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Edited Transcript of NPTN.N earnings conference call or presentation 2-Nov-20 9:30pm GMT

·36 min read

Q3 2020 NeoPhotonics Corp Earnings Call SAN JOSE Nov 3, 2020 (Thomson StreetEvents) -- Edited Transcript of NeoPhotonics Corp earnings conference call or presentation Monday, November 2, 2020 at 9:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Elizabeth Eby NeoPhotonics Corporation - Senior VP of Finance & CFO * Timothy Storrs Jenks NeoPhotonics Corporation - Chairman, CEO & President * Wupen Yuen NeoPhotonics Corporation - Senior VP, GM & Chief Product Officer ================================================================================ Conference Call Participants ================================================================================ * Joseph Lima Cardoso JPMorgan Chase & Co, Research Division - Analyst * Ku Kang B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components * Mauricio Alberto Munoz Roldan Raymond James & Associates, Inc., Research Division - Senior Research Associate * Richard Cutts Shannon Craig-Hallum Capital Group LLC, Research Division - Senior 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 ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good day. Welcome to the NeoPhotonics Third 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 a property of NeoPhotonics and any recording, reproduction or transmission of this call without the expressed written consent of NeoPhotonics is prohibited. I'd now like to turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead. -------------------------------------------------------------------------------- Erica L. Mannion, Sapphire Investor Relations, LLC - President [2] -------------------------------------------------------------------------------- Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the third quarter of 2020 and outlook for the fourth quarter of 2020. On the call today are Tim Jenks, Chairman and CEO; and Wupen Yuen, Chief Product Officer; and Beth Eby, Chief Financial Officer. Tim will begin with a review of the company's business in the third quarter and a discussion of relevant market trends. Wupen will provide a summary of products, technologies and growth drivers for our highest speed products. Beth will then provide financial results for the third quarter before providing the outlook for the fourth quarter of 2020. The call will then be open 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 conversions 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 in the Investor Relations section of 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 November 2, 2020, 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. Our business in Q3 was very strong, especially at the highest speeds. At the same time, we're dealing with the challenges of the global pandemic and with the revised restrictions in August from the Department of Commerce, BIS pertaining to Huawei. Our third quarter revenue was $102 million, up 11% year-over-year. Our non-GAAP gross margins continued to expand, reaching 34%, which represents an increase of 5 percentage points from the year prior. This is an exciting time for NeoPhotonics as we are seeing increases in design wins, backlog, higher volumes and resulting share gains in our highest speed over distance solutions with a broad range of customers, both historical customers and new customers. We have new 400-gigabit coherent module products that will ramp in 2021. Further, we expect our longer distance 400ZR+ module products to accelerate our growth with new use cases coming online in 2022. Each of these points indicate a coming acceleration of revenue growth. Given this, we thought it would be helpful to take a step back and review our high-speed developments, look at the performance of our business, excluding Huawei, and outline our strategy going forward. In the first 9 months of 2020, our year-on-year growth was 20%. But let's look at our 400-gigabit and above business without Huawei. In the first 9 months of 2020, our year-on-year growth for this business was 91%. And in the current quarter, 400-gigabit and above products were 44% of our revenue, again, excluding Huawei. Further, 400-gigabit and above revenue has been accelerating throughout the year, and we expect this to continue through Q4. Keeping in mind that the number of 400-gigabit ports being shipped each year is approximately doubling, we are simultaneously gaining market share at the highest speeds. Note that as this market heats up, we will see increasing revenue from an expanded customer group beyond our 2 historically largest customers. With the industry-leading equipment companies leveraging NeoPhotonics products for their 400-gigabit and faster systems, our growth is strong with these customers. In our second quarter, we reported 2 10% customers. And as expected, in Q3, we added a third 10% customer. We believe the trends in our highest speed over distance products are favorable in terms of accelerating growth. And in our building and expanded customer base. Again, without Huawei, we are providing a revenue outlook for our fourth quarter of $67 million at the midpoint, which is a 16% sequential growth and considerably higher for the 400-gigabit and above products. For the longer term, we have said that we believe we will see 40% to 50% revenue growth over the next year on the same basis. Our outlook for sequential Q3 to Q4 growth shows good progress toward that goal. NeoPhotonics has been a leader in high-speed products since our entry into coherent optics face a decade ago. We are the primary supplier of ultra-pure life tunable lasers for the highest speed over distance applications, and we provide