Applied Optoelectronics, Inc. (AAOI) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon, I will be your conference operators. At this time, I would like to welcome everyone to Applied Optoelectronics’ Third Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be question-and-answer session. [Operator Instructions] Please note this call is being recorded. I will now turn the call over to Maria Riley, Investor Relations for AOI. Miss. Riley you may begin.

Thank you. I'm Maria Riley, Applied Optoelectronics Investor Relations, and I'm pleased to welcome you to AOI's third quarter 2015 financial results conference call. After the market closed today, AOI issued a press release announcing its Q3 2015 financial results. The release is also available on the company's website at ao-inc.com. This call is also being recorded and webcast live. A link to that recording can be found on the Investor Relations webpage of the AOI website and will be archived for 90 days. 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. 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 to differ materially from those anticipated in such forward-looking statements. You can identify forward-looking statements by terminologies such as may, expect, plan or believe, and by similar expressions. Except as required by law, we assume no obligation to update forward-looking statements for any reason after the date of this earnings call or 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 factor section of the Company's reports on file with the SEC. Also with the exception of revenue, all financial numbers 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 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. Before moving on to the financial results, I'd like to announce that AOI management will attend the Raymond James Technology Investors Conference in December, in New York City. We hope to have the opportunity to see many of you there. Now, I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics' President, Founder and CEO. Thompson?

Thank you, Maria. Thank you for joining us today. AOI delivered strong third quarter results with record revenue of $57.1 million above our $51 million to $54 million outlook. Third quarter revenue grew 56% year-over-year, we also achieved greater non-GAAP earnings per share of $0.40 which to be prudent and impressive 99% year-over-year increase. The upside on the company was driven by continued strong growth in our 40G datacenter products offset by sequential decrease in cable TV revenue. In the third quarter, datacenter revenue grew over 92% year-over-year and 30% on a sequential basis to reach a new record of $38.6 million. AOI remains as a forefront in developing and manufacturing [indiscernible] technologies that enables the industry transition [indiscernible] as the demand for higher bandwidth and terabits continue to grow. During our conference call last quarter we talked about being in several 100G datacenter qualification trials. Today, I am especially pleased to announce that AOI has secured two 100G design wins with two of our existing datacenter customers. We have already begun production of [indiscernible] units of 100G modules for these customers, which we expect to begin to deliver later this month. To our knowledge, AOI is a force in the market to report volume productions of 100G transceivers for hyperscale datacenter operator customers. Our ability to internally source 25G laser diodes and the more complex 100 light engines help escalate [ph] our time to market. We believe this new design wins are testaments to our leadership position in advanced optical technology. Overall, we are excited about the growth prospects associated with 100G and believe we are well position in this market. Turning to CATV business, we reported $14.2 million in revenue, representing 16% year-over-year growth driven by new design wins and never built [ph] in emerging markets. As we enter Q4, we do see some disruption in the CATV market due to consolidation activities, however, we believe this is a short-term in nature and as we go into 2016, we’ll continue to believe that the DOCSIS 3.1 upgrade cycle will present a key growth driver for AOI. By our estimation DOCSIS 3.1 upgrade cycle equates to $450 million incremental market opportunity over the next few years. In summary, we delivered a strong quarter, we are pleased with our result and market share gain. For the year-to-date we have grown revenue 46% and approximately double our non-GAAP earnings. I am especially proud of our teams’ accomplishment in being the force to market with volume production in 100G transceivers and want to thank our employees for all of their dedication and hard work. AOI remains focused on building our momentum to drive growth and achieve AOI long-term objective. With that, I will turn the call over to Stefan to review the details of our Q3 performance and outlook for Q4. Stefan?

