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NeoPhotonics Corp (NPTN) Q4 2018 Earnings Conference Call Transcript

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NeoPhotonics Corp  (NYSE: NPTN)
Q4 2018 Earnings Conference Call
Feb. 28, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the NeoPhotonics 2018 Fourth 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 will be available on the event calendar page of the NeoPhotonics website. I would now like to turn the call over to Mike Funari at Sapphire Investor Relations. Please go ahead sir.

Michael Funari -- Investor Relations

Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the fourth quarter of 2018 and outlook for the first 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 in the fourth quarter and a discussion of business drivers and products. Beth will then provide financial results for the fourth quarter before providing outlook for the first quarter of 2019. Beth will then open 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 a reconciliation of GAAP to non-GAAP results are provided in the Company's press release and related Form 8-K being filed today with the SEC and can be found in the Investor Relations section 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, 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 February 28th, 2018 and are described at length in our annual and quarterly SEC filings. Now, I'll turn the call over to CEO, Tim Jenks.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thank you, Mike and good afternoon. This was a strong quarter for NeoPhotonics. NeoPhotonics delivered solid Q4 results with revenue of $91 million representing 11% sequential growth and 19% growth year-over-year. Demand remained strong across all geographies, similar to the demand dynamics we saw throughout the year. Within the Americas and rest of world, demand in shipments continued their sequential growth trend while within China we saw a larger increase as a result of continuing domestic deployments especially in provincial network deployments from China Mobile as well as exports outside of China despite trade tensions. During the quarter, we saw growth that was consistent with normal seasonal demand patterns in China across our high speed product lines.

In addition, regarding 5G mobile deployments, we understand that China is granting initial 5G licenses for construction according to the Ministry of Industry and Information Technology. These licenses are expected to be issued in about 17 key cities and regions and we understand that these large-scale trials are starting. With continued strength in demand combined with increasing volume growth across various product lines, we achieved gross margin expansion of 460 basis points in the quarter. From Q1 to Q4, our margins expanded steadily by approximately 14 percentage points, significantly more than our normal annual improvement. I want to thank all our NeoPhotonics colleagues around the world who have worked hard to deliver this marked improvement. This quarter was our highest revenue quarter in the past two years with strong orders and shipments, profitable operations and positive cash flow.

Looking ahead, the drivers for the markets we serve are well aligned with our advanced technologies, high speed capabilities and strong presence in high speed components. Business drivers include continued growth in bandwidth needs in optical networks, increasing deployments of switches including multicast switches, the beginning of 5G wireless infrastructure deployments and continued demand with hyperscale data centers that include optical networking trends increasingly aligned with our core capabilities and providing us with a basis for our continued business growth.

As a leader in high-speed digital optoelectronics solutions for the highest-speed communications networks and data center interconnect and telecom network applications, we are seeing broad-based demand for our solutions as illustrated by high speed products for data rates of 100 gigabits and above comprising 86% of our revenues and continuing to be the driving force in our business direction. I am optimistic about NeoPhotonics new product prospects. Our advanced Hybrid Photonic Integration, which is our core technology is continuing to demonstrate its benefits in high speed applications by combining optical and electronic devices. We are now shipping products, not just to support 400 gigabits per second transmission, but also at 600 gigabits on a single wavelength while developing new product capabilities for 800 gigabits and one terabit per second. Our 400 gigabits and above product growth continues with these products comprising more than 10% of our revenue in the fourth quarter. We're increasingly ramping our 600 gigabit coherent solutions as well.

Both of these segments are expected to continue to see growth in DCI for the next several years as 400ZR pluggable coherent solutions become mainstream and higher speed line card solutions make their appearance. 100 gigabit data rates will continue to be used in volume for telecom and CATV for a long time and will continue to replace 10 gig at the edge of the network. At the same time, shorter reach 400 gigabit and 600 gigabit applications in hyperscale datacenters and metro applications will be additive to the 100 gig and 200 gig business levels. Further leveraging our industry leading high performance laser capabilities, including high performance EML lasers and optical IC components, NeoPhotonics has developed a range of solutions for PAM4 transceiver applications as well as non-hermetic lasers optimized for performance in silicon photonics based transceivers, which are expected to accelerate in deployments next year.

