NeoPhotonics Corporation

Welcome to the Neophotonics fourth 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 investor section. 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. I will now turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead.

Good afternoon. Thank you for joining us to discuss Neophytonics operating results for the fourth quarter of 2020 and outlook for the first quarter of 2021. On the call today are Tim Jenks, Chairman and CEO, Wu Pen-Yen, Chief Product Officer, and Beth Evie, Chief Financial Officer. Tim will begin with a review of the company's business in the fourth quarter and a discussion of relevant market trends. Lupin will provide a summary of products, technologies, and growth drivers for our highest speed products. Beth will then provide financial results for the fourth quarter and provide the outlook for the first quarter of 2021. The operator will then open the call for questions. The company's press release and management statements during this call will 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 8K 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 a 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, and subsequent events. Various factors could cause actual results to differ materially. Some of these factors have been set forth in our press release, dated February 25, 2021, excuse me, and are described at length in our annual and quarterly SEC filings. Now, I will turn the call over to CEO, Tim Jenck.

Thank you, Erica, and good afternoon. Neophotonics completed a strong 2020 with revenue of $371 million. We continue to be a leader in high-speed optoelectronic solutions. Neophotonics is the primary supplier of ultra-pure light tunable lasers for the highest speed over distance applications. And we provide the highest bandwidth receivers and highest baud rate modulators. For the last three years, we've been steadily introducing new lasers, modulators, and receivers for the highest speed applications at 600 gigabits per second and 800 gigabits per second in chassis-based systems, as well as several new high-speed coherent module products for 400 ZR and 400 ZR Plus applications. As a result, demand for Neophytonics' highest-speed products is very strong, with accelerating market adoption and deployments and related market share gains at 400 gigabits per second and beyond, especially for links requiring the highest speed over distance. These high-speed 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 fourth quarter and full year results are evidence of this strength. Each of the following metrics exclude Huawei, given the tightened Department of Commerce BIS restrictions. Our revenue grew 18% sequentially to $68 million. This was again largely attributable to our products for 400 gig and above applications. These products grew 35% sequentially and comprised 46% of revenue in the quarter. On a full year basis, these products grew 92% year over year. We have realized continual growth in our 400 gig and above product applications. In Q1 of 2020, these products grew 46% year over year, and their growth accelerated to deliver 153% year over year growth by Q4. Our strategy is to grow the business by focusing on the highest speed over distance solutions at 400 gig and above for telecom equipment providers. Within this, The newest and highest data rate communication systems are operating at 600 gig and 800 gig per wavelength, and they are now being offered by several of our customers who directly or indirectly use our high-speed component. As a result, and in the first quarter, we expect the growth of our 400 gig and faster revenues to continue to more than double versus the previous year's first quarter. As we have stated previously, with the number of 400 gig and above ports being shipped approximately doubling each year, and our market share increasing at these highest speeds, we are seeing our customer diversification continuing to increase. In the fourth quarter, we had four 10% or more customers, ranging from 10% to 22% of revenue, comprising 67% of our total. For the full year, which includes Huawei, Our 10% customers were Huawei at 40%, Stiana at 17%, and Acacia Communications at 10%. For comparison purposes excluding Huawei, we had three customers totaling 10% or more of our revenue with Stiana at 29%, Acacia Communications at 17%, and Nokia at 11%. Products for chassis-based systems operating at 600 gig and 800 gig are rampant. and we continue to make progress in gaining design wins and qualifications for 400 ZR and 400 ZR Plus coherent modules with hyperscale data center operators. We have shipped dozens of units for qualification and we have installed our first production lines for these modules that are now being ready to ramp volumes. While we have had continued strength in the market for our highest speed products, in recent months we have seen some softness with customers serving the North American cloud market following substantial bandwidth deployments that were pulled into 2020 in response to the pandemic. Longer-term demand for products for 400 gig and above applications remains robust globally. We anticipate some ups and downs in deployment rates that are typical in DCI build-ups, which may be exacerbated by share shifts among and between network equipment manufacturers, essentially all of whom are our customers. With components for chassis-based high-speed systems and 400ZR and 400ZR Plus modules as the growth drivers for our business, we believe rapid growth in our highest-speed products will continue in 2021 and 2022. We will have our normal seasonality in Q1 with sequential growth in following quarters. From a long-term network investment standpoint, we believe 2020 marked an upward inflection in high-speed network growth. While the pandemic drove needs to increase bandwidth deployments, this is a lasting trend. As the pandemic subsides, we expect that companies will move increasingly to hybrid workforce models in the future with continuing dependence on working from home. This will increase the need for bandwidth at the edge of the network and the need for high-speed interconnects throughout the network, thereby continuing to benefit our business. Virtually all of the leading network equipment producers around the world use Neophotonics products in their flagship high-speed systems. Over the last three years, we have developed advanced manufacturing methods for these highest-speed 400 gig and above products, scaled their production, all while steadily increasing our manufacturing utilization, reducing our depreciation costs, and expanding our margins. In spite of the impact of U.S.-China trade tensions, we see our actions benefiting our business for the longer term. I would now like to turn the call over to Dr. Wu-Pen Yen, our Chief Product Officer, to provide you with more details of our roadmap for 400G and above products and the trends that are driving their adoption. Wu-Pen?

