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NeoPhotonics Corp (NYSE:NPTN)
Q2 2020 Earnings Call
Aug 4, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day. Welcome to the NeoPhotonics Second Quarter 2020 Conference Call. This call is being webcast live on the company's website at www.neophotonics.com on the Events page of the Investors section. This call is the property of NeoPhotonics and any recording, reproduction or transmission of this call without the expressed written consent of NeoPhotonics is prohibited.

I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations. Please go ahead.

Erica Mannion -- Sapphire Investor Relations

Good afternoon. Thank you for joining us to discuss NeoPhotonics' operating results for the second quarter of 2020 and outlook for the third quarter of 2020. On the call today are Tim Jenks, Chairman and CEO; and Beth Eby, Chief Financial Officer. Tim will begin with a review of the company's business in the second quarter and a discussion of market drivers and products. Beth will then provide financial results for the second quarter before providing the outlook for the third quarter of 2020. 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, include all income statement and balance sheet amounts and percentages other than revenue, unless otherwise noted. These non-GAAP financial measures are prepared are not prepared in accordance with GAAP and are not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. These financial measures and a reconciliation of GAAP to non-GAAP results are provided in the company's press release and related Form 8-K being filed today with the SEC and can be found in the Investor Relations section on NeoPhotonics' website. Material contained in the webcast is the sole priority 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 August 4, 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 S. Jenks -- President, Chief Executive Officer, Director and Chairman of the Board

Thank you, Erica, and good afternoon. Our business continues to perform well despite the challenges of operating through a full quarter in the COVID pandemic. We continue to put the highest priority on the health and safety of our employees, our supply partners and their families. Revenue in the second quarter was $103 million, growing 26% year-over-year compared to 23% growth in the first quarter. Our growth for the last four quarters was 19% over the prior year. Non-GAAP gross margins continued to expand to 33.2%, up eight percentage points from the year prior and two percentage points sequentially. Similarly, our operating margin and EBITDA are at the highest levels in our history. Our non-GAAP EPS was $0.16 per share. Sequential growth was driven by cloud and data center demand as our 64-gigabaud and other products for 400-gigabit and above applications accelerate. We view ongoing demand for bandwidth and associated infrastructure upgrades for data centers to be an important growth area in the years ahead, notably at 400 gigabits and above. NeoPhotonics continues to be an industry leader for the highest speed over distance, optical network solutions, supplying customers with components and modules, which deliver the highest interconnect bandwidth per wavelength and per fiber for distances at 40 kilometers and longer. Our products enable these highest data rates in backbone networks, regional and metro area networks and the biggest pipes for data center interconnects. Our high-speed products now consistently represent 90% or more of our business. Within this, our newest and highest speed products, including ultra-pure light tunable lasers, high-speed modulators and receivers are at the core of 400-gigabit per second, 600-gigabit and 800-gigabit solutions.

These components are also used in lower speed applications, such as 200 gigabits to extend the reach to longer transmission distances. Taken together, these highest speed over distance deployments are forecasted to be among the fastest areas of growth in the industry for the next several years and have been driving our recent growth in both revenue and profitability. We believe that our products for 400-gigabit and above applications will approach 20% of our total revenue this year. Beyond top line growth, our 400-gigabit and above solutions are also increasing our customer revenue diversification. At this point, almost all of the world's leading network equipment customers leverage NeoPhotonics' products for their 400-gigabit and faster systems. Moreover, these customers are now ramping their deployments. In the second quarter, excluding our top two customers, our next eight customers combined grew a total of 35% sequentially. We expect this trend to continue. We anticipate that we will have additional industry leaders become 10% customers during the second half of 2020. Based on our existing customer orders and delivery commitments for 400-gigabit and above products. Trade tensions are causing market share shifts between our customers due to the breadth of our design wins and customer base, NeoPhotonics is likely to be a beneficiary of these shifts. For example, a market share shift of one 400-gigabit and above port, away from our largest customer and to another industry leader, would likely be favorable to NeoPhotonics in revenue terms. Similarly, a market share shift of one 100-gigabit port away from our largest customer and to another leader, would likely be roughly equivalent to NeoPhotonics in revenue terms. Over the last year, we have reported that our largest customer, Huawei, has had a plan to build strategic inventory due to trade tensions. We believe at this point that they have achieved their goal.

