Applied Optoelectronics, Inc. (AAOI) Q2 2022 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Applied Optoelectronics Second 2022 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Lindsay Savarese. Please go ahead.

Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics and I'm pleased to welcome you to AOI's second quarter 2022 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2022 financial results and provided its outlook for the third quarter of 2022. 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 are 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 Q2 results, and Stefan will provide financial details and the outlook for the third quarter of 2022. 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 can 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. In some cases, you can identify forward-looking statements by terminology such as believes, anticipates, estimates, intend, predict, expect, plan, may, should, could, would, will or things, and by other similar expressions that convey uncertainty of future events or outcomes. 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 third quarter of 2022. Except as required by law, we assume no obligation to update forward-looking statements for any reason after 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 and filed with the SEC, including the company's annual report on Form 10-K for the year ended December 31st, 2021. Also, all financials 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 you to know that date of our third quarter 2022 earnings call is currently scheduled for November 3rd, 2022. Now, I'd like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?

Thank you, Lindsay, and thank you for joining our call today. I would begin with some highlights from the quarter before. I turn the call over to Stefan Murry, who will discuss a more detailed review of our second quarter financial result and outlook for the third quarter. Our second quarter revenue was adversely affected by a delay in completion of several orders from CATV customer that we expect to ship in Q2. During the quarter, the customer requested certain change to several orders, but due to well-known supply chain issues, we were unable to adjust production and procure raw material to address these changes prior to quarter end and the revenue therefore slid into Q3. We have since shipped substantially all this order and also late. We recognized the result in revenue, this shipping delays negative impact our Q2 revenue by approximately $6.7 million. As a result, our total revenue for the second quarter decreased 3.5% year-over-year to $52.3 million, which was below our expectations. Turning to rest of our result, our gross margin was in line with our expectations and non-GAAP EPS was above our expectations. For the revenue in our CATV segment of $23.7 million was down 14.1% year-over-year and was down 5.1% sequentially due to the reasons I mentioned above related to the late shipping. So, overall the main environment remind robust as MSO, particularly in North America continue purchasing additional network products in order to upgrade their network. Total revenue for our data center product of $21.5 million, decreased 4% year-over-year and what essentially phrase [indiscernible]. As we have discussed previously, the slight year-over-year in total revenue is due to a decline in 40-g, which is nearly the end of its lifecycle. This decline was partially offset by an increase in 100-g and finally, we continue to ramp later this year with the year-over-year growth for our total revenue to June. We continue to see good customer traction on 400-g. Today we have received nearly $5 million in orders for all 400-g products, most of which we expected to be shipped in Q3 and Q4 of this year. During the second quarter, with few EBITDA wins of lift design wins 204, our 400-g products, both with existing hyperscale data center operator customers. We also had to design wins for our 100-g products with hyperscale customers. We have two 100-g wins with network equipment manufacturers, supplying the data center industry. The remainder two design win were in our Fiber-to-the-Home, telecom and other categories. With that, I'll turn the call over to Stefan to review the details of our Q2 performance and outlook on Q3. Stefan?