Thank you, Tim, and good afternoon. The acceleration of our components for 400G and above chassis-based systems, which drove much of the growth in 2020, is a strong beginning. As the market continues to move to higher and higher speeds, including 600 gig and 800 gig, we are increasingly well-positioned to ride this next wave of growth. We have announced and are now sampling our newest 96-gigabaud component suite, the superb 800G DCI and 400G long-haul transmission, enabled by our ultra-low noise tunable lasers and also wide bandwidth modulators and receivers. We expect these products will reach general availability in Q4 of 2021, adding to the revenue stream of our leading 64 gigabyte component suite. Layered on top of these chassis space opportunities is the 400 ZR and 400 ZR Plus coherent module market. We believe we have been a leader in launching 400ZR and 400ZR Plus modules. These products effectively double our adjustable market while serving a particularly fast-growing segment given the importance of hyperscale metro data center interconnect applications. We believe cloud providers, especially hyperscale data center customers, will be the early adopters of this technology. These will be new volume customers for us beyond our customer base of network equipment manufacturers. Our new 400ZR and 400ZR Plus coherent module products are game changers. They package state of the art data rates and system level interfaces in very small and low power form factors, enabling them to be plugged directly into routers and switches bypassing traditional DWDM equipment. This capability enables operators to realize major savings in network equipment, as well as lower total power consumption and better environmental sustainability, thereby driving adoption rates and expanding use cases, including in new areas such as interconnects for distributed edge networks and for 5G cell sites. We have samples of 400ZR QSFP-DD and OSFP modules to multiple hyperscale customers and are in the test and qualification process. We are one of the very few who are capable of meeting the challenging 400ZR optical specification. We continue to expect completion of qualifications in the first half of 2021, with deployment starting in the second half of the year. An important addition is that we have now demonstrated 400 ZR Plus performance in a QSPDD form factor by leveraging the industry-leading optical performance of our tunable laser and silicon photonics components. We believe that 400 ZR Plus in QSPDD form factor will be widely adopted in cloud-based metro networks for 5G. This is important as the 400 ZR Plus market segment substantially extends that of standard 400ZR. We expect that our 400ZR-plus modules at metro and longer distances will provide a third major growth revenue stream that will begin to ramp in 2022. Filled on our high-performance 64-gigabyte components, our CP2-DCO 400G modules are now shipping in a high-performance C++ version, offering a wider optical spectrum and, therefore, higher capacity. This product has demonstrated the best transmission performance for 200G and 400G available in a CP2 DCO form factor. Combining its unique ability to operate in 75 gigahertz channel spacings with the wider C++ spectral band, Our CP2-DCO supports fiber capacity that leaves the industry at 32 terabits per second for regional and metro applications and 16 terabits per second for long haul. This wide spectrum performance equals or exceeds line-haul based 64 gigabit solutions while reducing power consumption approximately 40%. Each of these new high speed systems including 400ZR and 400ZR-plus 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 capability. These applications are athermal multiplexing products, or AWGs, specifically designed for 400 ZR and 400 ZR plus applications have completed qualifications and will be deployed in open line systems in conjunction with the deployment of 400 ZR networks. We are at the early stages of several long-term micro trends. We see rapidly growing global bandwidth demand as a result of cloud services, the new requirements of remote working, artificial intelligence and machine learning, 3D sensing and light applications, plus 5G wireless rollout. As a result, it's an exciting time as we believe our advanced technologies for speed over distance meet these growing needs at the heart of the industry. With that, I will turn the call over to our CFO, Beth Beebe.