Rounding out our suite of key coherent optical components are our high bandwidth receivers and modulators, which are used in our ClearLight coherent DCO modules along with our performance focused optical ICs which allow honing performance in our coherent modules. Shipments of our CFP-DCO modules continued to increase. Beyond our existing portfolio of leading-edge, high performance products, we continue to innovate to address the needs at the highest product speeds in next generation networks.

I'd like to note that the Optical Fiber Communication Conference and Exhibition will take place in San Diego next week. OFC is the largest and most influential trade show in our industry and we're making several significant product announcements. First, we will be demonstrating live operation of a 64 gigabaud silicon photonics based coherent optical sub-assembly or COSA which combines our designs for high speed modulators and receivers in a compact package suitable for use in 400ZR pluggable modules. The COSA can be implemented either a BGA, a ball grid array or a hermetic gold box package. Second, we will demonstrate live operation of the next generation of our External Cavity narrow linewidth tunable laser which is based on silicon photonics optics and can be directly integrated with other silicon photonics circuits or separately packaged in a similar form to our current Nano-ITLA. Third, we will demonstrate a photonic integrated circuit-based tunable optical filter array that can be integrated with multicast switches to enable low-cost pluggable coherent modules to be used in contention with or CDC networks. And finally, we will introduce and demonstrate in live operation, a ClearLight CFP2-DCO coherent module to join our existing CFP-DCO module. The CFP2-DCO is based on all our internal optical components to achieve high performance.

With increasing volume and revenue growth, I noted that our margins have expanded 400 plus basis points in Q4 over Q3 and 14 points from the first quarter to the fourth quarter. Our cost and expense management initiatives have been effective throughout the year. After the annual declines in pricing and seasonal volume changes resulting from the shorter Q1 in China, we expect to continue to deliver solid cost reductions. Over the last several years, we have detailed our efforts to focus on our profitable growth businesses while trimming areas that are less competitive or unprofitable. This quarter, we took further steps to end production of unprofitable client-side transceivers as well as the signing of an agreement to exit our Russia operations. We announced these changes in early January. We are encouraged by the results thus far and intend to continue on this path finding additional efficiencies while focusing on the technologies and products in which we have key leadership positions.

Finally, in the fourth quarter, we received some notable customer recognition including Huawei's prestigious Global Gold Supplier Award. We are beginning to see 5G deployments in Asia and additional 400 gig and 600 gig deployments globally resulting in overall growth in our coherent business as well as our high speed laser and passives businesses. With that, let me turn the call over to our CFO, Beth Eby.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Thank you, Tim, and good afternoon. As Tim mentioned, revenue was $91.1 million, up 19% year-over-year driven by strong demand from both Western customers and China. Strong volumes and execution similarly drove gross margins up, which combined with improved operating leverage resulted in net profitability on a non-GAAP basis and positive free cash flow. China represented 59% of total revenue compared to 56% in the prior quarter. Shipments to the Americas were 20%, down from 27% in Q3 with normal movement of customers contract manufacturing between geographies. Huawei Technologies, including its affiliate HiSilicon Technologies was our largest customer and accounted for approximately 44% of the Company's revenue, down from 47% last quarter. This is in the normal range of quarterly fluctuation for Huawei. Our next four customers after Huawei represented 41% of total revenue compared to 42% in Q3.

Our non-GAAP gross margin in the fourth quarter was 28.6%, up 460 basis points from Q3. Within this, product margins were 31.6%, down less than 1 point from last quarter as higher than expected volume and solid cost reductions partially offset the impact of the annual price reductions that will have full impact in Q1. The other cost of sales charges of 3 points were comprised of approximately 150 basis points of under absorption charges in our laser fabs and 150 basis points of other charges mostly the impact of tariffs related to the US-China trade discussions.

Moving to operating expenses, total non-GAAP operating expense for the fourth quarter was $22.3 million, slightly less than expected as we pushed out certain R&D spending. Non-GAAP operating profit for the fourth quarter was $3.7 million or 4% compared to a negative 3% in Q3 driven by the gross margin improvement in the quarter. Non-GAAP net income for the fourth quarter was $2.4 million compared to a loss of $2.1 million in the third quarter, slightly better than expected on a lower tax provision. This translates to a non-GAAP earnings per share of $0.05 compared to a loss of $0.05 in Q3. For the fourth quarter, adjusted EBITDA was $10.5 million compared to $6.2 million in Q3.