the highest bandwidth receivers and highest baud rate modulators used in speed over distance interconnects. For the last 3 years, we have been steadily introducing new lasers, modulators and receivers for the highest-speed applications at 600-gig and 800-gigabit plus several new high-speed coherent modular products including 400ZR. As a result, demand for NeoPhotonics highest-speed products is very strong with accelerating market adoption and deployments and related market share gains of 400 gigabits per second and beyond, especially for ones requiring the highest speed over distance. These deployments are among the fastest areas of growth in the industry, driven by cloud and data center demand, and they've been driving our growth and profitability. Our strategy is to rapidly grow the business by supporting the highest speed over distance solutions at 400 gigabits and above for telecom equipment providers and expand our business by ramping our new 400ZR and 400ZR+ coherent modules to cloud and hyperscale data center customers starting in 2021. Our preparations for this have been a long time in the making. NeoPhotonics specializes in products that operate at the highest speed over distance, with products that are designed and engineered by our talented employees around the world, who simultaneously make our components work together to deliver the highest speeds and highest performance used in networks today. For all of the leading network equipment producers around the world using NeoPhotonics products in their flagship high-speed systems. Over the last 3 years, we have developed advanced manufacturing methods for these highest-speed 400-gigabit and above products. Scaled their production, all while steadily increasing our manufacturing utilization, reducing our depreciation costs and seeing our margins expand. I am very proud of our team for what they have achieved. The acceleration of our components for 400-gigabit and above chassis-based systems is only the beginning. As the market continues to move to higher and higher speeds, including 600-gig and 800-gig, we are increasingly well positioned to capture this next wave of growth. Layered on top of this is the opportunity for our 400-gigabit coherent module products for 400ZR and 400ZR+ applications. We are a leader in the launch of 400ZR and 400ZR+ modules, which will effectively double our addressable market, given the importance of hyperscale data center interconnect and metro applications. Cloud providers, including hyperscale data center customers will be the early adopters in this market. These will be new volume customers for us beyond our network equipment manufacturer customer base. Given our design wins, customer forecast and the rate of industry growth at the highest speeds, we are looking forward to seeing our business without Huawei grow at 40% to 50% over the next year. By mid-2021, we expect to see an additional revenue stream from our 400ZR coherent modules being sold into hyperscale customers, 400-gigabit and above port growth, including 400ZR is forecasted to grow at an 80% 5-year compound annual growth rate through 2024, further supporting our long-term growth prospects. Beyond top line growth, we typically achieve higher-than-average gross margins from our highest-speed products. As these products become an increasing fraction of our revenue mix, we believe we will see a favorable trend in our margins. It's such an exciting time at NeoPhotonics due to the growth opportunities we face. I will now turn the call over to Dr. Wupen Yuen, our Chief Product Officer, to provide you with more detail of our road map for 400-gigabit and above products and the trends that are driving our adoption. -------------------------------------------------------------------------------- Wupen Yuen, NeoPhotonics Corporation - Senior VP, GM & Chief Product Officer [4] -------------------------------------------------------------------------------- Thank you, Tim, and good afternoon. Tim outlined in explaining our strategy, NeoPhotonics is in a strong position to deliver accelerated growth as we expect to ramp production of former ZR modules beginning in mid-2021. On top of the growth of lasers and 64-gigabaud components that are driving our current growth. Our new 400-gig coherent module products are real game changers, as the package state-of-the-art data rates and system interfaces in very small and low power form factors, enabling them to be plugged directly into routers and switches by casting traditional DWDM equipment. This capability enables operators to realize significant savings in network equipment, thereby driving adoption rates and expanding use cases. With our leading vertically integrated laser and silicon photonics technologies, NeoPhotonics has been the first 400ZR module vendor to successfully perform 400ZR link ups at the major cloud providers with both OSFP and QSFP-DD modules and to demonstrate the interoperability that promises to enable the rapid increase in the adoption of former ZR technology. Our 400ZR solutions leverage our leading laser capability and our in-house high-performing silicon photonics integration. We expect to complete our 400ZR collaboration at the lead cloud customers by the first quarter of 2021. We expect initial volume applications for 400ZR to be with major cloud providers for metro data center interconnects. However, with 400ZR+ capability for longer distances. There is also an opportunity for new use cases to emerge beyond natural data center interconnects into edge use, 5G backhaul and longer distance regional interconnects. It is important to note that for NeoPhotonics, the 400ZR and 400ZR+ module market segments expand our overall accessible market as it adds higher ASP