Thank you, Wu-Pen, and good afternoon. Neophotonics continued to execute well through a tough 2020. We are seeing the results of our investment in speed over distance products with growth in revenue overall for the year and in the 400G and higher speed. We delivered substantial increases in gross margins and profits for the year, and when the Department of Commerce tightened the rules around shipments to Huawei, we took action to improve structural costs and reduce expenses while continuing to invest for growth. We are ahead of schedule on those changes. All of this resulted in record levels of cash. Summarizing the full year 2020, we delivered revenue of $371 million, up 4%, even with the additional Department of Commerce restrictions, non-GAAP gross margin of 31% a four-point increase over 2019, and GAAP gross margins of 28%, a three-point increase year-over-year. Lower year-over-year operating expenses and increased operating leverage while we maintained the investment that will drive accelerated growth. A total year non-GAAP profit of $16.7 million, up from a $0.4 million profit last year, and GAAP profits up from a loss of $17 million in 2019 to a loss of $4 million in 2020, even with the restructuring costs. And lastly, free cash flow of $41 million up from $25 million, with net cash almost doubling from $47 million to $90 million. By all metrics, this was a strong year for neophotonics. Moving to Q4 performance. Good revenue growth from Western customers and strong execution resulted in higher than expected Q4 revenue of 68.2 million, lower operating losses, and a non-GAAP EPS loss of 14 cents per share, well above the expected 18 cents per share loss. As we indicated last quarter, we did not have any revenue from Huawei in Q4. The demand for our products and the strong growth in the market resulted in 18% sequential growth from our other customers. We are well on our way to a more diversified customer business model even before we ramp the 400 VR modules in the back half of 2021. Our non-GAAP Q4 gross margin was 24.7%, down 8.9 points, but still in the upper half of our guidance range. A small increase in product margins was more than offset by higher excess capacity charges, as expected given the lower volumes. Total non-GAAP operating expense for the fourth quarter was $23.7 million, down $0.8 million from Q3, and better than expected on faster execution of spending reduction. As a reminder, in our last earnings call, we announced that we expected to reduce spending by about $2 million per quarter from Q3 as part of our restructuring. Non-GAAP operating loss for the fourth quarter was $6.9 million, or 10%, compared to a 10% profit in Q3. The drop is as a result of the Department of Commerce action. Below the operating profit level, we had two largely offsetting impacts in foreign exchange and a non-GAAP tax adjustment. In Q4, appreciation of the Chinese Yuan relative to the U.S. dollar drove a foreign exchange loss of approximately 3.5 million. As a reminder, the functional currency of our China operations is the Yuan. The FX loss is driven by the revaluation of China balance sheet items to the end of quarter exchange rate. The foreign exchange impact was largely offset by the true up of the non-GAAP tax for the full year of 2020 of $3.5 million. This true-up reverses the non-GAAP tax adjustment charges taken in our foreign entities where the expenses were reimbursed by the U.S. and as a result covered by the U.S. net operating losses. This will be the method that we use for non-GAAP tax adjustment going forward. Non-GAAP net loss for the fourth quarter was $7.2 million, or 14 cents per share, compared to the midpoint of our expectations of a loss of 18 cents on faster implementation of the operational changes we outlined 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 22.7%, down about a point from Q3 on lower volumes. Operating expense was $23.3 million, down $3.6 million from Q3, on $3.2 million of one-time events, mostly the settlement of our litigation with APAT Opto Electronics, as announced last quarter. Operating loss for the fourth quarter was $7.9 million, and net loss was $11.5 million, which included a net gain of $2.1 million of legal settlements and advisory services, a gain of $1 million on the sale of assets, and expenses of $3.3 million of stock-based compensation expense, $0.7 million of accelerated depreciation and restructuring, and approximately $0.2 million of amortization of acquisition-related intangibles. Turning to the balance sheet, we finished the quarter with $123 million in cash, investments, and restricted cash. This cash position is the highest in our history. Net inventory was $47 million flat versus last quarter. Days of inventory was 80 days, as we worked through inventory and raw materials orders that were in progress when the additional restrictions by the Department of Commerce were announced. Cash from operations was just over $5 million, and CapEx was just under $5 million, resulting in free cash flow of approximately $1 million. We remain in a good position to continue to drive the growth of neophotonics. Before I discuss our revenue and earnings outlook, 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. As Tim mentioned, we have seen several changes in recent months. Notably, we have begun to see softness at the start of the year from network equipment companies serving the North America market. We believe this is due in part to the timing of bandwidth deployments related to the pandemic. Current customer indications are that some demand has moved to later in 2021 due to travel restrictions limiting deployment of new systems. This leads us to estimate full-year revenue growth excluding Huawei of 25% to 35%. To reiterate, we believe overall demand in the mid and long term for 400G and above components and modules remains unchanged. In addition, as a result of our efforts to develop products which comply with the most recent BIS restrictions for Huawei, we expect a modest level of shipments to Huawei in forward quarters. With these changes, we still expect to return to operating profit in Q3. As usual, Q1 is our seasonally lowest quarter for revenue and margin due to the Chinese New Year shutdowns and implementation of annual pricing reduction. We improved from that point as volume increases and on the implementation of cost reductions through the year. The company's expectations for the March 2021 quarter are Revenue in the range of $57 million to $62 million, GAAP gross margin in the range of 16% to 20%, non-GAAP gross margin in the range of 18% to 22%, GAAP diluted earnings per share in the range of a $0.28 loss to an $0.18 loss, and non-GAAP diluted earnings per share in the range of a $0.20 loss to a $0.10 loss. These numbers are reflective of approximately 50.7 million basic shares. In summary, for 2021, we are focused on driving growth in our 400G and above product lines, moving into the hyperscale market with added customers for our 400ZR and 400ZR Plus modules, and a return to profitability. Our strong cash position and the restructuring allows us to invest for that growth while positioning us for even higher levels of growth and profit in 2022. This concludes our formal comments, and I would now like to ask the operator to open up the line for questions.