As our next group of customers ramp their respective systems for 400 gigabits and above applications, we believe the strength of deployments from these customers will offset potential revenue impact from Huawei's inventory adjustments. We previously noted that carriers in China are using Super C-band spectral window to increase fiber network capacity, leveraging the NeoPhotonics C++ LASER product and 64-gigabaud component and module solutions. Using higher baud rate is efficient for distance and this expanded spectral range allows additional wavelength channels, increasing fiber capacity in backbone and provincial networks. Looking beyond 2020, strong progress continues with our 400ZR and 400ZR+ pluggable coherent modules, which we launched in the fourth quarter last year. Our 400ZR and 400ZR+ modules for cloud and Ethernet applications are in-customer qualifications, having moved from initial sampling in the first quarter. We have taken further steps toward establishing the 400ZR and 400ZR+ ecosystem. Together with Inphi, we completed the industry's first interoperability demonstration of OIF 400ZR compliant, coherent transceivers, operating over a 120-kilometer optical fiber link and utilizing multiple wavelengths across the C-band. Full 400ZR coherent optical transceivers carried error-free traffic, demonstrating the availability of interoperable coherent transceivers for multiple vendors. This is a key step to enable next-generation DCI links using IP over DWDM and the 400ZR architecture. We expect initial volume applications for 400ZR to be with hyperscale customers for data center interconnect. However, with 400ZR+ capability for longer distances, there is also an opportunity for new use cases to emerge beyond data center interconnects, including metro area interconnects, 5G backhaul interconnects and longer distance regional long-haul interconnects. It is important to note that for NeoPhotonics, the 400ZR and 400ZR+ module market expands our overall TAM as it adds higher ASP module solutions to our existing market-leading position and highest speed over distance components.

Additionally, each of these new high-speed systems, including 400ZR and 400ZR+ applications, operate over DWDM line systems, including open line systems that requires specific high-performance multiplexing products having unique channel spacings and filter shapes and channel monitors, which we also provide. Rapidly growing global bandwidth needs continue to be the fundamental driver of our business, whether it be for cloud services, capacity increases due to remote working, high-speed deployments to the edge or 5G wireless rollouts, with increasing momentum in 400-gigabit and above design wins across the major network equipment manufacturers, as well as the 400ZR and 400ZR+ opportunity in 2021. And with caution due to risks related to the ongoing pandemic. We remain optimistic that industry trends continue to move in NeoPhotonics' favor.

With that, I'll turn the call over to CFO, Beth Eby.

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Thank you, Tim, and good afternoon. NeoPhotonics' performance remains strong with Q2 non-GAAP EPS of $0.16, higher than our guidance range as a result of outstanding execution by our team and our suppliers in a challenging quarter. As Tim mentioned, revenue was $103.2 million, above the high end of our outlook. Huawei was 52%, and our next four customers contributed 30% of revenue, similar to last quarter. Our revenue was not materially impacted by the most recent U.S. Department of Commerce restrictions on the sale of customer design products designed or manufactured using U.S. software or manufacturing equipment as we design all of our own products. Similarly, as we stated in our press release dated May 26, based on our review of the products we ship, our revenue was not materially impacted by the addition of FiberHome and their affiliates to the Entity List. We remain committed to complying with all U.S. EAR rules. Our non-GAAP Q2 gross margin was 33.2%, coming in toward the high end of our range. Within this, product margins were 36.3%, up slightly from last quarter on increased volume. Other cost of sales charges of 3.1 percentage points improved sequentially as expected. These charges were approximately one point of warranty charges, one point of residual tariff adjustments, 0.5 point of underutilization and other minor charges. Total non-GAAP operating expense for the second quarter was $23.6 million, slightly lower than expected on continued pushouts related to COVID-19 impact. The spending delays are not impacting our project timing. As we said last quarter, we expect to make up the first half underspend in the back half of the year to ensure continued success of our 64-gigabaud and 400ZR programs. Non-GAAP operating profit for the second quarter was a record for NeoPhotonics at $10.7 million or 10.4%, reflecting both the increasing leadership of our products and our continued strong execution. Non-GAAP net income for the second quarter was $8.7 million or 8.4%.