Thank you, Thompson. Total revenue for the third quarter grew 56% year-over-year and 15% sequentially to reach a record $57.1 million. Datacenter revenue in the third quarter reached $38.6 million, an all-time high that represents a 92% year-over-year increase and 30% increase over Q2. Sales of our 40G products contributed 90% of datacenter revenue in the third quarter. As Thompson mentioned, we were recently awarded two 100G design wins, we have already commenced production for products related to these design wins with initial deliveries scheduled for this quarter. Based on discussions with our customers, we expect the hyperscale datacenter operators to continue purchasing 40G transceivers while at the same time equipping their new datacenter builds with 100G technology. However, in Q4 we expect to see a sequential decline of approximately $3 million to $5 million in our datacenter business as one of our datacenter customer is expected to trim inventory levels somewhat during the quarter. We believe that this inventory reduction is unrelated to the 100G transition and we expect more normal order patterns to resume in Q1. In the fourth quarter and for the entire year, we expect to have two datacenter customers each contributing more than 10% of our revenue and we are in various stages of qualification with several additional hyperscale datacenter customers for 100G product. Overall we are very pleased with our datacenter revenue growth, which is up 71% year-to-date, well above our baseline expectation of 45% growth in 2015. Turning to our cable television market, revenue from CATV products in the third quarter grew to $14.2 million up 16% over Q3 of last year. On a sequential basis CATV revenue declined by 13% due to lower international sales especially for Latin America and consolidation uncertainty in the US. As Thompson mentioned, we expect to see a short term slowing in the CATV market among two of our customers as the regulatory process for their proposed acquisition is taking longer than expected. In parallel, we see merger activities among the CATV MSOs which adds additional short term uncertainty. Although we have achieved CATV revenue growth of 31% on a year-to-date basis, these consolidation activities could impact our ability to meet our baseline expectation of 20% growth in the segment for the year. We continue to believe DOCSIS 3.1 will be a significant growth catalyst for our CATV business. The MSOs have recently begun to make public initial details of their DOCSIS 3.1 deployments and these publicly announced plans further reinforce our belief that initial DOCSIS 3.1 field trials are ongoing and that widespread deployment will begin in early to mid-2016. As the CATV market leader, we believe AOI remains very well positioned to capture a significant portion of the DOCSIS 3.1 infrastructure spent directed towards node and head end replacements. Revenue for our FTTH segment came in at approximately $1.0 million. Revenue in this segment is expected to continue to fluctuate quarterly in the $0.1 million to $ 2 million range in the near term. Our telecom segment delivered record revenue of $3.1 million, up 48% sequentially and benefited from recent design wins with several of our telecom customers. In the third quarter, we had one 10% or greater end customer in the data center business that contributed 59% of total revenue. Moving down the income statement, Q3 total gross margin was 31.7%, a decline of 201 basis points when compared with the 33.7% percent reported in Q2 of 2015 and a decrease of 152 basis points from Q3 of last year. Our consolidated Q3 gross margin was negatively impacted by a shift in our product mix within the datacenter segment with sales of certain shorter reach transceivers which carried lower margins in the quarter predominating. This trend reflects the particular needs of a customer during the quarter but we have improved fields and undertaken cost down measures for these products and we do not expect these products to detract significantly from gross margin in the fourth quarter and beyond. Accordingly we anticipate the gross margin will return to a more normalized 33.5% to 34.5% range in the fourth quarter. As a reminder, our gross margin can fluctuate from quarter-to-quarter due to the product mix as well as the initial ramping for new products. Total operating expenses were $11.2million or 19.6% of revenue compared with $10.2 million or 20.5% of revenue in the prior quarter. R&D expense was $5.3million or 9% of revenues compared with $4.6million or 9% in the prior quarter. Sales and marketing expense was $1.5 million or 3% of revenue down from $1.6 million or 3% of revenue in the prior quarter. G&A expense was $4.3 million dollars or 8% of total revenue, up $0.4 million when compared to the prior quarter. The increase is driven by increased headcount and consulting expenses associated with our maturation as a public company. Looking forward in Q4, we expect total operating expenses to increase modestly over the Q3 level with the majority of the increase in G&A mostly associated with year-end audit fees. Non-GAAP operating income in Q3 was a record $6.9 million compared with operating income of $6.6 million in the prior quarter and operating income of $3.2 million in Q3 of last year. Non-GAAP net income after tax for the third quarter grew to a record $6.7 million compared with $6.1 million in the prior quarter and $3.1 million in Q3 of last year. We reported non-GAAP net income of $0.40 per share up from $0.38 cents in the prior quarter and up significantly from $0.20 in Q3 of last year. GAAP income for Q3 was $2.7 million or $0.16 per diluted share compared with GAAP net income of $6.1 million or $0.38 per diluted share in the prior quarter. The Q3 weighted average fully diluted share count was approximately 16.7 million shares. Turning now to the balance sheet, we ended Q3 with $50.1 million dollars in total cash, cash equivalents, short-term investments and restricted cash compared with $44.3 million at the end of the previous quarter. Our Q3 cash balance reflects $38.7 million in net proceeds from our recent at-the- market offering and $9.3 million in cash used in operations. Accounts receivable increased to $41.1 million compared with $32.9 million last quarter and accounts tables increased approximately $1.8 million over Q2. We made a total of $14.5 million in capital investments in the quarter including $8.1 million in production equipment and machinery and $6.5 million on construction and building improvements, mostly for our new production facility in Sugar Land. As of September 30, we $60.2 million in inventory, an increase of $7.8 million dollars from Q2, that was primarily driven by an increase in raw materials as we prepared to ramp production for 100G and continue to stock finished goods in VOI warehouse with our largest datacenter customer. Moving to our outlook, we expect Q4 revenue to be between $49 million and $52million representing 35% to 43% year-over-year growth. We expect Q4 non-GAAP gross margin to be in the range of 33.5% to 34.5%. Non-GAAP net income is expected to be in the range of $4.9 million to $5.9 million and non-GAAP EPS between $0.28 per share and $0.33 per share using a weighted average fully diluted share count of approximately 17.7 million shares. With that I will turn it back over to the operator for Q&A. Operator.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Simon Leopold with Raymond James. Please go ahead.

