Applied Optoelectronics, Inc. (NASDAQ:AAOI) Q3 2023 Earnings Call Transcript

Applied Optoelectronics, Inc. (NASDAQ:AAOI) Q3 2023 Earnings Call Transcript November 9, 2023

Applied Optoelectronics, Inc. beats earnings expectations. Reported EPS is $-0.00027, expectations were $-0.05.

Operator: Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics’ Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Please note, this event is being recorded. I will now turn the call over to Lindsay Savarese, Investor Relations for AOI. Ms. Savarese, you may begin.

Lindsay Savarese: Thank you. I’m Lindsay Savarese, Investor Relations for Applied Optoelectronics. I am pleased to welcome you to AOI’s third quarter 2023 financial results conference call. After the market closed today, AOI issued a press release announcing its third quarter 2023 financial results and provided its outlook for the fourth quarter of 2023. The release is also available on the company’s website at ao-inc.com. This call is being recorded and webcast live. A link to the recording can be found on the Investor Relations section of the AOI website and will be archived for one year. Joining us on today’s call is Dr. Thompson Lin, AOI’s Founder, Chairman and CEO; and Dr. Stefan Murry, AOI’s Chief Financial Officer and Chief Strategy Officer.

Thompson will give an overview of AOI’s Q3 results, and Stefan will provide financial details and the outlook for the fourth quarter of 2023. A question-and-answer session will follow our prepared remarks. Before we begin, I would like to remind you to review AOI’s Safe Harbor statement. On today’s call, management will make forward-looking statements. These forward-looking statements involve risks and uncertainties as well as assumptions and current expectations, which could cause the company’s actual results, levels of activity, performance or achievements of the company, or its industry to differ materially from those expressed or implied in such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as believes, forecast, anticipates, estimates, intends, predicts, expects, plans, may, should, could, would, will, potential or things or by the negative of those terms or other similar expressions that convey uncertainty of future events or outcomes.

The company has based these forward-looking statements on its current expectations, assumptions, estimates and projections. While the company believes these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond the company’s control. Forward-looking statements also include statements regarding management’s beliefs and expectations related to the expansion of the reach of our products into new markets and customer responses to our innovation, as well as statements regarding the company’s outlook for the fourth quarter of 2023. Except as required by law, we assume no obligation to update forward-looking statements for any reason after the date of this earnings call to conform these statements to actual results or to changes in the company’s expectations.

More information about other risks that may impact the company’s business are set forth in the Risk Factors section of the company’s reports on file with the SEC, including the company’s annual report on Form 10-K for the year ended December 31, 2022 and the company’s quarterly report on Form 10-Q for the quarter ended September 30, 2023. Also, all financial results and other financial measures discussed today are on a non-GAAP basis, unless specifically noted otherwise. Non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation between our GAAP and non-GAAP measures as well as a discussion of why we present non-GAAP financial measures are included in our earnings press release that is available on our website.

I’d like to know that data of our fourth quarter and full year earnings call is currently scheduled for February 22, 2024. Now I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics’ Founder, Chairman and CEO. Thompson?

Thompson Lin: Thank you, Lindsay, and thank you for joining our call today. Our third quarter revenue and non-GAAP EPS were in line with our expectations. While our non-GAAP gross margin was better than our expectations, we are pleased by the continued progress we have made on improving our gross margin and by the continued strong growth we saw for our 100G and 400G products in our data center business during Q3. The combination of revenue growth and improving gross margin allow us to generate $3 million in adjusted EBITDA during the quarter. During the third quarter, we delivered revenue of $62.5 million, which was within our guidance range of $60 million to $66 million. We delivered non-GAAP gross margin of 32.5% above our guidance range of 29.5% to 31%, mainly driven by our favorable product mix shift and contribution from revenue recognized as part of our non-recurring revenue from Microsoft.