I will close out my discussion of the second quarter income statement with a review of our GAAP results. Second quarter gross margin was 32.5%, up two points from Q1, driven by an increase in volume. Operating expense was $26.9 million, up $4.5 million quarter-over-quarter, as expected, with the lack of the onetime license credit in Q1 and higher variable compensation expense. Operating profit for the second quarter was $6.6 million, which included $3.8 million of stock-based compensation expense and approximately $0.3 million of amortization of acquisition-related intangibles and other costs. Net profit for the quarter was $5.7 million compared to a profit of $6.3 million in the prior period. Turning to the balance sheet. Our cash position continued to improve to $113 million of cash, short-term investments and restricted cash. Cash from operations was $10 million, and we paid down $4 million of debt while increasing our inventory is planned to buffer continued supply chain volatility. We continue to be well positioned to invest in our next phase of growth. Before I discuss our earnings and revenue outlook for the third 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. As we have noted in the last few quarters, we believe that Huawei and their affiliate, HiSilicon, have been building strategic inventory. We believe this action is now complete and future orders will better reflect end customer demand. As Tim mentioned, given the strength and demand of our highest speed products, we expect that our other customers will continue to ramp, largely offsetting the Huawei decrease. The net result is a Q3 revenue outlook, which is nominally in line with Q2.

Gross margin reflects some increase in underutilization charges. This is the result of slower than planned deployment due to COVID-19 of customers' silicon photonics-based transceivers that use our fixed wavelength lasers. As I mentioned earlier, operating expense is increasing in the back half of the year to maintain the planned investment in 64-gigabaud and 400ZR for the year. We believe that investment will continue to drive revenue growth and customer diversification in 2021 and beyond. In Q3, we are taking the unusual move of including a $1 million FX impact in our forecast or a $0.02 per share adverse impact, as we have seen an increase in the value of the Chinese yuan relative to the U.S. dollar. As a reminder, this impact is the noncash revaluation of our U.S. dollar assets on our China balance sheet and will change if the U.S. dollar valuation recovers. Given that, the company's expectations for the September 2020 quarter are: revenue in the range of $97 million to $105 million; GAAP gross margin in the range of 29% to 33%; non-GAAP gross margin in the range of 30% to 34%; GAAP diluted earnings per share in the range of a $0.03 loss to a $0.07 profit; and non-GAAP diluted earnings per share in the range of $0.03 to $0.13 profit. These numbers are reflective of approximately 547 million fully diluted shares. In summary, we have now had eight quarters of delivering year-over-year revenue growth, expanding gross margin and positive free cash flow. We have also delivered four quarters in a row of profitability. Q2 revenue grew 26% year-over-year, and our non-GAAP gross margins expanded by eight points over the same period last year, demonstrating our focus to drive profitability. Net cash increased from $26 million to $77 million from the same period last year, putting us in a good position to fund long-term growth with an expanded customer base. We are excited about our growth prospects. This concludes our formal comments.

And now I will ask the operator to open up the line for questions. Brad?

Operator

Thank you. [Operator Instructions] We will take our first question from Samik Chatterjee with JPMorgan.

Joe Cardoso -- Analyst

Hi guys, this is actually Joe Cardoso on for Samik Chatterjee. For my first question, I just wanted to know, relative to your 2Q revenue performance, whether you guys actually ended up seeing any COVID headwind there. And then relative to your 3Q guide, are you guys baking any COVID headwind?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

So what we said when we put the Q2 guide in place was that we were expecting about $10 million of supply chain headwinds, we were able to mitigate almost all of those in which is how we got the revenue over our guidance range. We are still seeing supply chain impacts in Q3, but we believe, based on our experience in Q1 and in Q2, we believe that we will be able to mitigate those through the quarter.

Joe Cardoso -- Analyst

Understood. And then just relative to your comments on Huawei and then finally achieving the inventory level, I suppose that they were targeting, as you see maybe how Huawei revenues kind of moderate in subsequent quarters and potentially offset by ramping business with other customers, how do you guys expect to impact your margin? Is it would you expect a margin benefit from that shift in customer mix?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

I think we'll see ups and downs and need to see the exact numbers on what those are. Huawei is our largest customer. They get the most volume discounts, but that is could be offset by some level of underutilization charges, so we need to see how that plays through when we see their actual orders.

Operator

Thank you. We'll take our next question from Fahad Najam with Cowen and Company.