model solutions with high internal content to our existing market-leading position in high-speed over distance components. We expect that our 400ZR+ modules will provide yet a third growth revenue stream that will begin to ramp in 2022. Additionally, each of these new high-speed systems, including 400ZR and 400ZR+ applications, operate over DWDM line systems, including open line systems. These require specific high-performance multiplexing and demultiplexing products that have unique channel spacings and filter shapes, including channel monitoring curability, to which we are also a leading supplier to cloud equipment providers. During our second quarter, we conducted a webinar on trends and technology, in which we discussed the key change enabled by 400ZR architecture. And in September, we held an additional webinar, detailing the key differentiation of leading high-speed over distance solutions. Information from these trends in technology webinars remains available from investors presentations at the Investor Relations section of NeoPhotonics website. Rapidly growing global bandwidth demand continues to be the fundamental driver of our business, whether it'd be for cloud services, capacity increases due to remote working, high-speed deployment to the edge, artificial intelligence and machine learning or 5G wireless rollouts. With that, I will turn the call over to our CFO, Beth Eby. -------------------------------------------------------------------------------- Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [5] -------------------------------------------------------------------------------- Thank you, Wupen, and good afternoon. Q3 was a strong quarter with revenue of $102.4 million, non-GAAP gross margin of 33.6% and non-GAAP operating profit of $9.9 million, all at the high end of our revised outlook. These results were partially offset by an adverse FX impact of $3.4 million or $0.06 per share, resulting in a non-GAAP Q3 EPS of $0.11. In more detail, Huawei was 44% of revenue in Q3, and our next 4 customers were 39%. We had 3 10% customers in the quarter. Our non-GAAP Q3 gross margin was 33.6%, coming in at the high end of our range. Within this, product margins were 39 -- 36.9%, up slightly from last quarter on favorable product mix. Other cost of sales charges of 3.2% were approximately 2 points of underutilization and a point of warranty and other minor charges. Total non-GAAP operating expense for the third quarter was $24.5 million, slightly lower than expected on early execution of cost reduction programs. Non-GAAP operating profit for the third quarter was $9.9 million or 9.7%, just under our operating model of 10%, reflecting continued strong execution throughout the company. Appreciation of the Chinese yuan relative to the U.S. dollar was the primary driver of a foreign exchange impact of approximately $3.4 million in the quarter or $0.06 per share. As a reminder, the functional currency of our China operations is the yuan. The FX loss is the noncash revaluation of the 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 third quarter was $6.2 million. I'll close out my discussion of the third quarter income statement with a review of our GAAP results. On October 5, we increased our estimates for the quarter, in line with the results I have just detailed. At that time, we noted that the Department of Commerce had expanded restrictions on Huawei and its affiliates, and we announced that we would manage the business without revenue contributions from Huawei. As a result, we have taken actions to align our capacity and production infrastructure with expected demand levels. Charges of $9.4 million were incorporated in our GAAP results for Q3 and include severance charges of $0.9 million as expected. Inventory write-downs of $4.4 million, $1.3 million less than estimated on lower material cancellation charges and equipment write-down of $4.1 million. The total charges related to the action are now expected to be $10.9 million through 2021. This is less than the $12.1 million estimate stated in our press release. Third quarter gross margin, including $9.3 million of the charges I just mentioned, was 23.8%. Operating expense was $27 million, lower than expected on early execution of spending reductions. Operating losses for the third quarter were $2.5 million, which includes the impact of the restructuring and other related charges of $9.4 million. $2.8 million of stock-based compensation expense and approximately $0.3 million of amortization of acquisition-related intangibles and other costs. Net loss for the quarter was $4.9 million. Turning to the balance sheet. Our cash position continued to improve to $123 million of cash, short-term investments and restricted cash. Cash from operations was $15 million. We spent $4 million on CapEx and we paid down $1 million of debt. This cash level puts us in a good position to continue to invest for the growth that we see in lasers, 64- and 96-gigabaud components and 400ZR and 400ZR+ modules. Before I discuss our earnings and revenue outlook for the fourth 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. The restructuring that we implemented when fully realized allows for breakeven at revenue of $80 million based on the current mix. Within this, we will continue to invest in the growth drivers of our business, including lasers, 64-gigabaud components and 400G modules. For Q4, there will be no revenue from Huawei. In Q3, excluding Huawei, our revenue was $58 million. We expect the continued rapid growth of products for 400G and beyond to drive revenue growth from this point forward. Gross margin reflects lower volumes and therefore, higher underutilization charges. We do expect to see an increase in operating