Our non-GAAP loss per share was $0.05, which was within our guidance range of a loss of $0.06 to earnings of $0.01. Total revenue in our CATB segment was $10.3 million, down 67% year-over-year and up 10% sequentially, in line with our expectations. Total revenue for our data center products of $48.8 million, more than double year-over-year and increased 77% sequentially largely due to increased demand for our 100G and 400G products. As we continue to see the run-up of our 400G products, revenue for our 100G products nearly tripled year-over-year, while revenue for our 400G products increased more than 10 times in the same period. With that, I will turn the call over to Stephen to review the details of our Q3 performance and outlook for Q4. Stefan?

Stefan Murry: Thank you, Thompson. As Thompson mentioned, our third quarter revenue and non-GAAP EPS were in line with our expectations, while our non-GAAP gross margin was better than our expectations. We’re pleased by the continued progress we have made on improving our gross margin and by the continued strong demand we saw for our 100G and 400G products in our data center business during Q3. The combination of revenue growth and improving gross margin allowed us to generate $3 million in adjusted EBITDA during the quarter. Before turning to discuss our detailed results and outlook, I want to provide an update on the sale of our manufacturing facilities located in the People’s Republic of China and certain assets related to our transceiver business and multichannel optical subassembly products for the Internet Data Center, fiber to the home, and telecom markets.

On September 12, 2023, we announced the termination of our purchase agreement with Yuhan Optoelectronic Technology. This decision was based on Yuhan’s failure to meet agreed-upon deadlines and we lost confidence in their ability to complete the transaction. We are exploring additional options with new potential buyers. Turning to the quarter, our total revenue for the third quarter increased 10% year-over-year to $62.5 million, which was in line with our guidance range of $60 million to $66 million. As Thompson mentioned, the increase in revenue was largely due to growth of our 100G and 400G data center business. During the third quarter, 78% of our revenue was from our data center products, 16% was from our CATV products, with the remaining 6% from FCTH, Telecom, and others.

In line with our expectations, CATV revenue in the third quarter was $10.3 million, which was down 67% year-over-year and up 10% sequentially. We were encouraged by the sequential growth that we saw in our CATV business in Q3. Looking forward, we continue to expect that our near-term CATV business will be down compared to the historic highs we saw in 2021 and 2022, as the MSO’s transition to next-generation architecture. We anticipate this transition will begin to take place in 2024. Looking further ahead, we continue to carefully monitor MSO plans to move to DOCSIS 4.0 networks. And we continue to believe AOI is a leader in technologies that will enable DOCSIS 4.0, and that our products are well-suited for when the push to install amplifiers and other network elements for DOCSIS 4.0 begins.

In line with our new strategy of directly selling to the MSO’s, we have continued to expand our product portfolio. Just last month, we announced the launch of QuantumLink, the latest solution within our Quantum bandwidth line of products, designed to provide remote management and monitoring of cable amplifiers that we believe will reshape the cable broadband market. Operators using QuantumLink will now have the ability to remotely manage cable broadband amplifiers, ushering in a new era of efficiency, convenience, and enhanced service quality for our customers. Last month, we attended the Society of Cable Telecommunications Engineering Expo, or SCTE, where we demonstrated our complete line of quantum bandwidth products, including various amplifiers and the QuantumLink control solution I mentioned above.

We’ve received very positive reactions from many of our customers. They are particularly interested in our QuantumLink solution, which several customers have asked to become a standard for the CATV industry. We are pursuing this standardization with cable labs and anticipate that this technology may be chosen by MSO’s as their preferred control architecture for their upcoming deployments. Lastly, and in line with our new strategy, we are pleased to have secured a distribution relationship with Digicom, a stocking distributor. Digicom will be an exclusive go-to-market supplier of our Quantum12, high-gain balanced triple, and high-gain dual system amplifiers and line extenders. This relationship enables customers to receive the latest network equipment with the same quality and performance they expect, while providing the industry’s best product delivery lead times.

Turning to our data center business, our Q3 data center revenue came in at $48.8 million, which more than doubled year-over-year and was up 77% sequentially, largely due to increased demand for our 100G and 400G products as our customers continued to purchase our existing products. In the third quarter, 74% of our data center revenue was from our 100G products, 13% was from our 200G and 400G transceiver products, and 7% was from our 40G transceiver products. Notably, revenue for our 100G products increased 75% sequentially, while revenue for our 400G products increased 74% sequentially and accounted for just under 11% of our total data center revenue in Q3. Looking ahead, we’re encouraged by the strong demand we’ve been seeing, and we expect Q4 to be similar to Q3.