Fahad Najam -- Analyst

Thanks for taking my question. Tim, I want to ask you a big picture question on for getting putting a Huawei aside, your U.S.-based largest customer has certainly done a significant amount of vertical integration. How should we be thinking about your non-Huawei business, how are those customers vertically integrating? And how do you your business being impacted by that plan? And are you beginning to see some of that shift already from some of your non-Huawei customers, internally develop some of the components that you were previously supplying to them?

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

Well, we do see and we have commented in past quarters about some level of vertical integration. But as I said in the prepared remarks, if we look beyond our top two and to our top 10, essentially, the other eight did grow 35% Q2 over Q1, and they are collectively on a growth path. Of those, the vast majority are not vertically integrated. Now we do expect that the rate of growth will continue and the industry forecasts suggest that for 400 gigabits and above, the growth rates are expected to be quite good. And then right now, that is for 400 gig, 600 gig and to some extent, for 800 gig, all of that for us is at a component level with the exception of telecom-focused coherent modules. But the by the time we get to 2021, then we're looking at 400ZR being an additional revenue capability and then 400ZR+. So there are, without doubt, headwinds to vertical integration. By the same token, there are continuing to be very good opportunities with an expanding market and expanding TAM that we're addressing. And these opportunities are really what's causing us to be pretty excited about the prospects.

Fahad Najam -- Analyst

Got it. And then on the near term, can you speak to I mean, there's always this concern, and I appreciate the comments that you had. But maybe if you can give us some idea in terms of inventory buildup in China. I mean, certainly, 5G is a big piece of the deployment in China. Do you know how much of your revenue can be attributed to 5G deployment versus the DCI-type deployments? Just kind of help us understand the end application that's driving much of your demand for your components?

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

Let's see. For 5G, we have to think about the front haul, mid-haul and backhaul aspects of a 5G deployment. Early in the deployment, it is mostly front haul and some mid-haul. Our largest position would be in the backhaul, which would move toward network build-out, and it is based both on the rate of deployment of the front haul and the subscriber usage. So essentially, as they deploy front haul and mid-haul, they build it up with subscribers, then that requires more capacity for backhaul, and that would use that would impact us. So for the part that is front haul and mid-haul, we do sell some fixed wavelength lasers and components, but it's actually a very small percent of our revenue in total. So there really is kind of very modest impact on revenue at the moment.

Fahad Najam -- Analyst

Thank you. I'll pass along.

Operator

Thank you. And we'll take our next question from Alex Henderson with Needham & Company.

Alex Henderson -- Analyst

Thank you very much. Hello. So I thought I'd start with a little bit of mundane stuff. Could you give us some direction on what you think the tax rate is going to do or tax expense is going to do for the next quarter or 2? Something less mundane.

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Our tax rates remain the same as we have NOLs that offset the U.S. taxes. Japan is 35%. China is 25%. We have had a shift in approach of how those taxes are accrued. And honestly, Alex, they're still sorting out because Q1 and Q2 were both significantly higher profits than expected. We got hit with a significantly higher tax burden in Q1 and Q2 than expected.

Alex Henderson -- Analyst

So I assume it's something considerably less than the 1,500 that was posted in the June quarter?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

No, that's the right one for June because June was a...

Alex Henderson -- Analyst

No, no, no, I mean, going forward.

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Yes. Yes, it will it should average out over the year to something slightly lower than our current levels.

Alex Henderson -- Analyst

Great. And I just wanted to make sure I understood your comments around Huawei. Clearly, the revenues were benefiting from a build in inventory. Now you're saying your other customers are going to be able to offset some relative weakness in Huawei. But then you also said that Huawei orders would be to meet demand. Do you expect Huawei to sustain the current level of inventory and therefore, underlying demand growth out of China would be consistent with the order rate growth rate? Or do you expect them to start to draw the inventory down a little bit? I'm not sure I completely got the subtlety around that.

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

Yes. So the trade tensions are putting Huawei in a somewhat unique position. And they have built up a strategic inventory, and we do expect that they will continue to be purchasing products that are based on their market demand and run rate as opposed to working down their strategic inventory. That would change if there was a highly favorable change in the trade tensions. But as it is, we do expect to have a smaller revenue base from Huawei as a result because over the last year, we have had a larger-than-normal Huawei percent of revenue as they were accumulating strategic inventory. Historically, over multiple years, looking back about five years, Huawei has been in the range of high 30s to 40% of revenue, but in the last year, it's been more like 50%. So that's how we expect it to play out. Now as we look out toward, beyond the quarter and next year, Huawei is in a situation where they may see, they may be subject to market share shifts. And as I commented, their competitors are our customers as well. And the relative balance of market share remains to be playing out. However, if they are losing share, then their inventory actually, on a relative basis, is probably more than ample, but we do expect them to purchase on an ongoing basis.