I will close out my discussion of the fourth quarter income statement with a review of our GAAP results. Fourth quarter gross margin was 24.8%, up from 23.2% in Q3. The fourth quarter margin includes the costs related to the end of life inventory writedown of $2.6 million. Operating expense was $29.2 million, up from $27.6 million in the preceding quarter due to a $2.2 million litigation settlement and $1.3 million of restructuring charges as announced as part of our January 14th press release. Operating loss for the fourth quarter was $6.6 million which included $3.6 million of stock-based compensation expense, $2.6 million of end of life inventory writedown, $1.3 million of restructuring charges for asset writedowns, $2.2 million of litigation settlement expense and approximately $0.6 million of amortization of acquisition related intangibles and asset disposition related charges. Net loss for the quarter was $6.7 million compared to $8.1 million in the prior period.

Turning to the balance sheet, we finished the quarter with $77 million in cash investments and restricted cash, up $12 million from the third quarter. Net inventory was $52 million or 69 days, down $5 million from the third quarter on strong customer demand. This level of days inventory was lower than target, but we expect this to increase back toward our target range in Q1. Free cash flow was $10 million.

Before I discuss our revenue and earnings outlook for the first 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 the risks and uncertainties that could affect future performance causing actual results to differ materially from our forward-looking statements.

The first quarter of 2019, we expect to see the usual seasonal reductions related to Chinese New Year production shutdowns and the full impact of annual price declines .Additionally, we are seeing some supply related constraints for certain purchase sub-components potentially pushing out a few million dollars of revenue to Q2.

As we have said previously, we will increase R&D spending in 2019 as we invest in our next generation of coherent products. Q1 includes early payment to support a number of new chips and components. Given that, the Company's expectation for the March 2019 quarter are revenue in the range of $77 million to $82 million, GAAP gross margin in the range of 20% to 24%, non-GAAP gross margin in the range of 23% to 27%, GAAP diluted earnings per share in the range of $0.28 loss to a $0.19 loss and non-GAAP diluted earnings per share in the range of $0.17 loss to an $0.08 loss. These numbers are reflective of approximately 46.6 million fully diluted shares. Our business for Q4 was strong. Revenue was up, gross margins continued to expand, operating leverage increased, inventories remain within target and we were profitable and free cash flow positive. While we are very mindful of the uncertainty of US-China trade discussions, the signals from our customers are positive for the coming year. Therefore, we remain optimistic about the revenue and profit trajectory of our business through 2019. With that, I'll ask the operator to please open up the line for questions.

Questions and Answers:

Operator

Thank you (Operator Instructions). We'll go ahead and take our first question from Richard Shannon of Craig-Hallum Capital.

Richard Shannon -- Craig-Hallum Capital -- Analyst

Hi Tim and Beth. How are you?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Hi Richard. Pretty good.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

I'm fine, how about you?

Richard Shannon -- Craig-Hallum Capital -- Analyst

Excellent. I don't know the line went quiet for about 20 seconds. I'm not sure if there's an issue, but anyway, I just make that known here in case the operator wants to take a look at that. Let's see here. I guess a couple of questions from me on the demand environment here, maybe Tim, if you want to add a little bit more thought to what you are seeing in China, both in terms of maybe port growth tender activity and maybe how soon things like 5G will start to have an impact on your business?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yes, let's see in China overall, the business growth has continued to be pretty strong. We saw good demand in Q3 and Q4 and as we look at 2019 in our prepared remarks we said that messages from our customers are continuing to be strong. We do see in high speed ports, you know, China is probably up about 15% year-over-year, it might be in the range of 240,000 ports or so. And so this is reflecting the continued port growth and we're anxious to see how that plays through the rest of the year. But, thus far, it's been in line with their projections.

Richard Shannon -- Craig-Hallum Capital -- Analyst

Okay. That is helpful. A question I've asked, I think, in the last couple of calls regarding your laser business, maybe, Tim, if you can discuss when we expect to see some ramp up there. I know you've been selling 28-gigabaud lasers for a while. When should we see a 53-gigabaud lasers pickup and when could we see that underloading charge go away there?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Well, let's see, we are seeing a pretty meaningful backlog and so that business actually has been increasing and that is also, I think, reflective of the onset of 5G. I think, as you know, there is a fair amount of utilization in the kinds of lasers that we make for front-hauling the analog RF links that are used in 5G networks. Our 53-gigabaud product is in design-in cycles with several folks. We would expect that that would be producing meaningful volume and ramping by the end of this year and through 2020. Does that address your question?