As a reminder, as we have discussed on our prior couple of earnings calls, we signed two agreements with Microsoft earlier this year, including a development program to make next-generation lasers for its data center, both for 400G and beyond, and for the development of their 400G and next-generation active optical cables. While not guaranteed, we continue to believe that the revenue opportunity for our 400G and 800G products could be greater and a longer duration than the revenue contribution we saw from this customer during the peak of the 40G product cycle, which suggests that revenue from these products may exceed $300 million over the several years of these build-outs. During the quarter, we received requests from Microsoft to expedite our production ramp for these products, which we are attempting to accommodate.

Based on these expedite requests, we believe demand for these products remains strong, and our production teams are working very hard to add capacity for this production, which we now expect will allow us to begin shipments later this month, rather than in late December as originally planned. Notably, the revenue increase we saw from Microsoft this quarter is for mostly existing products. As I just mentioned, we still expect to begin shipping initial quantities of the products related to these new agreements to Microsoft by the end of this month for their testing, and believe that production will begin to bring up in December. We also believe that the value proposition that we offer to Microsoft is just as strong with other data center operators, and we are working with several of them to evaluate our technology and qualify our products.

This includes our 800G products. During the quarter, we shipped samples of our 800G data center products to two different customers. By the end of the year, we expect to ship samples of 800G products to two additional data center customers. This would bring our total to four different data center customers who would be evaluating our 800G products by year end. Now turning to our telecom segment. Revenue from our telecom products of $3 million was down 55% year-over-year and down 27% sequentially, largely driven by softness and 5G demand, particularly in China. Looking ahead, we expect telecom sales to fluctuate around current levels. For the third quarter, our top 10 customers represented 96% of revenue, up from 86% in Q3 of last year. We had two greater than 10% customers, one in the data center market and one in the CATV market, which contributed 64% and 12% of our total revenue respectively.

In Q3, we generated non-GAAP gross margin of 32.5%, which was above our guidance range of 29.5% to 31% and was up from 24.8% in Q2 of 2023 and up from 18% in Q3 of 2022. The increase in gross margin was driven mainly by our favorable product mix shift and contribution from revenue recognized as part of our non-recurring revenue from Microsoft. We remain committed to the long-term goal of returning gross margin to around 40% and believe that this goal is achievable. Total non-GAAP operating expenses in the third quarter were $21.4 million or 34.2% of revenue, which compared to 19.4 or 34.3% of revenue in Q3 of the prior year, largely driven by increasing legal costs, increased shipping costs, commensurate with our increased revenue and increased marketing spend to promote our CATV products.

Looking ahead, we expect non-GAAP operating expenses to range from $21 million to $23 million per quarter. Non-GAAP operating loss in the third quarter was $1 million compared to an operating loss of $9.3 million in Q3 in the prior year. GAAP net loss for Q3 was $9 million or a loss of $0.27 per basic share compared with the GAAP net loss of $15.6 million or a loss of $0.56 per basic share in Q3 of 2022. On a non-GAAP basis, net loss for Q3 was $1.7 million or a loss of $0.05 per basic share, which was in line with our guidance range of a loss of $1.9 million to a profit of $0.2 million or a loss per share in the range of $0.06 to earnings of $0.01 per basic share and compares to a net loss of $7.1 million or a loss of $0.26 per basic share in Q3 of the prior year.

The basic shares outstanding used for computing the net loss in Q3 were $32.8 million. Turning now to the balance sheet, we ended the third quarter with $31.2 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $28.6 million at the end of the second quarter of this year. We ended the quarter with total debt, excluding convertible debt, of $46.6 million, down slightly from $46.9 million at the end of the last quarter. As of September 30, we had $67.5 million in inventory compared to $66.3 million at the end of Q2. We made a total of $2.1 million in capital investments in the third quarter, which was mainly used for production and R&D equipment. As we disclosed in March, we initiated a new at-the-market offering.