Great, thank you very much, appreciate getting first question here tonight. Handful of things I'd like to ask, let me first knock down a couple of quick kind of modeling housekeeping easy ones So you're still in an investment mode in terms of CapEx, so wondering if you could talk a little bit about how to think about CapEx for December and for 2016 in terms of your budgeting.

Yeah, we don't really give CapEx guidance as you know, what we said in the past is that we've spend - we invest in CapEx as we see near term opportunities presenting themselves to the extent that - and we've indicated before that they track a quarter or two ahead of revenue. To the extent they were continuing to grow and see these great opportunities in 100 gig, we do expect to continue to invest in production equipment and capacity and certainly for the plant that houses that equipment, but the timing of that we haven't disclosed that.

Okay and then you talked a little bit about the customer in the datacenter side being a little bit softer in the December quarter and you don't think that this is related to the 100 gig transition. Is this related to kind of a seasonal aspect we see with some data center operators where they don't want to touch the network during the month of December when it's a busy time and they just want to make sure their network is stable, is that the rationale for the slowing?

That's a good question Simon, I mean, it's always conceal that could be some effect there but I think really what's going on here is look, we had a fantastic Q3, we way over performed on the datacenter side, we had an enormous growth there, it was a great quarter on the datacenter business and the fourth quarter will just be a little bit less than what we expected. So really, I think the story here is we're continuing to be very much on track if you kind of look at Q3 and Q4 together. There may be some effect on holiday seasonality I can't rule it out but basically what happened I think it's just that we shipped a lot in Q3 and it's just slightly less in Q4 rate.

Great and then obviously the big news here is the second award or actually two awards for one 100 gig design wins, so that's obviously a big deal here. So want to get a better understanding in terms of how to think about this because you did say you'd see shipments in December. I'm presuming that shipping them doesn't mean you're going to have material revenue, so December will be at most modest revenue of 100 gig if that's correct and also in terms of the two design wins, are these identical form factors from two different operators or they are different flavors out there, if you could give us some sense of kind of the product types. Thanks.