Operator

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

Richard Shannon -- Analyst

Hi, thanks for taking my questions as well. Maybe a question on the third quarter, asking a slightly different way than one in prior ones here. Is it fair to think about the sales guidance here, which is kind of down, I think, down slightly at the midpoint here, essentially flat, but pretty close. Is it safe to think about Huawei being down and the rest of your aggregate revenue is kind of flat to up? Or should we think about that differently?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

No, I think that's a that's the right way to think about it is Huawei has been building inventory. We believe they're going to hold that inventory and still continue to order. As Tim just said, but we're seeing good growth from the high-speed purchases of others.

Richard Shannon -- Analyst

Okay. Tim, I think you said you expect one or more 10% customers in the second half of the year. Can you characterize these guys in any way? Or I would assume they're OEMs? Or is there a possibility to even see direct cloud customers? And if they are OEMs, can you characterize them in any way geographically or otherwise?

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

Yes. Sure. So specifically, I said that these are network equipment manufacturers that I'm referring to. So that, yes, they're OEMs. But there are a number of companies that have launched 400 gigabit, 600 gigabit and the new systems, and demoing even higher speed. And so we're selling to each of those. And as they ramp, that's seeing a much higher than market average rate of growth. The result of those ramps is we are seeing increasing quarter-over-quarter revenue, but we're also seeing strong backlog for subsequent quarters. So we're in the situation where, certainly, in the case of Huawei's unique position, they have been the largest, but they are challenged by the overall trade situation. We've got a very strong group of customers relying on our component solutions for their 400 gig, 600 gig and above products. And as those ramps, that's a very strong growth stream for us going forward. And the customers are kind of all in the top 10 network equipment companies in the industry.

Richard Shannon -- Analyst

Okay. That's helpful, Tim. One last quick question, I'll jump out of line, for Beth on the opex here. Your guidance and your discussion, you mentioned a higher level here for this quarter. I think you're implying it beyond that. How should we think about the trajectory or model for opex as would go out a few quarters here? Is it expected to flatten out or kind of represent of sales? Or how should we think about that?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Yes. This year is going to be unusual because we were so low in Q1 and Q2, and so we'll balance that out in Q3 and Q4 because the projects we're working on are important. But ongoing, the model that we're we've said for a while now is gross margin of 35%, and opex is 25% of revenue. That's how I model it out.

Operator

Thank you. Our next question comes from Tim Savageaux with Northland Capital Markets.

Tim Savageaux -- Analyst

Hi, good afternoon. Well, a couple of questions. Let's continue on with this sort of discussion around changing customer mix. And you mentioned that kind of 35% sequential increase, I guess, in customers three to 10 in Q2. Do you expect that sort of trajectory to continue into Q3? I guess would be the question. And in which case, you could see your Huawei concentration come down almost to kind of historical levels. Is that the magnitude of shift that you're implying in the guidance or might you see a sequential growth rate slow a bit with the new customers?

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

Tim, that's exactly right. That's exactly right. We are referring to customers three to 10. We do expect that rate of growth to continue based on our view of our committed shipments in our backlog. For these higher speed systems, we have a range of products that we sell. We have narrow line with lasers, which are critical in the highest rate systems. We have our coherent driver modulator or CDM. We have our high-bandwidth receivers. We combine these together in our CFP2, a 400-gig module and different customers qualify one to all of these products. And so each customer is a little different in terms of their content, but for some customers, as they ramp, our content is very, very strong. And this is why I said in my prepared remarks that we can be a beneficiary of this as customers argue over market share.

Tim Savageaux -- Analyst

Okay. And just a follow-up on that. I have one afterwards, but that was interesting. So it sounds like in addition to the different customer mix here, you might have kind of mix issues going on a couple of different fronts that I'd like to ask about. One, I think you alluded to was maybe component versus module, right, where some of these newer customers you're seeing come in might be more focused on the module level. I don't know if that has a maybe a revenue plus possibly a margin minus, I'm not sure. And then can you speak to whether there is a changing kind of end market mix is that customer mix shifts? And that do you see at 400-gig and up more cloud-type applications versus carrier, metro, long-haul transport applications?