To date, we have raised $43.1 million net of commissions and fees under this new program, including $22 million raised in Q3 and $11.2 million raised after the end of the quarter. Moving now to our Q4 outlook. We expect Q4 revenue to be between $63 million and $67 million, and non-GAAP gross margin to be in the range of 34.5% to 36%. Non-GAAP net income is expected to be in the range of a loss of $0.9 million to income of $1.2 million and non-GAAP income between a loss of $0.02 per basic share and income of $0.04 per basic share, using a weighted average basic share count of approximately 35.1 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?

Operator: [Operator Instructions] The first question comes from Jeff Coach [Ph] with Raymond James. Please go ahead.

See also 15 Most Anticipated TV Shows of 2023 and 16 Best Places to Live in Texas.

Q&A Session

Unidentified Analyst: Yes. Thanks guys. In for Simon. Just really quickly on the Microsoft income that’s non-recurring. Can you talk about — maybe quantify it for the quarter and like what’s built in for guidance and how we should think about that relative to the ramp would be helpful. Thank you.

Stefan Murry: Yes. Well, I can’t comment on the exact amount of nonrecurring engineering costs that would be covered under our nondisclosure agreement with Microsoft. So it was not the primary contributor to the increase in gross margin.

Unidentified Analyst: Okay. Great. And then maybe you can just give some color on the segments, like kind of how you’re thinking about some of the other segments going into December?

Stefan Murry: Yes, as we noted there — sure. Yes. So as we noted, we’re pretty excited about the progress that we’re making on the datacenter business. As we mentioned, Microsoft is accelerating their demand for the new products that we’ve been discussing based on the new contracts that we have. And that’s really positive for us. I mean there’s a limit to how fast we can speed up the production, of course. So it’s not going to dramatically change our revenue picture in the fourth quarter, but we’re encouraged by the increase in demand that we’re seeing. We’re also really encouraged by the progress that we’ve made on 800G. As we noted, we’ve sampled that already to several customers, and we expect to sample it to several more customers before year-end.

So we’re really excited about both of those, the progress that we’re making on that front. On the cable TV side of things, we did have — as you’ve seen from the other companies that have reported already, the situation in cable right now across the board is muted compared to where it was a year or two ago, for sure. But we’re encouraged by the sequential uptick in revenue there. And the progress that we’ve made in terms of our new model of selling directly to the MSOs and the acceptance that the MSOs have had of our new technologies like Quantum Link, which we talked about in the prepared remarks earlier, has been really phenomenal. And we’re really, really excited about the progress that we’ve made there as well. So those two segments, I think, obviously account for the vast majority of our business.

The Telecom market will be somewhat muted. As we noted, the 5G business in China has been relatively slow, and I don’t necessarily see a recovery of that in the short term, at least. But certainly, the two business segments that account for the vast majority of our revenue are both heading in the right direction.

Unidentified Analyst: So could you see cable TV — sequentially into December? Or do you think it — we continue to see sequential growth. And then is it — when do you see an inflection there from like you were saying, is that for DOCSIS 4.0, is that more — 2024?

Stefan Murry: Right. So you’re cutting in and out there a little bit, but I think I understood your question to be on cable TV. Do we expect to see some sequential growth into Q4? And I think you could tell from the guide, we don’t expect like dramatic growth in cable, but there’s probably some opportunity for some growth there. As we discussed, the cable market will recover — or we expect the cable market to recover substantially during the DOCSIS 4.0 introduction, which will happen in the middle part of next year. In the meantime, we are seeing some customers that are finally starting to burn through their inventory of DOCSIS 3.1 products, the 1.2 gigahertz. So I expect to see some sort of modest improvement there, but the dramatic uptick that we expect to see will be with DOCSIS 4.0 in the middle part of next year.

Thompson Lin: Yes. So basically — this is Thompson. We believe CATV, we can see very, very strong growth in next year from, I would say, the end of Q2 or sometime in Q3 next year. And more important, the gross margin will be much better. That’s the key. It’s not [indiscernible], it’s gross margin improvement.

Unidentified Analyst: Terrific. Appreciate the time. Thanks.

Operator: [Operator Instructions] The next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead.