our products, some of our products are unique and differentiated in their capabilities. And so others, they do have Chinese competitors or Japanese competitors or both. I think what's -- what will happen in the redesign, that will happen over time just as -- they may modify their supply chain over time. Certainly, we'll modify our customer mix over time. And frankly, my crystal ball isn't quite clear enough to see how all that will play out.

--------------------------------------------------------------------------------

Michael Edward Genovese, MKM Partners LLC, Research Division - MD and Senior Analyst [67]

--------------------------------------------------------------------------------

Okay. Fair enough. Let me just ask on 600G. You've made some positive comments about 600G versus. But where you were 3 months ago on 600G, do you feel better, worse? Are things moving faster, slower? What's your view?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes, I'd say better. For 600G, it was pretty -- it was early days a quarter or 2 ago. We're shipping products into that space, and the volumes are increasing. So we're feeling pretty good about it.

--------------------------------------------------------------------------------

Operator [69]

--------------------------------------------------------------------------------

We'll now take our next question from Alex Henderson with Needham & Company.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [70]

--------------------------------------------------------------------------------

I was hoping you could talk a little bit about how you feel about the DCI market as we start to anticipate the move to ZR, ZR plus down the line and whether that helps you, hurts you? How does it play out relative to your positioning?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [71]

--------------------------------------------------------------------------------

Well, let's see. That is the $4 billion question, Alex. There are 2 parts to that. First one is that the 400ZR approach is capable and enabling a slightly different architecture. It will take time for it to roll out. But essentially, we are selling a component suite into 400 gig and 600 gig, going into line cards or pizza box architectures now and we've developed a full 400ZR capability component suite for pluggables as well. So for us, the 400ZR will -- is primarily on our silicon photonics platform where we have nano tunable lasers and COSAs that go into 400ZR. We see that as really 2020, ramping in 2021.

And so that market is an upper for us. It also expands the size of the market. By the same token, the market that is using pizza boxes and line cards today, 400 gig, 600 gig, that will expand to include 800 gig. And then as I said, they will coexist. And then we also have recent deals that affect who's in control of the market share and what systems offer. And I think that is also a big determinant into how the 400ZR market develops. This is an important set of topics for our industry, for our company and for our competitors as well. We're feeling our positions in terms of technology, products and road map are actually quite well suited for the direction it's moving.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [72]

--------------------------------------------------------------------------------

Great. One for you, Beth. The currency gain in the quarter, $1 million I think you said, I'm assuming you have some currency benefit in the September quarter guidance. Or are you assuming that drops out totally? And to the extent that there's a big shift in the exchange rate versus the Chinese currency here, does that have an impact on your thinking?

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [73]

--------------------------------------------------------------------------------

So what we -- our functional currency in our Chinese operation is the RMB. So all the $1 million of currency gain that we put in there is a revaluation to a weaker yuan during the prior quarter. To the extent that we finish this next quarter with a weaker yet RMB, then there will also be a gain. But we do not include those in our forecast because we don't forecast currency.

--------------------------------------------------------------------------------

Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [74]

--------------------------------------------------------------------------------

And so I should assume then that you're not using the currency as of the last look before you came into the room, but rather the currency at the end of the June quarter as your exchange rate?

--------------------------------------------------------------------------------

Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [75]

--------------------------------------------------------------------------------

Correct. Correct.

--------------------------------------------------------------------------------

Operator [76]

--------------------------------------------------------------------------------

We'll move on and we'll take the next question from Simon Leopold with Raymond James.

--------------------------------------------------------------------------------

Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [77]

--------------------------------------------------------------------------------

Just wanted to get broader thoughts about vertical integration. Specifically, both Huawei and Ciena have made comments in the past about efforts to vertically integrate. Ciena made an acquisition a couple years ago. Just trying to understand what they may be doing, where it would overlap with your products and where you see opportunities continuing even with vertical integration by your customers.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [78]

--------------------------------------------------------------------------------

So I think in the case of Huawei, for example, to some extent, Huawei has been trying to risk mitigate against what is happening right now. And with this denial order, Huawei is continuing to operate in part because of work that they have done to risk mitigate. It's a little different than the acquisition that Ciena did. Ciena was certainly working to have certain technologies that can't be copied by others or essentially to make additional propriety part of their fabric, if you will. And to an extent, I see some of that in the recently announced Cisco deal as well as the possibility of Cisco being in more control of their future as a result.