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

Yes. So for the right now, the 400 gigabit, 600 gigabit and above applications are primarily components and line card that are essentially fabricated by network equipment manufacturers, some of which are used in DCI. The preponderance are telco. The designs that we have and products for coherent modules do include a CFP2 400-gigabit product that is capable of distances essentially much longer than VR alone. And so these are for regional network applications. And kind of leading market for that kind of deployment actually is the market in China. For in 2021, we would expect to be ramping 400ZR cloud and Ethernet versions. This, for us, would mean the OSFP form factor and QSFP-DD form factor. And those are decidedly cloud-focused customers and applications.

Tim Savageaux -- Analyst

Okay. And that was going to be the area of my final follow-up, which is on ZRs. I don't know if you heard the Inphi call this morning, but the interoperability test was also mentioned. So was at least some opinion over there about prospects extending beyond the DCI market and that ZR could have, as you mentioned, in your remarks, kind of significant applications kind of on the telecom side, and I think you mentioned metro in a range. So would you say visibility toward those applications has increased for you over the last quarter or so as you've moved from sampling into qualification. Maybe you could characterize your opportunities, cloud versus telecom and whether telecom has increased over that time period?

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

Well, I think for the 400-gig modules for 400ZR, this is really focused on cloud. And I think you referred to Inphi's call this morning, and I think we would agree with their timing of is being mostly 2021 and with volume in the second half of 2021. Our product offerings do include capabilities for taking this to ZR, 400ZR, but also for 400ZR+. And this is where, as I said in my prepared remarks, we would expect there to be additional use cases. And the use cases do extend for these longer interconnects. So not just data center interconnect, but metro, 5G backhaul and regional and long-haul interconnects. And so these would essentially be telco. So the 400G in the ZR application is cloud first, but then the additional use cases would have it gain share in telco applications.

Tim Savageaux -- Analyst

Thank you. That helps.

Operator

Okay. And we'll take our next question from Simon Leopold with Raymond James & Associates.

Mauricio Munoz -- Analyst

Thank you for taking my question. This is Mauricio in for Simon today. I think if you could continue to extend on the 400 gig, the ZR opportunity, maybe you can sort of help us understand the size of the ZR for you. But also, if you could talk about the competitive landscape here, as you will likely be directly competing with some of your current customers as well as those who supply DSP, a coherent DSP capabilities to you.

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

Okay. Well, let's see. First is the discussion of the opportunity in VR. I think over the last two conference calls in response to questions, we talked about this as potentially $500 million over three years. I think the view is increasing closer to $1 billion opportunity over three years for the market. And so we're competing for a share of that opportunity. That would be the size of the ZR TAM, if you will. Now with our product offerings being each of three form factors in both ZR and ZR+, we would be competing for all of the TAM. Our served market is, therefore, quite broad. But again, the first real application is 400ZR serving the cloud. With respect to DSPs, we did the interop with Inphi, and we did say in that press release that we used a DSP for that product from them, and they have been a strong partner. We have also deployed in the past other coherent module products using DSPs, including from NEL in Japan. So we are it depends on the product, deploying DSPs from different vendors.

Mauricio Munoz -- Analyst

Thank you.

Operator

Thank you. And we will take our next question from Dave Kang with B. Riley FBR.

Dave Kang -- Analyst

Thank you. Good afternoon first of all. Hello. Did you give out what the book-to-bill or maybe perhaps orders were? And how do they compare with the first quarter?

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

No, we didn't give that out. We generally don't report on our book-to-bill, but I will say that first quarter was quite strong. The second quarter as well. If we look back over the year, we've consistently had a positive book-to-bill, but we don't generally report quarter-to-quarter the specific numbers due to the amount of VMI that we have because meaningful amount of our shipments are from vendor-managed inventory. The book-to-bill doesn't reflect that.

Dave Kang -- Analyst

Got it. And regarding Huawei, obviously, there can I have a lot of questions. But my question is where do you think they trough that? And how long do you think it will take?

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

Say that again? I misunderstood you.