expense in Q4 as continued spending reductions are offset by a planned NR repayment for investment in 400ZR developments. Lastly, subsequent to the end of the quarter, we signed an agreement to settle our lawsuits with APAT Optoelectronics. This settlement will result in a gain of $2.9 million in Q4, which will be included in our GAAP results. Given that, the company's expectations for the December 2020 quarter are: revenue in the range of $64 million to $70 million; GAAP gross margins in the range of 20% to 24%; non-GAAP gross margins in the range of 22% to 26%; GAAP diluted earnings per share in the range of the $0.26 loss to a $0.16 loss; and non-GAAP diluted earnings per share in the range of a $0.23 loss to a $0.13 loss. These numbers are reflective of approximately 50.3 million basic shares. In summary, Q3 reflects the strength of our base business, we'll be continuing the trend of delivering year-over-year growth in revenue and profitability. With our increasing momentum in 400G and above design wins across major network equipment manufacturers as well as the 400ZR and 400ZR+ opportunities in 2021 and beyond, we remain optimistic that industry trends continue to move in NeoPhotonics favor. For the longer term, we have said that we expect to see 40% to 50% revenue growth over the next year, excluding Huawei, the 16% revenue growth from Q3 to the midpoint of our outlook for Q4 is good progress toward that objective. In addition, we expect to get back to non-GAAP operating profit in Q3 and GAAP in Q4 of 2021. Over the last 2 years, we have shown that we can work through financial transitions. We believe we can continue to drive both revenue growth and an expanded customer base in 2021 and beyond. This concludes our formal comments. And I will now ask the operator to open up the line for questions. James? ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) And we'll take our first question today from Richard Shannon with Craig-Hallum. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2] -------------------------------------------------------------------------------- I guess my first one is on gross margins for the guidance here in the fourth quarter. If I look at the kind of the fall through rate, it's a little bit higher rate than we normally see on kind of both average and up and down, I think a little above 50% of my calculations are right here. It would suggest that Huawei has been a fairly healthy mix of gross margins, which I guess seems antithetical to the thought process on Huawei getting good pricing. So wonder if you could help us understand the gross margin dynamics here? Why you're kind of settling out at 24% then how should we think about it going forward? -------------------------------------------------------------------------------- Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [3] -------------------------------------------------------------------------------- So what you're seeing is what we expected to see in a little bit of an increase from on product margin from not having Huawei. They were the biggest customer, they get the biggest volume discounts, but it wasn't hugely different than our other customers on a product-to-product level, they don't get that much more of a discount. And then we are seeing a fair chunk of underutilization charges, as you would expect from losing a 44% customer in 1 quarter. That is in both our Japan and our China factories. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4] -------------------------------------------------------------------------------- Okay. That is helpful. My follow-on question here is kind of looking at your revenue progression here past the fourth quarter. I think you said that the pro forma rate here, excluding Huawei, so was 16% quarter-on-quarter in the fourth quarter. Obviously, we'd expect to see that in the first quarter with your normal pricing dynamics. But how much of this track as we get to that 40% to 50% growth over the next year and getting to pro forma profitability in the third quarter? How much of that is dependent on customers outside of Huawei gaining some share and also with ZR product rollouts to get to that point? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [5] -------------------------------------------------------------------------------- Richard, it's Tim. First of all, we do expect normal seasonality. What we've said that we expect to see a 16% sequential growth Q3 to Q4. And then normally, Q1 is the shorter with China New Year as well as reflecting pricing. So Q1, we'll have that normal seasonality this year. We would then expect to continue to grow. And then in the second half of the year, as we're ramping 400ZR, we would expect to see an acceleration. That is the normal case, and it's not particularly dependent on share shifts between and among our lead customers. -------------------------------------------------------------------------------- Operator [6] -------------------------------------------------------------------------------- Next, we'll hear from Tim Savageaux with Northland Capital Markets. -------------------------------------------------------------------------------- Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [7] -------------------------------------------------------------------------------- A couple of questions, I guess. And I'll start on the operating expense side. And obviously, you're looking to -- it looks like you're keeping that flat despite the revenue decline, and you referenced in the release and some of the follow-up commentary. Some increased focus on ZR. I wonder if you could try and quantify that. And you also -- and is that a net the flat OpEx of the NRE payment that you described? And can we