So different customers, I think, have different rationale. The volumes through the course of these events have continued to grow and data rates have continued to increase, both trends of which have provided growth opportunities for NeoPhotonics as we stay on the leading edge of technology. For us, the imperative is to stay on the leading edge and to offer some differentiated solutions from what they would otherwise have, and that is part of what we have to do on a daily basis.

--------------------------------------------------------------------------------

Operator [79]

--------------------------------------------------------------------------------

We'll move on to Tim Savageaux with Northland Capital Markets.

--------------------------------------------------------------------------------

Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [80]

--------------------------------------------------------------------------------

Yes, appreciate the follow-up and I'm glad we got to Cisco-Acacia because that was going to be my question. I imagine both of those companies could be among your top 5, certainly among your top 10 customers. So at a high level, do you see any kind of business impact, positive or negative, from that potential transaction? But really, the bigger question is with Cisco, I guess, having taken a look at the coherent DSP space where there's a limited amount of suppliers and decided that the DSP was pretty strategic especially as they move toward pluggable, I wonder if you could discuss the role of laser technology relative to coherent DSP? You mentioned it's another one of the levers designers have. But in terms of kind of the strategic nature of laser technology, this whole equation relative to what we've seen with the DSP side, I'd be interested in your views there in addition to any potential impact, positive or negative, of the transaction on your run rate business.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [81]

--------------------------------------------------------------------------------

For these high-speed data rates, the aspects that I talked about in the prepared remarks, being able to leverage baud rate or signal rate as opposed to leveraging higher order modulation, these are kind of the core elements. A lot of time and attention is given to the discussion of DSP. But the DSPs operate -- over time, they're operating with input signals and the input signals, their clarity and their data rate is kind of a precursor to system performance.

To that extent, the lasers, in order to operate at the very -- at the higher data rates, the lasers have to have very narrow linewidth. They have to have very low phase noise. In order to increase the baud rate, you have to have very, very low phase noise. And our laser technology which leverages what we call ECL, External Cavity Lasers, which are offered in our micro-ITLA and our Nano-ITLA, these offer the lowest phase noise by a considerable margin in the industry. And that is critical to these higher data rates, and it's also critical to be able to operate with the higher order modulation, the QAM modulation that is used. So it absolutely is the case that laser technology matters, the characteristic of line within phase noise matters and the characteristics of the lasers that NeoPhotonics sells are the best in the industry for these characteristics, which is why we do say that we do have the product properties to be the laser of choice at the high data rates.

--------------------------------------------------------------------------------

Operator [82]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [83]

--------------------------------------------------------------------------------

Tim, if this was answered earlier, my apologies. But I don't recall you all ever breaking out your narrow linewidth tunable laser revenue, specifically for the laser. Have you done that? Or can you do that, more importantly?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [84]

--------------------------------------------------------------------------------

What we have said is we have 3 different types of lasers, and we've said that lasers actually represent approximately half of the revenue of the company and that the largest part of our lasers are the narrow linewidth tunable lasers. So I think that's the level of granularity that we'll provide, Paul.

--------------------------------------------------------------------------------

Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [85]

--------------------------------------------------------------------------------

I'll take a shot at this, but I guess that leaves a little room for interpretation, but would it be over 25% of total revenue?

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [86]

--------------------------------------------------------------------------------

Yes, it would.

--------------------------------------------------------------------------------

Operator [87]

--------------------------------------------------------------------------------

Thank you. That does conclude today's question-and-answer session. I'd like to turn the conference back over to management for any additional or closing remarks.

--------------------------------------------------------------------------------

Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [88]

--------------------------------------------------------------------------------

Well, thank you very much for your time and interest in NeoPhotonics today. We do look forward to updating you on our progress in the future. Have a good day.

--------------------------------------------------------------------------------

Operator [89]

--------------------------------------------------------------------------------

Thank you. That does conclude today's call. Thank you all for your participation. You may now disconnect.