Richard Shannon -- Craig-Hallum Capital -- Analyst

Yes. Maybe just a follow-up on that last comment there on the 53-gigs, specifically, Tim. What kind of share do you think you can capture in this market? And do you see this as a supply or technology constrained market?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Well, let's see, I think as we talk about 53-gigabaud, we're referring to electro-absorptively modulated lasers. So the EML lasers, there are a handful of manufacturers of 28-gig and then 53-gig is one step tougher than that. So, with four, five companies supporting that business, I would expect that our capacity is in line to pretty well evenly divide the market, but I think how we each support end use customers will be decided during the course of the year, but we'll see how that plays out.

Richard Shannon -- Craig-Hallum Capital -- Analyst

Okay, fair enough. We'll look forward to talking to you throughout the year on that topic. I did have another question on supply constraints. I think, Beth, you had mentioned this in your prepared remarks regarding relative to guidance for the quarter. Tim, if you can help us understand where you're seeing these supply constraints, what the nature of them are, is this industry wide or specific to NeoPhotonics and when does those constraints end?

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Well, I'll start that and Tim can pile on. What we're seeing is tightness in some of the global parts and couple of our Neo-specific parts. I think, I've mentioned in the past that lead time on packages was increasing. We're starting to see -- we're getting the increased supply that we expect for Q2. That's why I deliberately said that we've got a few million of revenue that's likely pushed from Q1 to Q2.

Richard Shannon -- Craig-Hallum Capital -- Analyst

Okay, that's helpful. Last question for me, I'll jump out of line. Can you identify or at least describe your other 10% customers in the quarter other than your number one customer, please?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Our other customers are all the -- they haven't really changed identity, so each of the largest telecom equipment providers are generally in our top half dozen customers.

Richard Shannon -- Craig-Hallum Capital -- Analyst

Okay. I guess, specifically, do you have any other 10% customers in the quarter and so what were those percentages?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yeah, well, for the next four, they did add up to 41%. And so the -- I think, we'll report those when we file the K.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

And to answer where Richard is going, in our K, we will report that Ciena was a 24% customer for the year.

Richard Shannon -- Craig-Hallum Capital -- Analyst

All right. That's helpful. Thank you very much. I will jump out of line.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thanks, Richard.

Operator

(Operator Instructions) We'll take our next question from Fahad Najam of Cowen & Company.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Hey, Fahad.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Hey, Fahad.

Fahad Najam -- Cowen & Company -- Analyst

Hey, Tim, Thanks. Looks like Richard asked all the questions that were going to be on my list, but let me ask you on the China commentary a little bit. In terms of the 15% port growth, I would assume -- if you can remind us where the annual price resets. Are those in the 10% to 12% range? And if that's the case, should we take the net China revenue for the year is going to be up 3% or so, taking into effect the pricing reset?

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

So, let me talk to historical averages for a moment, Fahad, and then we'll go into this year. On average, what we've seen is port counts grow by about 15% plus or minus 5% and then price declines in the range of 10% to 15%. What we're seeing this year is port counts of about 15% growth and price declines are at the lower end of the 10% to 15% average.

Fahad Najam -- Cowen & Company -- Analyst

Okay, thank you. Tim, if I were to look at North America, the strength in North America with 400 gig shipments, is the bulk of your North America shipments now almost all majority 100-gig and would it be fair to say that 400-gig approaching almost 50% of your North America sales or is there still room to grow 400-gig plus?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

So, as we said in the prepared remarks, our high speed, which is all 100-gig and above is 86% for the quarter and over the last two years that has been steadily trending up. We also said that 400 gigs, specifically 400 gig is above 10% for the quarter. I think for some time the speeds of 100-gig, 200-gig, et cetera, there will be a significant volume, particularly as the 100-gig starts to replace -- at the edge of the network starts to displace some 10-gig. So, essentially, 100-gig will continue to generate volume for quite some time, but 400-gig is growing. It's quite strong in Western markets, but it's also growing in China. So, we're shipping a fair amount of products that go to China as well, and we would expect that that growth rate will stay higher than the rest of our business.