conclude from this that you've got some greater visibility on the timing and the magnitude of that ZR opportunity? -------------------------------------------------------------------------------- Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [8] -------------------------------------------------------------------------------- So I'll let Wupen comment on the ZR opportunity. On the OpEx, and you know this well, Tim, we have been pushing the OpEx from the first half of this year to the second half of this year all along. We are comfortable enough with the ZR opportunity that we are continuing to do the investments needed in order to support that. And that's what you're seeing in Q4 is there's a couple of big NRE payments that were scheduled for Q4. We have maintained those. But -- and those are pretty much almost all offset by the reductions that we're implementing. What we said in the press release earlier this quarter is from the Q3 point to where we will land is going to be about $2 million of reduction by Q2 of next year. Wupen, you want to talk about the ZR opportunity and what gives us confidence? -------------------------------------------------------------------------------- Wupen Yuen, NeoPhotonics Corporation - Senior VP, GM & Chief Product Officer [9] -------------------------------------------------------------------------------- Yes. On the ZR opportunity, we still expect the first ramp will start around mid-2021. And we do have more granularity than that on the timing, but nor do we see any reason for schedule delay. So we still are counting on mid-2021 early ramping of 400ZR. -------------------------------------------------------------------------------- Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [10] -------------------------------------------------------------------------------- Great. And then with regard to Huawei, Lumentum corresponding to suggest that their revenues with Huawei might move to a reduced level, but not to 0. I just want to kind of refocus on how you guys are approaching this, and you stated that you're kind of managing the business, assuming there's no revenue, but as you kind of bump up against the reality of the situation, maybe you can update us on what the dynamics might be allowing various suppliers to CF or other suppliers not to or whether you're kind of just taking this approach conservatively and are seeing you won't be able to share. -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [11] -------------------------------------------------------------------------------- Yes. Thanks, Tim. We did say that we would expect to see a situation where we'd have to cease reliance on revenue with Huawei. And as we said in our prepared remarks, it will be 0 in the fourth quarter. We're not guiding more than a quarter, but for now, it's 0. -------------------------------------------------------------------------------- Timothy Paul Savageaux, Northland Capital Markets, Research Division - MD & Senior Research Analyst [12] -------------------------------------------------------------------------------- Okay. And then last one for me. You mentioned you had added a 10% customer in the quarter. I wonder if you could talk about what sort of -- provide any further color on either applications, geographic focus or any other indications of -- and I imagine ex Huawei that becomes a substantially larger customer. But any more color about how your customer base is broadening out generally. And if there are any particular geographic or product drivers of that? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [13] -------------------------------------------------------------------------------- Yes. The situation is, as I said in the prepared remarks, in the first 3 quarters, year-to-date, our business was up 20%. But the highest speed, the 400 gigabits and above is a real driver. And that's actually up 91%. And it's with a range of customers. And so it actually is the rapid growth of customers at the highest speed, which results directly in or having additional 10% customers. And we don't really see that slowing down, quite frankly. The -- there are a number of customers who are growing with these trends that are strong partners in 400-gig, 600-gig, 800-gig systems. And ultimately, this would expect -- we would expect this to be a pretty important part of our dynamic through 2021 as well. The -- while the first 3 quarters were up 91%, it's actually at an accelerating rate. In other words, first quarter to second quarter to third quarter, each quarter, the amount of additional revenue from the highest speed has gone up. So I think that will change the face, I think, a bit of the 10% customers with or without Huawei. And obviously, we have 0 Huawei going forward. So all of the dynamics that we're seeing in growth for 400-gigabit and above products and systems will be the drivers for who's in that category going forward. I hope that helps. -------------------------------------------------------------------------------- Operator [14] -------------------------------------------------------------------------------- We'll now hear from Dave Kang with B. Riley. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [15] -------------------------------------------------------------------------------- My first question is regarding your third 10% customer. Could it become #1 in the fourth quarter, meaning it will actually jump over your #2 customer? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [16] -------------------------------------------------------------------------------- Well, I don't think we're going to -- anything is possible, but I don't think we will provide guidance on individual customers, Dave. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [17] -------------------------------------------------------------------------------- Okay. Fair enough. Just more on that customer. I mean, can you just at least tell us which products and for which market, is it long-haul, metro data, DCI, any more color? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [18] -------------------------------------------------------------------------------- Well, yes, because it's all for 400-gigabit and above. And the drivers of that are laser modulator and receiver. And because that's the case because as we've indicated, the 400ZR growth, we expect to start in mid-2021, as Wupen highlighted. So the -- but it is driven by 400-gig and above applications, and we expect that to continue. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [19] -------------------------------------------------------------------------------- Got it. And my follow-up is sticking with 400-gig or actually 400-gig and above. Between those 3 components, 400, 600 and 800, can you just split roughly how they break out? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [20] -------------------------------------------------------------------------------- Well, let's see. The number of systems companies that are actually selling systems at 800-gig today is limited because it's really just emerging. So the preponderance of the volume and the revenue is in the 400-gig and 600-gig both of those are going strong, but the 400-gig adds in a whole another dimension because 400-gig and 600-gig both have chassis-based systems that leverage our component suite. But then the advent of 400-gigabit coherent modules is really causing a pretty significant change. Wupen said it was a game changer and that really reflects the introduction of 400ZR products in the OSFP and the QSFP-DD form factor, and those are additive to products that we introduced 400-gig CFP2-DCO, which we started shipping a couple of quarters ago. So at the moment, without a doubt, 400-gig and 600-gig are considerably larger than 800-gig. But the overall trend is going to continue to increase the speed and increase the revenues for each of these products. Now we do think that in 2021, the ramping of 400ZR is an important dynamic because that just creates a whole series of use cases for increasing volume, revenue and contribution to our business. I hope that helps. -------------------------------------------------------------------------------- Ku Kang, B. Riley Securities, Inc., Research Division - Senior Analyst of Optical Components [21] -------------------------------------------------------------------------------- Yes. And my last question, if I may, is on actually 100-gig. So how should we think about 100-gig with all these high-speed optics ramping? Is it going to go down or go sideways? Any more color on that? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [22] -------------------------------------------------------------------------------- Yes. So the dynamic is -- for 100-gig is you have some increasing volume and price pressure. Wupen, you may want to talk about the use cases on 100-gig case. -------------------------------------------------------------------------------- Wupen Yuen, NeoPhotonics Corporation - Senior VP, GM & Chief Product Officer [23] -------------------------------------------------------------------------------- Yes. So we expect 100G to stay more or less flat, and it's still probably the workhorse to offer long-haul for a while. And so we see that being flat, but we do see that in another few years or so, call it, 3, 4 years later, you will see a penetration of 100G into the edge of the network associated with the edge cloud. So we think 100ZR in a small form factor will start to show up in another 3 to 4 years. And that will drive the growth of 100G from that point on. -------------------------------------------------------------------------------- Operator [24] -------------------------------------------------------------------------------- Next question will come from Simon Leopold with Raymond James. -------------------------------------------------------------------------------- Mauricio Alberto Munoz Roldan, Raymond James & Associates, Inc., Research Division - Senior Research Associate [25] -------------------------------------------------------------------------------- This is Mauricio in for Simon. You guys continue to indicate expectations to grow your customers outside of Huawei by 40% to 50% last year. And I was just wondering if you could sort of help us quantify what is the mix of the ZR in those expectations? It seems that -- I mean, big growth outside of Huawei might suggest that you're planning to sell directly into the hyperscale, the ZR into the hyperscale. And these 2 are potentially -- some of these could become 10% customers for you. Just wondering if you have any sort of commitment or indication on how large this opportunity could be for you in 2021? And then also as a follow-up, do you see any risk on those expectations, given the recently announced acquisition of Inphi by Marvell. -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [26] -------------------------------------------------------------------------------- So let's see, there was a lot in that question, Mauricio. Let's start with the -- the fact of the matter is, as in our business, in the third quarter, we have 44% of our revenue, this is excluding Huawei, 45% of our revenue is from 400-gigabit and above applications products. And as I said, for the year-to-date, that group of products, now 44% of our business, it grew 91% year-over-year. And so there's a lot of tailwinds for that going into the end of the year, fourth quarter and then into 2021. And we're