Thank you, Thompson. As Thompson mentioned, our second quarter revenue was adversely affected by a delay in the completion of several orders from a large CATV customer that we had expected to ship in Q2. During the quarter, the customer requested certain changes to several orders, but due to the well-known supply chain issues, we were unable to adjust production and procure raw materials to address these changes prior to quarter end, and the revenue therefore slipped into Q3. We have since shipped substantially all of these orders and although delayed, we have recognized the resulting revenue in Q3. These shipment delays negatively impacted our Q2 revenue by approximately $6.7 million. As a result, our total revenue for the second quarter decreased 3.5% year-over-year to $52.3 million, which was below our expectations and essentially flat compared to Q1. While our revenue came in below our expectations, we delivered gross margin in line with our expectations and non-GAAP EPS above our expectations. We're encouraged by the strong CATV environment, the recovery in the telecom market, and the traction we are seeing with our 400-g products. During the quarter, we secured eight new design wins. Of these design wins, two were our 400-g products, both with existing hyperscale data center operator customers. We also had two wins for our 100-g products with hyperscale customers. We had two 100-g wins with network equipment manufacturer supplying the data center industry. The remaining two design wins were in our FTTH, telecom, and other category. We continue to see good customer traction on 400-g and we expect orders will ramp up in the second half of this year. On our Q1 call, we have discussed how a major hyperscale data center customer selected AOI as a vendor for several of our 400-g products. We are pleased to have completed the interoperability testing with the company's other prospective vendors. And we have begun to receive sizeable orders for shipments beginning in Q3. This was an addition to the two new designs for 400-g and the quarter that I just mentioned. One was with a major hyperscale operator and the other was with a smaller operator. These new wins further bolster our expectation for continued ramp in 400-g later this year and into 2023. Turning to our second quarter results 45% of our Q2 revenue was from CATV products. 41% was from our data center products, and the remaining 14% from FTTH, telecom and other. In our CATV product segment, the overall demand environment remains robust MSOs, particularly in North America, continue purchasing additional networking products in order to upgrade their networks. However, for the reasons I mentioned earlier related to the orders that slipped from Q2 into Q3, we generated CATV revenue of $23.7 million down 14.1% year-over-year and down 5.1% sequentially. Looking ahead, we currently expect strong sequential improvement in CITV revenue in Q3. Further out, we continue to have good visibility with CATV orders as we see our backlog stretching throughout 2022 and into 2023. We have significantly increased production capacity for CATV products, and we believe that we are well positioned to deliver on the demand that we are seeing. Our Q2 data center revenue came in at $21.5 million down 4% year-over-year, and up 0.4% sequentially. In the second quarter 71% of our data center revenue was from our 100-g products. 21% was from our 40G transceiver products, and 1.1% was from our 200-g and 400-g transceiver products. As Thompson noted earlier, we have booked nearly $5 million in orders already for 400-g products. And with our production capacity ramping, we expect to ship most of these in Q3 and Q4 of this year. Now turning to our telecom segments, revenue from our telecom products of $6.3 million was up at 88.3% year-over-year, and up 19.2% sequentially. Our strong second quarter performance was driven by recovery in the China Telecom market. Looking ahead, we continue to expect to see fluctuations in revenue in telecom, as the outlook for China Telecom remains somewhat murky. For the second quarter, our top 10 Customers represented 87.1% of revenue up from 86.8%. In Q2 of the prior year, we had two 10% or greater customers in the second quarter, one of the CATV market and one in the data center market. These customers contributed 40% and 22.2% of total revenue respectively. In Q2, we generated non GAAP gross margin of 16.7%, which was within our guidance range of 16.5% to 18% and was down from 17.5% in Q1 of 2022 and 25% in Q2 of 2021. The decline in our gross margin was mostly due to continue challenges with the supply chain. Totaled non-GAAP operating expenses in the second quarter were $18.2 million, or 34.9% of revenue, down from $20 million, or 36.9% of revenue in Q2 of the prior year. R&D expenses decreased year over year reflecting the timing of certain R&D projects, which we believe will come back next quarter. And our sales and marketing expenses benefited from some reduced shipping costs as well as lower personnel costs. Looking forward, we expect non GAAP operating expenses to hover around $20 million per quarter for the rest of the year. Non GAAP operating loss in the second quarter was $9.5 million, compared to an operating loss of $6.5 million in Q2 of the prior year. GAAP net loss for Q2 was $14.5 million, or a loss of $0.52 per basic share, compared with a GAAP net loss of $8.2 million, or a loss of 31 cents per basic share in Q2 of 2021. On a non GAAP basis, net loss for Q2 was $7.6 million, or a loss of $0.28 cents per basic share, which was better than our guidance range of a loss of $8.4 million to $9.5 million, or loss per share and the range of $0.30 to $0.34 cents per basic share and compares to a net loss of $4.1 million or a loss of $0.15 cents per basic Share. In Q2 of the prior year, the basic shares outstanding used for computing the net loss in Q2 were $27.6 million. Turning now to the balance sheet, we ended the second quarter with $40.7 million in total cash, cash equivalents, short term investments and restricted cash. This compares with $40.1 million at the end of the first quarter. We ended the quarter with total debt of $63.8 million, down from $67.2 million last quarter. As of June 30, we had $98.2 million in inventory, compared to $92 million dollars at the end of Q1. Inventory increased primarily due to the delay in shipment of the CATV orders that we discussed earlier. We made a total of $1 million in capital investments in the second quarter, including $0.7 million in production equipment and machinery, and $0.2 million in construction and building improvements. For the first half of the year, our total CapEx spend has been about $2 million. Looking ahead to the second half, we would expect flat to slightly higher CapEx spending. So for the year, we currently expect between $4 million and $6 million in total CapEx. Before turning to guidance, I would first like to provide an update on the supply chain environment. We continue to see challenges in some areas of our supply chain particularly semiconductors, as in prior quarters. We have adapted to these challenges by purchasing materials from alternative often higher cost sources. In some cases, we are able to reduce the impact by redesigning products to utilize components with better availability and cost. But this is not always possible for every shortage. We currently see approximately $1 million to $3 million in potential revenue reduction in q3 due to component shortages. However, this amount represents revenue that will be shifted to Q4 Rather than lost revenue. Moving out to our Q3 outlook, we expect Q3 revenue to be between $57 million and $60 million and non GAAP gross margin to be in the range of 16.5% to 18.5%. Non GAAP net loss is expected to be in the range of $7.6 million to $9.1 million and non GAAP loss per basic share between $0.27 and $0.32, using a weighted average basic share count of approximately 27.9 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Tim Savageaux with Northland Capital Markets. Please go ahead.