Dave Kang -- Analyst

Sales from Huawei, where do you think I mean, you guys did what about $53 million or so with Huawei in the second quarter. Just trying to gauge what the bottom is as far as Huawei is concerned.

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

Well, let's see. As I said previously, we've seen historically over a longer term, we've seen Huawei revenue to be approximately equal to their market share. That historically has been mid-30s to 40%, something like that. But Huawei is in an interesting and unique position right now with the trade tensions and the geopolitical tensions. We have to be pragmatic and expecting that there will be market share shifts, and we're seeing some of that. And so how that plays out over the longer term is really not possible for us to accurately forecast at the moment. But what we do expect is that the revenue, specifically from Huawei, will no longer reflect buildup of strategic inventory. And that's really the key point here.

Operator

Thank you. And we'll take our next question from Michael Genovese with MKM Partners.

Michael Genovese -- Analyst

Thanks. Hi. First question, can you just tell us more detail, again, what's going on with the gross margin, I think you said something about underutilization and delay in the third quarter that's causing gross margin to be down sequentially. Could you explain that better?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Yes. So as you've heard me say for a number of quarters, we become underutilized on a regular basis in our indium phosphide fabs, with two indium phosphide fabs. So we have customers that are doing some very interesting sipho-based transceivers that use our fixed wavelength lasers and a couple of those projects have pushed out. Not because of our products, but because of maybe their own internal projects.

Michael Genovese -- Analyst

So is that the reason that the gross margin I mean, you came at 32.5% guidance to 32. Is that the explanation for that?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

That's the biggest one.

Michael Genovese -- Analyst

Okay. I know you only guide one quarter at a time, but do you any comments or make any comments on fourth quarter versus normal seasonality with this customer mix shift going on? Do we want to think about the fourth quarter cautiously?

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

I'm always cautious. But what we did say in Tim said in the prepared remarks is that we do expect to have multiple 10% customers, and that we see good momentum on our 64-gigabaud and highest speed product revenue.

Michael Genovese -- Analyst

Okay. And then last one for me. There's been a lot of discussion about Huawei. And I understand the inventory discussion. I understand the market share discussion. But what we haven't talked about is, do you have any more color or visibility or clarity on the potential for knock-on effects of if they have trouble getting supplies in some other part of the business? I mean there just seems to be a lot of confidence here that Huawei is going to remain a sizable customer well into the future. And can you talk about the risk of that not happening? Or is that something we have to worry about?

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

Well, by the way, Mike, I think it's an insightful question because the we have to think about it in multiple ways. So in the first instance, in China, Huawei has a broad portfolio of systems that they're going to continue to deploy. And to the extent that there are knock-on effects, as you say, and they're unable to get some parts then they will be fulfilling customer orders in China with things that they can fulfill. In the international market, it's a little different situation because in the international marketplace, there are more competitors with strong market positions. But as I said previously, all of those customers are essentially our customers as well. So to the extent that there are market share shifts, things may have a little bit of a delay period, for example. But ultimately, if Huawei's share decreases in the international market, we would expect to be a beneficiary of their whoever is gaining the market share from Huawei, we would expect to be supplying to them as well. Now in China, we have to look at two effects. The first one is just what's happening with Huawei's supply chain. But in China, as in the rest of the world, we sell to all of the network equipment companies. So to the extent that they're our share shifts to other Chinese network equipment providers, we would be in those supply chains, too. So because Huawei has been a significant customer, and they have been the largest market shareholder in the industry, and they have been building strategic inventory, they get kind of outsized identification, and therefore, they get outsized risk profile. But the fact of the matter is, to the extent that there are share shifts in China or outside China, other companies will win, and we supply to the other companies as well. So that's how we look at the whole equation for that.

Operator

Thank you. [Operator Instructions] We will take our next question from Alex Henderson with Needham & Company.

Alex Henderson -- Analyst

Thanks. So I was hoping you could go back to the basics a little bit and talk about what's going on in China in terms of the actual demand from that geography. I think you've got as good a pulse on that as anybody and pretty hard for us to read it externally. Can you give us some sense of how many what the port growth might look like? And has that changed between national backbones and provincial? Just some color around that would be very helpful.