seeing in the fourth quarter, 16% sequential growth, which, of course, is contributed to the -- to what we are expecting. Now because of the fact that 400ZR, we expect to start midyear, the second half of the year would see -- it would see some amount of ZR for Q3, Q4 next year. The precise amount, I think, remains to be seen. We're not guiding that -- we're not guiding out there at this point. But what we know is and I think what we've talked about in the past is the size of the market. We've got import growth terms. We have an 80% 5-year compound annual growth rate. In revenue terms, it's about a 70% compound annual growth rate over the same 5-year period. As the market expands from what right now for 400-gig and above from about a $200 million mark going to a $1.8 billion market out 5 years from now. So the precise mix on components, the components for chassis-based systems or 400ZR modules, that really remains to be seen, but we have strong conviction that the products that we have launched go to both the chassis-based solutions and to the module-based solutions. So we expect to participate in all of that. Now you did also ask about recent deals. I think what's important is that I think what we've seen recently that deals do take time to get to closure. So certainly, for the next year or so, we would expect -- you mentioned Inphi, we would expect them to continue to operate independently, and that's just fine. So I don't think there's a lot of change in the market or the supply patterns in the immediate term, although in the longer term, it does add one more to consolidation, which is reducing the number of direct competitors in that space. I hope that helps. -------------------------------------------------------------------------------- Mauricio Alberto Munoz Roldan, Raymond James & Associates, Inc., Research Division - Senior Research Associate [27] -------------------------------------------------------------------------------- Yes. Pretty helpful. And then a quick housekeeping item. You had talked about 3 10% customers this quarter. Huawei, obviously, at 44% of sales I think you mentioned. And could you quantify the other 2, even if you don't name them, please? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [28] -------------------------------------------------------------------------------- No. I think we're just naming 10% customers as we're required to do. We're just naming just saying that how many we have. -------------------------------------------------------------------------------- Operator [29] -------------------------------------------------------------------------------- We'll now hear from Samik Chatterjee with JPMorgan. -------------------------------------------------------------------------------- Joseph Lima Cardoso, JPMorgan Chase & Co, Research Division - Analyst [30] -------------------------------------------------------------------------------- This is Joe on for -- this is actually Joe on for Samik. And yes, so just my first question is actually following up on the previous question on Huawei. And apologies for beating the dead horse here. But maybe if I ask it a different way. Have you guys completed your due diligence relative to the restrictions in shipping to Huawei? And has the conclusion to that been that you can't ship at all? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [31] -------------------------------------------------------------------------------- I think the answer to that is there's an ongoing evaluation on a couple of different dimensions. The way the restrictions are defined, one has to have -- the restrictions pertain to the use of U.S. technology and software. And we use a considerable amount of U.S. technology and software, but not exclusively. We have substantial amount of foreign made products. Most of which actually do use some U.S. technology or software. So how we or others, Joe, about the business is ongoing, I don't think I would describe anything is done. But certainly, it's very clear for the fourth quarter that there won't be any Huawei revenue. And we're not guiding beyond that, but for now 0. -------------------------------------------------------------------------------- Joseph Lima Cardoso, JPMorgan Chase & Co, Research Division - Analyst [32] -------------------------------------------------------------------------------- No. Got it. Understood. And then my second question is just relative to, obviously, Lumentum reported this morning. And they had highlighted a slowdown in telecom customers just related to COVID impact on things like customers trialing products or just not able to physically deploy products. And obviously, you guys are highlighting some relatively strong growth here, excluding Huawei, particularly in the high-speed products. But just curious to hear your thoughts relative to NeoPhotonics business? Have you guys seen any moderation in growth as you progress through the quarter and into the first month of 4Q relative to 30 days ago or 90 days ago? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [33] -------------------------------------------------------------------------------- Yes. The -- essentially, there are more deployments of existing systems. That's an important element as opposed to higher ramping of new systems. You do see that. And the corollary is that there is some slowdown with respect to deployment rates versus expectation, prior expectation on new systems. Now for telecom, it's -- therefore, it's a bit of a mixed bag; for the data center interconnect, it's been quite strong. And what we see is a mixture of those 2. I hope that helps. -------------------------------------------------------------------------------- Operator [34] -------------------------------------------------------------------------------- (Operator Instructions) We have a follow-up from Richard Shannon with Craig-Hallum. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [35] -------------------------------------------------------------------------------- I guess 2 quick one -- 2 quick ones for me. I'm not sure I'd stepped off for a couple of minutes, so I may have missed a question on this. But if we look into the fourth quarter with Huawei dropping out here, could we see 1 or 2 more 10% customers in the quarter? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [36] -------------------------------------------------------------------------------- Yes. I think the -- as I indicated in the prepared remarks, we've got strong traction in wins, volumes and ramps. So I think what I'll say is we'll lose Huawei, but we won't give precise outlook on how many customers, but we have several other strong customers. So we'll see how it plays out by the end of the quarter. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [37] -------------------------------------------------------------------------------- Okay. Fair enough. And my follow-on, Tim, if it was in your remarks or Wupen's but regarding ZR, did I hear you say that you're expecting to qualify first with a cloud vendor in the first quarter. Did I hear that correctly? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [38] -------------------------------------------------------------------------------- No. What we said was -- well, we do expect to do our first qualifications in the first quarter and we do expect that the cloud hyperscale guys are going to be the early adopters. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [39] -------------------------------------------------------------------------------- Okay. So the qualifications are starting in the first quarter. I would assume the ramp in the middle of year and they got to finish... -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [40] -------------------------------------------------------------------------------- Qualification started in the first quarter of 2020 but we would the -- we would expect to be done by the first quarter of next year. And -- but I think in our prepared remarks, Wupen did say that we expect to complete with big cloud customers in Q1 of 2021. -------------------------------------------------------------------------------- Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [41] -------------------------------------------------------------------------------- Do you have a guess or that you care to share on how many ZR customers you expect to be shipping in volume, say, by the end of next year? -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [42] -------------------------------------------------------------------------------- Well, I'll just say somewhat it's tongue in cheek that I hope I would underestimate that. But no, I'm not going to speculate it. -------------------------------------------------------------------------------- Operator [43] -------------------------------------------------------------------------------- We have a question from Tom Diffely with D.A. Davidson. -------------------------------------------------------------------------------- Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [44] -------------------------------------------------------------------------------- When you look at the prospects of getting back to profitability in few quarters, did that require just the revenue growth you're getting from your non-Huawei customers? Or do you need to deal more with the cost structure? -------------------------------------------------------------------------------- Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [45] -------------------------------------------------------------------------------- We will always look at cost structure as we have been over the last couple of years. But no, we are -- we expect to be able to get back to profitability without Huawei. In -- as we said, non-GAAP operating profit in Q3. -------------------------------------------------------------------------------- Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [46] -------------------------------------------------------------------------------- Okay. Great. And then you made a comment about increased R&D spending for 400ZR in the fourth quarter. Is that just a new higher level of spending or is that a onetime issue? -------------------------------------------------------------------------------- Elizabeth Eby, NeoPhotonics Corporation - Senior VP of Finance & CFO [47] -------------------------------------------------------------------------------- No, that's a onetime NRE payment for 400ZR. -------------------------------------------------------------------------------- Operator [48] -------------------------------------------------------------------------------- That will conclude today's question-and-answer session. -------------------------------------------------------------------------------- Timothy Storrs Jenks, NeoPhotonics Corporation - Chairman, CEO & President [49] -------------------------------------------------------------------------------- Very good. James, thank you and for everyone dialing in. Thank you for joining our call today and for your interest in NeoPhotonics. We do look forward to updating you in the future and meeting with shareholders, again in person once we are able. Have a good evening. -------------------------------------------------------------------------------- Operator [50] -------------------------------------------------------------------------------- That will conclude today's conference. Thank you for your participation. You may now disconnect.