Thank you. If you would like to ask a question at this time, please press star followed by the number 1 on your telephone keypad. If you're calling from a speakerphone, please make sure your mute function is off to ensure your signal can reach our equipment. Again, star 1 to ask a question. And first, we'll go to Fahad Majam from MKM Partners. Your line is open.

Thank you for taking my question. First a clarification and then a question.

Clarification is on, did I hear you correctly that you had four 10% customers in the fourth quarter?

Who were the four 10% customers? For the fourth quarter, we did have four customers and the percent of revenue ranged from 10% to 22%. As usual, well, those four added up to 67%, Fahad. What we did is we did disclose in the prepared remarks the four customers or the 10% and above customers for the year, okay? And so I hope that helps. Okay.

Now to my question, there are two parts to it. One on

diversification.

Can you tell us in terms of where you think your, you know, with your VR revenue wrapping, what type of diversification are you expecting?

Do you think VR is going to account for greater than 10% of the total revenue for the year? And then a more broader forward-looking question for you, Tim, is on As you look at 800 gigs getting inside the data center, there's talk about using SAM for technology using higher modulated speeds like 95 gigawatts. Do you see that as a potential TAM expansion opportunity? Does that further enhance your diversification strategy? Thank you. Yeah, there was a lot in that. Let me comment, first of all, about 400 ZR and revenue, and then I think I'll ask Wu-Pen Yuan to comment on the use of technologies for Intra Data Center. The expectation based on customer schedules for 400 ZR is that After qualifications, we may have some low-level production by the end of the first half, but primarily that would be, you know, for ramp purposes, it would be in the second half. And it is conceivable that it could reach 10% of, you know, annual revenue, but, you know, I think that's, you know, it's in that range. You know, the different customers have different schedules, and so it remains to be seen, you know, how many people actually, you know, started deployment and have meaningful volume in 2021. Wu-Pen, do you want to comment on the question about PAM4 technology?

Yeah, so definitely. So, yeah, 800G technologies, I think both the PAM4 and Coherent will likely be used. And for Coherent side, internal data center would be an opportunity that could expand our TAM and further diversify our business going forward. In the meantime, also just keep in mind, we also have, you know, optical devices, lasers, and other optical devices actually can go into PAN4 as well. So we do see both the PAN4 and Coherent will play a role in the data center 800G, and we who view those as the opportunity for us to diversify our business further.

Thank you. I appreciate the answer. Rupen, if I can ask you a follow-up regarding the use of 96 gigabot technology inside the 800 gig opportunity. If I'm not mistaken, there are not many existing intra-data center optic suppliers that have modulators that can attend that kind of performance. And so do you think that at 96 plus gigabaud type of performance and using PAM technology, it inherently kind of favors you guys, whether it's with the coherent light approach or even leveraging your high-speed modulator technology. Could you extend that potentially in the time for a solution?