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

Okay. The overall demand in China has continued to be I will say it's actually surprisingly strong given the given what we might otherwise conclude just from media in the U.S., essentially, China Mobile is continuing to do deployments. They are using, as I said in the prepared remarks, they're deploying using the C++ spectrum. This is where they use a wider spectral width, add more channels and then they can get even more capacity with the additional channels on each wavelength and on each fiber. So that is actually going strong. And it also is important to note that uses, among other things, our C++ LASER product as well as our 64-gigabaud components. And so it is while I said that the customers, if you will, three through eight, we're growing 35% sequentially, it's also true that we have essentially 64-gigabaud revenue streams from the major players in China as well. So our visibility to national backbone versus provincial backbone is really not different than before. It's hard to see the differences because of the fact that the provincial networks aren't accompanied by broad announcements. But the overall consumption in terms of ports is I think it's in the range of up 10% or so from last year. So it's continuing to be consistent business.

Alex Henderson -- Analyst

I guess I'm a little confused by that comment. The 10% port growth in China is below historical averages, I think, 15% plus. And if I adjust for pricing, that would imply down revenues, can you clarify that? Because that doesn't sound correct to me. Did you mean revenue port? Or do you mean shipment unit ports?

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

I'm referring to our assessment of total ports between Huawei, ZTE and FiberHome. And I'm not intending to comment on whether other analyst numbers are right or wrong. We see a modest increase in the total number of ports and within the error range. Is it 10% or is it 15%? I'm not sure we're that accurate.

Alex Henderson -- Analyst

Isn't pricing still down double digits?

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

No.

Alex Henderson -- Analyst

Okay. So it's the function is that pricing has stabilized more than normal declines and then you're still seeing port growth, hence, revenue growth out of China, excluding inventory builds?

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

Well, yes, inventory is the elephant in the room, isn't it? So yes, aside from the biggest factor, yes.

Alex Henderson -- Analyst

Okay. Perfect. And do you have any sense of whether there's acceleration in that because of delays in the first half due to COVID or and therefore, in the back half, it will accelerate in terms of improved deployment rates? Or do you think it's decelerating? Any trajectory, first order derivative there?

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

Frankly, it's not that clear. What I would say is that we don't have that level of visibility yet for what how the third quarter and fourth quarter are going to play out. We have to keep in mind, Huawei was placed on the Entities List in the second quarter of 2019, FiberHome was placed on the Entities List in the second quarter of 2020. And with those companies being on the Entities List, that more than COVID or any other factor does have a stabilizing effect on pricing. The they are continuing to ship ports as long as they are able to be supported by their respective supply chain. There is supply chain risk. There's COVID supply chain risk. There's also entities list, and there are additional BIS requirements related to Huawei design, ship reduction. And all of these factors are they're identified, but they're not fully quantified. And so what we're seeing is continued demand, continued strength in terms of volume. However, our forward visibility is limited to what we actually know. And the our ability to speculate on what might happen, we don't have that ability. However, it is also notable, given Huawei's unique situation in the international marketplace and with the Entities List and the limitations on their chip availability. There is expectation for some loss of market share. That has two effects. One is that their strategic inventory is relatively larger. And we would expect to see increasing backlog and demand forecast from other customers. That will play out over the next two quarters.

Operator

Thank you. And ladies and gentlemen, that concludes today's question-and-answer session. I would now like to turn the call back to Mr. Tim Jenks for closing remarks.

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

Thank you for to everyone for dialing in. We thank you very much for your interest in NeoPhotonics. We do appreciate the diligent work of our employers and our suppliers to drive progress, especially in light of the current environment and the conditions of the ongoing global pandemic. Stay safe. We look forward to updating you in the future and meeting with shareholders again in person as we are all able to in the quarters to come. Have a good evening. [Operator Closing Remarks]

Questions and Answers:

Duration: 59 minutes

Call participants:

Erica Mannion -- Sapphire Investor Relations

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

Elizabeth (Beth) Eby -- Senior Vice President and Chief Financial Officer

Joe Cardoso -- JPMorgan -- Analyst

Fahad Najam -- Cowen and Company -- Analyst

Alex Henderson -- Needham & Company -- Analyst

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Tim Savageaux -- Northland Capital Markets -- Analyst

Mauricio Munoz -- Raymond James & Associates -- Analyst

Dave Kang -- B. Riley FBR -- Analyst

Michael Genovese -- MKM Partners -- Analyst

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