I will take your second question first; they are there different form factors for the two customers. And the first question had to do with what do we expect to see revenue wise in the quarter. We do expect to see revenue from these in the quarter, one of these two customers does have a VOI program so that's a little bit hard to predict exactly how much revenue will get into the quarter but we know that they want to take it very quickly. They're very excited about the 100 gig transitions, I would expect much if not most of what we shipped this quarter to actually show up in revenue in this quarter.

And what are the two form factors that you're going to be making in the corner?

We haven't disclosed that.

Okay, thank you for taking my questions.

Thanks Simon

The next question comes from Troy Jensen with Piper Jaffray. Please go ahead

Hey, congrats on nice quarter gentlemen.

Thank you

So Stefan, on the two 100G design wins, did you say those were with existing or new customers?

They are both with the existing customers.

Both of existing, so what is the pipeline for new customers look like on the 100G side?

We've got a number of opportunities that we're pursuing with several additional operators and I think we're pretty well, we're continue to be pleased and optimistic about the progress on there. To my knowledge at this point we haven't lost or been excluded from any opportunities related to 100 gig. And I think the cadence of interest we're hearing from the customers continues to be positive. I think, not all the customers are going to be moving at the same speed into 100 gig and so we would expect to see probably some additional design wins to the extent that we get them will be coming in Q1 and maybe even in as late as Q2

Okay, it shows you may not be able to answer; I’ll throw it out there. I will be curious on this kind of backlog because what I am getting to is in Q4 of last year and Q1 of this year you guys had there was a massive book-to-bill ratio right so it built up a lot of backlog. So I am just wondering if the kind of the upside we see, gain over the backlog or kind of what’s the backlog look going into December [ph]?

We haven't been giving any specific backlog numbers I mean and the reason for that has to do mostly with the amount of business that we have going into these VOI warehouses obviously backlog in that context doesn't - it's kind of meaningless because the order that the order and - essentially the book-to-bill time is almost instantaneous. So that’s why we’ve haven’t been giving specific numbers on the backlog, but what we trying to say here is that I think the opportunities are really there, we see Cable TV a little soft in the fourth quarter as we indicated and I think that has a lot to do with the M&A activity that's going on in the business, both among our immediate customers and their customers, but we expect to recover and certainly the 100 gig transition is going to be a big impact on the datacenter starting in this quarter and moving on to the future, but as far as specific backlog we don't disclose that.

Alright understood, can you just go over the comment you said about few 10% customers, is that what you are expecting them in the nest quarter or?

Yeah, we do expect to have two 10% datacenter customers in this quarter.

Okay, both existing or new one?

Both existing customers, yeah.

Alright, good luck and good luck in second half.

[Operator Instructions] The next question comes from Richard Shannon with Craig-Hallum. Please go ahead

Hi guys, thank you for taking my questions. Maybe I'll start with a couple on 100 gig. Stefan, If I heard your comments correctly, you are talking about initial shipments of I think a few thousand units, give us a sense is there - do you have any sense of the follow through beyond the fourth quarter, could there be a - will all the three see much bigger pick up later in the year just any sense of how that trajectory may go?

No, I think, we believe that this is the beginning of a continued deployment for 100 gig, at least among this particular customer. We think that this customer is probably the earliest or certainly among the earliest of the large datacenter operators to begin to put 100 gig into their network. These units that we're shipping now are for actual network deployment, they're not test units or for some trial or whatever, these are really going into the network and I would expect that they would continue to deploy and probably accelerate the pace of the deployment. And that's with this particular customer and then obviously the other customers will follow along in due course as they begin to implement 100 gig in their network

Okay, so the 100 gig you are shipping in the quarter is just for one of the designs is that right?

We're going to be shipping for both one of them is larger than the other.

Got it, okay, I know you probably won't say this but I'll ask it anyways, are these wins with your top customer can you say that? Can you tell us whether that's true or not

I mean there's both they're both with existing customers and I think it would be very logical to assume that it's with one of our top customers, yeah.