Yeah, I think the answer is yes. You know, 800G, you could use 96 or even higher ball rate. And we do think such a high ball rate is getting very challenging to implement. And that certainly is a strength for new photonics. So we definitely see that opportunity for all technologies to be applied to. 96 gigabytes or higher. Appreciate the answer.

Thank you very much. I'll pass it on.

And next we'll go to Dave King from B. Reilly. Your line is open.

Hi, Dave. Thank you. Hi.

Yeah, so, Beth, I'll ask you the first question then. What do you think the cash usage will be in the first half? I think you gave us... that data point for, you know, fourth quarter and first quarter. What about first half this year?

Yeah, we don't, as you know, we don't generally forecast our cash flow other than to say that CapEx runs 4% to 6% of revenue on average for any given year. And we still expect to, we've also said that we expect to be in the high end of that range for 2021 because of the ramp of 400 ZR. We are at the moment, as you saw in the numbers, our inventory has been about flat. So we're still working to burn off some of the inventory that was on order as the Department of Commerce tightened the rules around Huawei.

Got it. And then maybe, Tim, maybe you can take this. Price adjustment in December or late last year. Uh, price, price reductions, uh, each year, you know, historically they've been in the 10 to 15% range, but, uh, you know, uh, this year is actually a little better than average. So low end of that range. Got it. Um, you guys have any kind of a, uh, chip supply chain issues? You know, I'll tell you what the, uh, We're reading about it. We're seeing some impact. Some suppliers are complaining about it. Thus far, we haven't actually had any impact to our supply chain, but we are on top of it in terms of monitoring and looking further up the supply chain. But I hope that addresses the question. Yes. And then maybe my last question is regarding your first quarter outlook assumptions. How should we think about, you gave us some color as to how 400 gig plus will grow year over year. How will that change high speed optics versus non-high speed optics? It was high speed was about 46%. How is that number going to, how will that change in first quarter? Yeah, so actually high speed, which we've classified as 100 gig and above, was I think for the year it was 92% of the full year. Actually, I'm interested. Sorry, Tim. I'm interested in 400 gig and plus. 400 gig plus.

I understand.

That was 46%. Yeah. I thought so, but I just wanted to clarify. Okay. Okay. What we say as high-speed products, as a product group, is 92% of revenue. In the 400 gig and above products, they've been accelerating throughout the year. And by the fourth quarter, the fourth quarter contribution from 400 gig, products for 400 gig and above applications, actually was 46% of total revenue. And in my prepared remarks, I also said that that was up 153% over the same quarter of the prior year. So, you know, it has been growing rapidly, and it's now, you know, approaching half of our business. So can I assume that's going to be more than half in the first quarter, or should we be It sounds like 100 giga and below is experiencing softness. Well, I said in my prepared remarks that we actually do expect in the first quarter for it to, again, double over the prior first year. Whether or not that gets to, you know, I'd say we're creeping up on half of our business, but, you know, I'm not going to, I'm not going to actually say when that happens. I don't know enough. And actually, this will be my last question. Just to be clear, when you talk about some softness and some push-outs, I'm assuming you're talking about optics below 400 gig. Is that right?

I think we're seeing it in the overall market for... And it's a deployment timing thing, the same as some of our other co-travelers in this market have been talking about. The 400 gig and up will also be included just because it is a system deployment timing issue related to COVID and travel.

Got it. All right. Thank you.

And next we'll go to Paul Silverstein from Cowana Company. Your line is open.

Yes, I actually did hear and appreciate the response you just gave about the nature of neutral weakness.

But I just want to make sure I understand. From a demand perspective, you and Tim, you're not saying it's stopping the demand, but the weakness you're referencing, you believe it's due to logistical issues related to government in terms of

the ability of your network equipment customers to get access to service provider networks, or is there also demand components?

So what we're hearing from customers is more the former. And, you know, there is kind of a chorus of customer interest that suggests that they expect their demand as a result to be more back half loaded. And so overall, we are now kind of in the current order. We're hearing more concern about chips. As I indicated previously, that hasn't impacted us at this point, but to the extent that it impacts a customer's ability to do something with our products, it may have an impact. But generally, the bigger impact thus far has been how has COVID affected the rate of bandwidth deployment, certainly in 2020, and then how is it affecting new system deployments today?

As you well know, Paul, the overall demand profile for increasing bandwidth is the underlying profile that drives our business, and it has not changed.

I don't want to put words in your mouth, but I hear you all saying that logistical issues in terms of your customers getting access to service by the network is not being compiled in demand, or isn't being compiled in that sense.

It's hard for us to go to a root cause basis, but what their guidance has been and what the conversations with them have been is that there is an impact in deployment rate. Very, very recently, we've heard some references to chip supply. But there's also kind of the latent effects of share between and among network equipment companies as a result of the Huawei restrictions on Huawei. And so share shifts between customers can impact short-term orders, though the overall demand rate may not have changed. So that's as we see it today. And, Tim, I mean, it's going to be obvious. What you're referring to, if it sure goes from Huawei to Nokia, Huawei to Kina, Huawei to Infinera, well, long-term, for the winter of that, near-term, it's not a similar channel. It's a really similar channel. That's what you're referring to. Yeah, in the case of ShareShift, because, you know, we're supplying products to each of the major network equipment companies, and as we've commented in prior quarters, is to the extent that if a ShareShift moves from Huawei to another one of the Western customers, you know, net-net overall, that may end up being favorable to us in the... You know, the situation with share shifts between or among Western customers is a little, you know, a little harder to quantify, but it also is a question right now as to, you know, who's winning share and where. I understand. Tim, I recognize you want to get removed, but on the command question, obviously you all just got a big formal announcement since you're a Verizon agent here in the C-band. And they're big numbers, needless to say. Again, I recognize you want to remove it, but do you have any insight, direct or indirect, as to whether or not that's going to have some transitory impact on spend? I recognize the argument about when you spend that type of money for Spectrum, it's crazy not to go ahead and spend money on the infrastructure to get the infrastructure deployed and operational. On the other hand, obviously service providers are concerned about the bills they're giving and the cash flow, and so you have two diametrically opposites. forces. Ben, maybe you have some perspective here.

Hey, Paul. So what we are hearing so far is still the demand is still kind of second half of the year loaded. We did see the result of C-band auction today from FCC, and the carrier spent a lot of money, right? But we have not heard any changes on demand profile since being more of a second half of the year loaded.

I appreciate that. Two quick questions that I made very quickly. Tim Beth, can you share with us, and there's a reason for the question, but how much 600, 800 gig was the percentage of total revenue?

Was it a percentage of the 400 plus? Was it not a number?

Was it meaningful?

No, we just have 400 gig and above, and that was 46% of revenue in Q4. We don't break it out because in a lot of cases we can't. We're very clear on which products are used in 400 gig and above, but because of the fact that the products are actually baud rate rather than bit rate, it's it's not really possible to be as granular as what's 600 and what's 800. Understood. One last quick question. How many ZR customers do you expect in Redmond this year?

How many commitments do you have?

How many commitments for what? ZR. For ZR? ZR. You know, I think we're going to forecast that when we can actually talk about design wins. So, you know, there are only a few who actually have schedules for 2021. So it's a modest single-digit number. So, you know, it's not a lot. All right. I appreciate that. Thanks, Paul. Okay. Thanks, Paul.

And next we'll go to Sameek Kenerji from J.P. Morgan. Your line is open.

Hi. Thanks for letting me ask the question here. Just quickly, I think a good part on gross margin here. When I look back, you did about a 33-34% gross margin on about $100 million of revenue. As we look forward, how do we think about return to those levels in terms of what you need for some revenue, just given that I'm going to start with the second question first.

We do not have any estimate for the 400 ZR margins yet. Those terms are all still in discussion. We do expect them to be healthy once we get through the initial ramp. So you've always got in the initial phases of a product, you've got some yield improvement to go off and do. On the overall gross margin, our target remains 35 percent. We hit 34 in Q3 at over $100 million in revenue, so that remains our target. We have done, as you can see in our historical financials, we have done substantial improvements on gross margin, so we're at 68 million in Q4 for revenue. and we're at 25% gross margin. And we were at, last time we were down at $68 million in revenue, we were at 15% gross margin. So we've substantially improved gross margin over time. But until we hit our target of 35%, that remains our target. Okay. Thank you. Thanks for the question.

And next we'll go to Tom Disley from DA Davidson. Your line is open.