Fahad Najam -- Cowen & Company -- Analyst

If I could actually rephrase my question, what I was trying to get at was, what percentage of North America sales was 100-gig?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yeah, we haven't provided any breakdown by geography. So, I can't really answer that.

Fahad Najam -- Cowen & Company -- Analyst

All right. (inaudible) If I may shift to the issue on margins and the shortage of supplies. One, is there any negative headwinds on your margins from just because of the shortages if there are heightened pricing that you need to pay for these components? Is that -- if you could help us understand what the headwinds are for the gross margins. And also, in terms of how we should think about for the rest of the year, does this shortage fully recover in Q2 or is that always that it extends into Q3 or Q4?

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

You mean the Q1 gross margins?

Fahad Najam -- Cowen & Company -- Analyst

Yes, so let me repeat myself. The shortage -- component shortages that you highlighted, the few million dollars of revenue orders that got slipped from Q1. One, if there is any negative impact on your gross margins. I'm assuming that if there is any heightened prices that you need to pay for those components. Second question is, do you expect to fully recover all of that shortage in components, the revenue that you see slipping into Q2? Do you expect to recover all of that in Q2 or is there some meaningful lift that that gets pushed out to the remainder (ph) of the year.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

So while we don't have expedite fees related to those parts, we are, as you know mostly internal manufacturing, so anywhere we've got a supply constraint, it reduces the volume over which we're absorbing our fixed cost. So there is some level of just fixed cost related impact to the supply limits. As a long-term through the year we're in right we believe based on what suppliers tell us currently that we should be able to recover in Q2.

Fahad Najam -- Cowen & Company -- Analyst

All right, I appreciate it. I'll cede the floor.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thanks, Fahad.

Operator

Thank you. We'll now take our next question from Jun Zhang of Rosenblatt Securities.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Hey Jun, how are you?

Jun Zhang -- Rosenblatt Securities -- Analyst

Good, good. So yes, could you talk a little bit about ending the 100G the module production temporarily affect the (inaudible) and also the gross margin side for the short-term. Thanks.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yes, so, we did announce that we were ending production of certain modules. In the client side modules for 100-gig, it's been a business where we have increasingly focused on our component level solutions, we expect to continue doing that going forward, where we have very competitive lasers and optical ICs and so as we are supporting a wide range of customers with component level solutions into client transceivers, the few number of module products that we had into that domain was relatively small volume, not competitive and essentially, we felt that it was better interest for our business to focus on the component solutions to that. So that is going through an end-of-life process. We're manufacturing those in the first half of the year, but ultimately, because they are lower margin as it comes to an end, then it would actually have a bit of a, we would have a small but positive impact.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Yes, it wasn't a huge enough business to swing our margins. So as we finish the last time buys in Q1 and Q2 we should have a little bit of a pop in margin.

Jun Zhang -- Rosenblatt Securities -- Analyst

Okay, Got it.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Sorry Jun, go ahead.

Jun Zhang -- Rosenblatt Securities -- Analyst

Oh yes, I think the first half last year you had a big impact from your Japan fab. Could you talk a little bit about your current situation on the Japan side laser fab and what kind of the progress on the high speed laser, if both sit there (ph) the yield rate and also the demand side.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yes, there are a couple aspects here. So we have we have three different types of lasers that we offer. We provide tunable lasers for coherent products, we provide electroabsorptively modulated lasers or EML lasers that are used on principally on client side and now 5G front-haul. We also have a range of non-hermetic lasers that are designed for use in silicon photonics-based transceivers. So when you ask about Japan, it's principally referring to the EML type lasers that are used for data center client side and for front-haul. Ultimately, there are a couple of things to think about here. What we saw during 2017 is decreasing production volume partially that was the result of the inventory overhang partially, that was the result of yield, but ultimately volumes decreased. In addition, there were certain headwinds as certain applications in the particularly the FR reach and to a smaller extent the LR reach started to use DML type products. Now since that time, what we now see is some new positive trends in the EML business.

So for example, the use of EMLs for RF front-haul links in 5G for example also the move to 2 by 200 for 400 gig and 4 by 100 for 400 gig. These are both applications that will increasingly create demand for EML. So we see positive direction looking forward. At present, we have seen an increasing backlog, increasing volumes through our fab and increasing yield. So we're not full, we still have ways to go, but the trend is positive.