Okay, I think most people would assume that as well, but that's fair enough then. Can you just comment on anything on the competitive dynamics you're seeing in these which is obviously very early in the 100 gig cycle here are you seeing or hearing from these customers - perspective customer you are qualifying with are you seeing any other models out there that mature as yours?

Well, we’re set on the script [ph], I mean we're really excited about being the first out of the gate with 100G technology for the hyperscale datacenter operators. I know there's been a lot of talk in the industry about various different approaches and things like that and our position has been that all of this will become more clear in due time and I think we're very encouraged by where we're at. As far as changes in the competitive landscape to the extent that the competitors are actually getting qualified and we are starting to receive volume orders. I don't think we've seen any change in that competitive landscape. Alternative technologies and things like that that may come on down the line we don't know yet but we haven't seen him showing up in terms of shipments at this point.

Okay, fair enough one last question from me, I'll jump in a line. You mentioned in your last quarter's conference call that one of your customers, your largest customers moving to VMI and in this third quarter build inventories even more here. How should we think about inventories as we exit this quarter and what's kind of the normalized inventory’s [ph] ratio going forward?

Well, I think you know we would like to get the inventory, at least the growth rate in inventory down a little bit we don't want to continue to grow inventory at quite the pace that we have but we are undergoing a technology transition as you know from 40 to 100. Even though there's a great deal of commonality between those parts from the manufacturing standpoint they do use a lot of discrete different components. So in a sense we're kind of having the double inventory, certain raw materials and things like that plus we have the effect of this VOI warehouse where our customers themselves are inventorying 40 gig and 100 gig products. So I do think that we will probably continue to see some growth in inventory but hopefully at a slowing rate as we start to normalize the datacenter 100 gig orders.

Okay, that's a good perspective, that’s all the questions for me and congratulations on your early 100 gig success here.

Thanks very much, Richard.

[Operator Instructions] The next question is a follow up from Simon Leopold with Raymond James. Please go ahead

Great, thanks. Appreciate being able to get another in. You went through some of the commentary around the quarters - the third quarter gross margin a little bit quickly I just wanted to see if you could help us understand what went on. And my recollection from my notes some mixed issues this quarter that are temporary and you expect to get back to your normal range In December but just if you could go into some of the detail on the September gross margin.

Yeah, I think what we said basically is that we had a mix shift within the data center segment from somewhat longer distance type of optics to shorter distance type of optics. That’s not to say from long reaches, short reaches, it just from longer distance to a shorter distance. And those two carried somewhat different gross margin profiles in the quarter. What we have done during the course of the quarter is, undertake an effort to improve our yield and some other cost reduction efforts since that we think that those products won’t contribute negatively to the gross margin in the future. In addition to that, the mix itself may normalize itself in this quarter as well so we expect our gross margin to be back to our normalized range of sort of 33.5% to 34.5% in this quarter.

And in the September quarter the Cable TV gross margins were consistent with the trends you've seen in the last several quarters

Yeah, we haven't seen any significant departure from the normal trends in cable TV with respect to gross margins.

Great and then if we think about the longer term, should we anticipate that if and when 100 gig grows in the mix that should be a tailwind for gross margin

What we've said is that I mean you know in the short term as we ramp up new products, there's puts and takes right, we might see a somewhat advantageous pricing but on the other hand we oftentimes have somewhat lower yields initially, so it’s hard to say in the short term. In the longer term I think the gross margins are probably going to end up above where we currently are in the datacenter side of the business. No major changes long-term.

Okay, thank you for the follow up.

No problem, Simon.

This concludes our question-and-answer session. I would like to turn the conference back over to Dr. Thompson Lin for any closing remarks

Again thank you for joining us today. [indiscernible] this quarter and I’m competent in our growth prospect and our ability to achieve our long-term goal of becoming the leader in supplier of fiber optic and networking products. As always, we thank our investors, customers, and employees for your continued support.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.