Yeah, good afternoon.

I guess following up on the last question, do you expect any meaningful changes in OpEx over the next couple quarters? You've been cutting costs, but also you've got a ramp coming up, so I'm just curious what OpEx is expected to do.

What a good question. As we said, we did a Restructuring, we're at about $24.5 million, and this is all non-GAAP in Q3. Midpoint of our guide for Q1 is about $22.5, so we're hitting that target for that $2 million of restructuring savings a quarter earlier than we had initially forecast. What we will, we could see OPEX might pop up a little bit as we're doing the final ramps for the 400 VR. just because that is a major driver of growth. And if we need a couple extra dollars, then we're certainly not going to hold that back. But I would expect to remain, as we said, for the restructuring in the 22 to 23 overall range until we get revenue and profit back.

Okay, that makes sense. And then just two quickies on the 400 EUR. Were you expecting a qualification to happen in the first quarter?

And the second part of the question is, do you need more than one customer to hit your 10% of revenue this year? So it is the case that initially, last year in 2020, we anticipated that initial qualifications may be completed by the end of the first quarter. It's now looking like it's in the second quarter, as we indicated earlier. the answer to your second question actually depends on who the first customer is. And it's a customer and share award question that it's entirely possible for us to do it, but we don't know. So I think it would be inappropriate to try and predict that outcome. Okay, that makes sense.

Thank you.

Thanks, Tom.

And next we'll go to Simon Leopold from Raymond James. Your line is open. Hi, Simon.

Thank you for taking the time today. Hey, Marisa. Hey, man. Just an apology. Did you guys provide the annual revenue contributions from 400 veganables in 2020?

For 400 gig and above ex-Huawei, no, we just provided it in the fourth quarter, which was 46%. Let's see, for the year ex-Huawei, I think it's 35%. That's total sales.

Awesome. Thank you. And then, I could go a bit on the ER. I think, well, before that, I think I heard that you guys now expect your revenues to grow from 25% to 33% year-over-year in 2021. And what you mentioned was these toughness that you're seeing. from some WebScale audience, particularly as it pertains to North America demand. Could you please expand a bit on that topic? What kind of products are we talking about? Are these more WebScale operators, components that go into WebScale networks or North America T1 operators? If you could talk about that, please.

So I think, Murcio, you've seen a lot of this. Tim will pile on after I'm done. You've seen a lot of this from other players in the market as well. It looks like we're all kind of seeing the same thing of just a pause in deployment. And for us, we see it from the North American network equipment companies.

I think it's also, you know, and those guys all tend to be serving DCI. But where there's a, you know, where there's deployments, it's not limited to one.

Thank you. That's helpful. And then as it pertains to the VR, I think by now you have said qualifications to take place in the second quarter versus the first quarter before. Can you please talk about the competitive landscape? I think you previously identified Acacia and Infi as your closest competitors in the VR market. I'm just wondering if that continues to be the case or if that competitive pool has somehow expanded to include others. And I have a follow-up.

Yeah, no, I think you're accurate, Mauricio. You know, we are... I think we're one of the very few who can meet these competitive specs currently, and the two that you cited, you know, we do see them out there as well. So I think in addition to Neophytonics, Acacia Communications and InFi have 400ZR. You know, I think there are a lot of considerations here because There are 400 ZR and there are 400 ZR plus opportunities going forward. There are also considerations about power envelope, power consumption. And so, you know, as companies are initially rolling out products, it's, you know, meeting the appropriate specification. But keep in mind also that, you know, of course, Acacia is in a... contract to be acquired by Cisco. And similarly, InFi is planning to be acquired by Marvell. And so I think Neophytonics is the independent operator in this conversation.

Yeah, that makes sense. Very quickly on that, assuming that one of your large high-tech steel customers is qualified, for the VR. How do you think about your working capital for the rest of 2021, given that some of the requirements of these operators in terms of the amount of inventory in hand that they're required to have, et cetera?

Absolutely. These are fairly demanding customers. They ask that you carry a certain amount of inventory for them on their site and commit to certain levels of replenishment rates. So we would expect our working capital to increase and which is why we've got a hundred and twenty three million in cash and people ask me on a regular basis what are you going to do with all that cash and my my general response is priority number one is absolutely making sure that we can ramp these web scale customers and next we'll go to Alex Henderson from Needham your line is open thank you

Hello. I was wondering if you could talk about the relative advantages or disadvantages of 400GB VR versus the 800GB products that are out there and to what extent there's a lower power envelope or a difference in cost per bit or some other elements in terms of flexibility. How is the competition between 800 gig and 400 gig VR setting up?