Jun Zhang -- Rosenblatt Securities -- Analyst

Okay, got it. I think also my last question about I was asked by a lot of the clients about the two concerns, one is that during the trade war, China vendors tend to build some extra (ph) inventory. So, could you comment a little bit how you feel about the inventory level in China and also the second concern is that some of the chatter about Chinese vendor trying to switch or diversify their supply base, so could you also talk about the position of NeoPhotonics in the supply chain. Thanks.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Sure. Maybe I'll deal with that last question first is that the movement of supply and both increasing supply from China-based vendors as well as internalization. This has been a concern that has lasted for the last decade, so it's not new. Generally speaking, we have to make sure that we are innovating in our product development and doing so in ways that are ahead of the curve. We think that this has worked out quite well for NeoPhotonics. It has driven our focusing on the highest speeds and the innovations that serve the highest speeds and that is the focus of the Company.

You'll recall that two years ago, we exited the low speed business. The low speed business was an area that actually did see the impact of localization. That said, you know what we see right now is we see a relatively strong level of business in China. On an absolute level, the business with Huawei was up and China overall was up on an absolute and percent basis. We're also seeing that there are concerns from all of our customers on what happens with respect to trade, but by the same token, they are continuing to buy and use products that we manufacture and working with us on new designs.

So we see all of those activities as positive, though I will say we certainly do focus our time and attention on knowing what they're doing and what they're saying with respect to supply. Back to the first thing you asked about, we do take effort to triangulate on how much we're selling into our customers in China and what they're shipping. We think that to a limited level, there might be a little bit higher levels of inventory at the end of the fourth quarter. By the same token, we think that any strong tender activity can offset that readily. So the triangulation of products shipped in and product ships out is in reasonably close balance thus far.

Jun Zhang -- Rosenblatt Securities -- Analyst

Okay, got it, thanks.

Operator

Thank you. (Operator Instructions) We'll take our next question from Troy Jensen of Piper Jaffray.

Troy Jensen -- Piper Jaffray -- Analyst

Hey, thank you. So congrats on reaching profitability as promised.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thanks, Troy.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Thank you.

Troy Jensen -- Piper Jaffray -- Analyst

Maybe first for you, Tim, I got some follow-ups for Beth. but can you just give us an update on the CFP2-DCO that you're launching here at OFC. When do you think you'll move into general availability for the product?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

During 2019, the product is a very capable product. A lot of things in the DCO world are increasingly important both on telecom side and the data center side. So specific schedules, we have been continuing to increase our output on DCOs in general. That's good capability and so this expands our product range, but 2019 is an important year for the new product.

Troy Jensen -- Piper Jaffray -- Analyst

Okay. Can you let us know who your DSP partner is for the DCO? Is it multiple or just focusing on one?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Now, we actually buy from each of the merchant vendors or DSPs.

Troy Jensen -- Piper Jaffray -- Analyst

Okay, perfect. And how about -- for Beth here, OpEx of $24 million to $25 million versus just reporting $22.3 million in the fourth quarter, so it's a pretty big step function and I think, Tim, you talked about after Q1 some cost cuts. Can you just kind of help us out with how you think OpEx is going to kind of throughout the year? And I know you said R&D kind of investments is probably the big step function here but just more insight and that will be helpful.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

We have some one-time payments in Q1 on certain chips and components that we're designing, but we're within a broad range of $24 million to $25 million. I would expect us to stay in that range for most of the year.

Troy Jensen -- Piper Jaffray -- Analyst

Okay.

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Sometimes lower end of the range, sometimes upper end of the range, just purely based on the timing of mass payments and the like.

Troy Jensen -- Piper Jaffray -- Analyst

Okay. All right, understood. I guess that's all I had, I'll see you guys in San Diego.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Very good. Thanks a lot, Troy.

Operator

Thank you. We'll take our next question from Simon Leopold of Raymond James & Associates.

Mauricio Munoz -- Raymond James -- Analyst

Thank you for taking my question.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Hi, Simon.

Mauricio Munoz -- Raymond James -- Analyst

Sorry, it's Mauricio here. I just wanted to go over your inventory levels which seem to continue to decline in the quarter and sort of have like -- it seems that they hit a two year low with the inventories well below your 90 days target. How should we think about your inventory levels going forward, and any potential impact on your previous free cash flow expectations for 2019?

