May 14, 2020

The COVID-19 pandemic is a challenging time for all businesses, but it also is an opportunity for stronger companies to outperform the competition and gain market share. A bit of luck also helps. All companies not based in Wuhan should consider themselves lucky. Accelink was shut down for half of the first quarter and reported a 49% decline in revenues sequentially and a 40% decline y-o-y. Accelink has not provided guidance for the current quarter, but the company appears to be back to full production now and plans to catch up quickly. Strong demand for wireless fronthaul optics in China should help. Accelink secured a lot of these contracts in early 2020, along with Genuine Opto(HGG) – another Wuhan based company recovering from the shutdown.

Lumentum reported a 12% decline in revenues sequentially and a 7% decline y-o-y. These results are solid for a seasonally weak quarter, but their guidance for Q2 2020 was a disaster. COVID-19's impact on quarterly revenue will be more than $90 million (over 20% of Q1 2020 sales). About half of this lost revenue is a result of Lumentum’s inability to supply communication products due to both component sourcing and production limitations, and the balance is from reduced consumer and industrial market demand. Business closures in Malaysia, where a lot of component packaging operations are based, is the main challenge for Lumentum in the current quarter. Broadcom also mentioned extended lead times for their products due to business closures in Malaysia and the Philippines, where they package IC chips.

This was a red flag for revenue guidance from II-VI Photonics, which operates a large transceiver manufacturing facility in Malaysia. Surprisingly, the company experienced no interruptions at this facility so far, according to Chuck Mattera’s statement on the earnings call. II-VI Photonics reported a 6% decline in revenues sequentially. If we compare II-VI’s Q1 2020 revenue to the sum of Finisar’s and II-VI’s revenues in Q1 2019, we see a drop of 7.5%. Revenue for transceivers was flat compared to the previous year and declined 9% sequentially. The company guidance for Q2 2020 was $675 million at the midpoint – up 8% sequentially, and it reported a very strong stream of orders - many of which are long term supply agreements. Transceiver bookings were more than 40% above expectations, and ROADM bookings grew 50% sequentially.

As illustrated in the figure below, the investors were excited about the results and sent the stock up 25%. Chuck Mattera was also thrilled with II-VI Photonics' performance: “I want to really acknowledge our global supply chain organization. They've done a fantastic job. They were able to -- along with our strategic suppliers, which I also greatly appreciate, they were able to limit to a very small number, low single-digit millions of dollars of revenue that we were not able to fulfill because of the supply chain issues.” Mattera stated.

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Excellence in supply chain management is a must for a successful business, and it is priceless in times of disruptions. Large vendors will always have an edge in securing the required capacity from their suppliers. Vertical integration can also be an advantage and currently appears to be one to II-VI Photonics. This is an opportunity for larger companies with more resources and widely distributed operations to gain market share.

Our interviews with the leading suppliers of optical components and modules suggest that the industry supply chain is recovering quickly from the shutdown in Wuhan, which was a major disruption since the city is a hub for manufacturing. As this research note goes to publication in mid-May 2020, Wuhan is seeing a new, small outbreak of COVID-19 and is making plans to test all of its 11 million citizens within the next month.

Such uncertainty about the future creates a lot of anxiety. Some component suppliers are reporting 3x increases in orders – most likely an indication that their customers are building inventory reserves. This purchase acceleration is most likely the right strategy, but it will increase shortages in the supply chain that was already stretched even before COVID-19 disruptions. Demand for optics used in Cloud datacenters, DWDM networks, and wireless fronthaul spiked at the end of 2019, and it remains stronger than expected in the first half of 2020.

Inphi’s CEO Ford Tamer quoted Winston Churchill, who once said, "Never let a good crisis go to waste." Inphi was another company that cheered up investors with solid performance and exceptional guidance. Quoting Ford Tamer, “Inphi electro-optics data movement solutions are in the right place at the right time to support our customers' needs.” Inphi’s founder Loi Nguyen added more context to this story in his blog: The Rise of Internet 3.0.

Chuck Mattera summarized it as follows: “The way the world works and delivers vital services, including telemedicine and distance learning, is changing rapidly and permanently. This evolution in human behavior is clearly stressing both the wireline and wireless infrastructure, and that is driving cloud operators and service providers to commit to significant infrastructure upgrades.”

This is great for our industry, but let us not forget about the disruption caused by COVID-19. So many projects will be delayed in 2020. Demand from Cloud companies and Communication service providers may be steady, but investments into enterprise networks will drop sharply because of the economic uncertainty. Our latest Market Forecast Report discussed this situation in more detail. The bottom line is that we may have to wait until 2021 to see a real pick up in sales of optics, networking, and datacenter hardware.

Full text of the research note is available to clients at: https://www.lightcounting.com/auth/login


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