Alex, it's Wukong speaking. That's a great question. This is how we view this. 800G is going to be a universal platform, as you know. It goes short distance, DCI to long haul. We do see the 800G strength really in the ultra-long haul, high performance, applications, and we do see 400ZR being able to bypass the box, just plug into a router or switches, provides a lot of flexibility and potential cost savings to the web-scale customers. So, you know, we see 100G being a universal platform, powerful, but then we see 400ZR being a flexible platform that's cost-reducing and enabling new applications.

You know, I think the new applications... Is it just in the architecture then? Well, you know, this is Tim. Certainly the use cases, Alex, you know, you've got the 400ZR initially, but then there's an opportunity for the new use cases to emerge beyond DCI. And so that goes with 400ZR plus and longer reach, then you're able to... start accessing metro area interconnects, you know, 5G backhaul, and then potentially a longer distance regional. But, you know, that takes place over time.

Yeah, so what I was asking, though, is if I look at it on a cost-to-bid basis, just transceiver-to-transceiver, it doesn't strike me as a competitive advantage product. It's only in the fact that it's pluggable and that it changes the architectural structure pattern of the way the transceivers are deployed, that really is where it sparkles and changes the dynamics. Is it right to think about this as an architectural issue as opposed to just simply a cost per bit power envelope issue?

Actually, the first to think about really is the cost per bit issue because you skip the entire DWD inbox and all the associated client-side connections, right? You really plug you save one layer, right? You go directly plug the DWDN capable into a router. Prior to this, it was not possible to plug a router capable, pluggable DWDN that can go long distances before. But now this is really the first time that happens. So you can think about this really as a cost-driven approach and which then results in an architectural change.

But it's in the architectural change that the cost per bit is lower, not the cost per bit per light space.

If I don't look at the change in the architecture, I just plug the transceiver in to an existing DWDM box, it wouldn't have a cost advantage.

It would be actually disadvantaged. That's probably true. That's the way it shines, right?

But then that change is enabled by the fact that you have a very small plausible form factor.

And next we'll go to Harsh Kumar from Piper Sandler. Your line is open.

Yeah, hey, thanks for putting me in. Quick question. First of all, what do you think your exit run rate will be for 400 gig plus products as you either enter second half or you exit the year, time of the year, let's say? Harsh, this is Tim. The answer to your question has a couple of parts. The first one is that with the rapid rate of growth of 400 gig that we've experienced this year, you can predict a high exit percentage. However, it's also noteworthy that you know, our passive products, as Wu-Pen said in the prepared remarks, you know, we have products that do MUX and DMUX functions that are particularly good for the 400ZR architecture that we'll also deploy. Those products are not in our high-speed group. We report them as part of our network products. And so we would expect... growth there. And then in addition, as Beth said in the prepared remarks, if we do have some level of increased shipments for lower speed, for example, there are some current tenders pending in China that tend to be at 200 gig. So there are possible growth areas that are not 400 gig to you know, basically, you know, offset, you know, the rapid growth of 400 gigs. So I think we're not going to get too high in forecasting. We would like to see it be more than half of our business, but hard to predict at this point. Okay. For my follow-up, can I ask you, you talked a lot about sort of softening that you're seeing at some of your customers. I was wondering if you would have visibility of one level In other words, the actual hyperscalers or cloud guys or whoever that it is that you think the weakness is coming from, what do you think is causing that? Is it some level of inventory build? Is it just that they feel like demand's peaked? If you have any visibility in that, it would be really helpful. You know, in addition to the things we've already said, we think there's also an overall share shift. And so I think that will play out over the next quarter or two as we see deployment rates happen with and between the network equipment companies. And as we said earlier, they're all our customers, but how that share shift plays out matters. Very nice. Thank you.

Thank you.

And at this time, I'll turn it back to Tim Jenks for closing remarks.

Well, thank you for joining our call today and for your interest in neophotonics. The core trends of the industry play into our strengths in 2021 and in subsequent years. So I'm very proud of our team for what they've achieved. We do look forward to updating you in the future. Have a good evening.

That does conclude our call for today. Thank you for your participation. You may now disconnect.