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

So, always remember that our cash flow kind of follows our revenue by 90 days. So, you would expect to see us hit a low in cash flow for the year in the second quarter. So, backing up to the inventory question, 69 days is low, but if you take the same dollar level of inventory and just use Q1 revenue, then it's, we're back up to 77 days. So, we are lower than we would like. Every time we put something into the VMI hubs, it seems to get pulled. So it is lower than we would like and we will be trying to build it back up again.

Mauricio Munoz -- Raymond James -- Analyst

Okay, thank you. And then jumping into the regional demand, and particularly China, there have been multiple announcements by governments and operators in Europe and Asia, talking about plans to sort of exclude Huawei from their 5G initiatives, somebody even talking about an effort to push Huawei from their existing core network. Even, I mean, we believe that this is, if at all, a very low trend, but I guess my question is that, have you guys seen any trend from the Chinese operators perhaps starting to reshift share in favor of Huawei versus some of their counterparts in China? Some of their European counterparts, I meant, in China.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Well, in China, the largest market shareholder is Huawei. ZTE and FiberHome are numbers two and three and then the fourth player is Alcatel Shanghai Bell, who often is -- they are the one representative of Western companies and they are usually the smallest share. So during 2018, we have to say that we saw smaller share to ZTE given the band but that notwithstanding, generally speaking, we're seeing things play in the normal way. We would expect -- I said earlier, we were expecting 230,000, 240,000 ports in China, 15% growth in 2019. Probably 170,000 of those are going to be from Huawei. That leaves about 60,000 or so for FiberHome and ZTE which is in line with prior forecast. So there doesn't appear to be any meaningful share shift.

I do think that some of the news that I read on what companies or countries are saying have to be taken not just totally at face value. Small countries versus large countries, all countries are not the same in terms of their impact on a company the size of Huawei. Let's not forget that Huawei is a third of the industry and so their business is continuing to roll and so to some extent we do see countries or carriers saying they might reduce bidding by Huawei, but it's usually in things that they are not yet buying. So we haven't seen any real impact on the business.

Mauricio Munoz -- Raymond James -- Analyst

And then on that particular scenario, let's say, the -- it really happens. This is a question that we usually get from investors. Can you talk about the offsetting aspects for NeoPhotonics, meaning that Huawei perhaps losing some share in Europe, that share might go to the next largest optical system providers which it seems to be also the customer for NeoPhotonics. So if you can talk about that?

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Yes, for NeoPhotonics, I think, this is an interesting point, Mauricio, because we do have a significant business with Huawei, but we also have significant business with each of their competitors. And so we talk about our largest customer in our next four and while it's 4 to 1, it's also reflective of their respective market shares. So in terms of that, it's actually some level of balance. When we look at the hypothetical situation, what would happen if -- in terms of any company curtailing their overall business, we do believe strongly that the global trends on bandwidth consumption are not going to slow down. We think that there is going to continue to be need for high speed networks and they're going to get deployed. They're going to get deployed by telecom carriers and they're going to get deployed by hyper datacenter players and that is a competitive market where there are multiple suppliers. We enjoy a position where we sell to all of the multiple suppliers and we support each of them. So, I don't have a crystal ball that can say well enough what will happen either on a national level or on a by company level, but we will continue to do all we can to support our customers whoever they are and wherever they do business.

Mauricio Munoz -- Raymond James -- Analyst

Thank you. That's helpful. Thank you. Thank you for taking my questions.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

You bet, Mauricio. Thanks.

Operator

Thank you. This concludes today's question-and-answer session. I'll turn it back to Tim for closing remarks.

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thank you, Todd. I want to thank all attendees for the call, for your time and interest in NeoPhotonics. We look forward to updating you on our progress in the future. Have a good day. Bye.

Operator

Thank you, ladies and gentlemen, this concludes today's conference. You may now disconnect.

Duration: 48 minutes

Call participants:

Michael Funari -- Investor Relations

Timothy S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Elizabeth Eby -- Senior Vice President and Chief Financial Officer

Richard Shannon -- Craig-Hallum Capital -- Analyst

Fahad Najam -- Cowen & Company -- Analyst

Jun Zhang -- Rosenblatt Securities -- Analyst

Troy Jensen -- Piper Jaffray -- Analyst

Mauricio Munoz -- Raymond James -- Analyst

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