Hi, good afternoon. Question on your outlook in a comment you might have made about data calm. So as you look at the sequential increase your guiding for Q3, should we assume that's principally all cable TV catch up? Or is there anything else going on there? On the one hand, I think Thompson made a comment about returning to year-over-year growth in Q3 the second half or any particular color on that?

So the first question was about the nature of the sequential increase that we're forecasting in revenue. Yes, that's a lot of that is related to the cable TV increase. Data Center, we think we'll be kind of flattish sequentially. And as far as the returning to sequential growth that wasn't a specific statement Q3 or Q4, but we've said that at some point during the second half, so probably Q3 or Q4, we should return to sequential to year over year growth. Okay,

Okay. Just to follow-up on that, given the orders in hand and additional design wins for 400-g. It sounds like you expect that to ramp more material in Q4 or are you seeing any offsets and lower speed to kind of drive that flattish outlook for data center in Q3?

Yes. I mean, a lot of the 400G orders are going to start shipping later in Q3. So there's not as much effect in Q3 as you might otherwise, would otherwise expect if it was going to be for the entire quarter. And then there's always some fluctuation in some of the lower stuff as well. So, we do expect to see some ramp in 400G, but it'll be towards the end of the quarter more material in Q4.

Okay. And then maybe just one more, when you talk about the $5 million in 400G orders, should we assume that's primarily from your kind of, I guess, recently, historically, top customer? Maybe you've just added your other historical top customer, but should we assume that's concentrated with one major cloud operator? And how does that initial kind of batch of orders in hand compared to the kind of total opportunity that you see with either that cloud customer or the two major cloud customers?

Yes. So the orders that we've gotten so far bought for 400G by and large are not for the largest and most recent, largest major customer. It is for a couple of other hyperscale operators. As far as how we look at this opportunity, I mean, this is very much the beginning, that $5 million represents an accumulation of orders that we've received during the quarter. So it's not like that just all happen, say this month or this week, or something where we would expect that to be some sort of run rate. But the purpose of that is really, just to point out that we are starting to see a sizable backlog for orders. We're ramping our production capacity to be able to accommodate those orders. And that we'll be delivering on those orders and presumably, additional orders that will receive between now and the end of the year.

Okay. Thanks.

Our next question will come from Paul Silverstein with Cowen. Please go ahead.

Yes. Stefan, what's the visibility, if any, to margin improvement? What are the -- what needs to happen? I recognize everyone's being impacted by supply chain stuff included, what needs to happen for gross margin to get up to more meaningful level from here?.

I think as we highlighted in our prepared remarks earlier, the biggest factor that's been affecting us recently has been just -- there's not one particular supply chain issue that I can point to, there's been a lot of various different issues that we've had. I think this is not untypical for other companies, of course, not that's an excuse. But it's a little bit difficult to predict exactly what the trajectory of those prices is going to be. As we noted in our prepared remarks, we've done quite a lot of work on qualifying second sources, finding alternatives in many cases, redesigning products or portions of products to be able to accommodate, components that are either more available or available at a lower cost, or hopefully, both. So there's been a lot of activity that we've had. The difficulty in translating all that activity into improved gross margin is that, we have to -- if it's a redesign or something like that, we have to burn through the existing inventory. In some cases, the inventory that we're getting or the products that we're able to get are actually higher costs. So that kind of offsets what would otherwise be cost savings from other areas. So I mean, I think we're going to see improvement in gross margin towards the end of the year based on some of the new products that we have kicking in more meaningfully contributed to revenue at that time. And also some of the anticipated cost reduction, the combination of some of the cost reduction efforts that we have had. So our current expectation is from sort of an uptick in gross margin in Q4. But I will hedge that a little bit by saying that that assumes that the supply chain situation doesn't get materially worse, which seems like is unlikely at this point. But one never knows.

Yes. What you're talking about getting back to the mid high 20s before the incremental impact of supply chain, or you're not even talking about getting back to that level. And I guess what we're always trying to get to was to get to 30-plus beyond supply chain, what needs to happen? What can supply to -- just reparation supply chain, what can that get you back to? And then to get to 30 plus, what needs to happen beyond supply chain normalization?

Yes, I think supply chain probably gets us back into the low to mid 20s. To get to 30%, we would need to see contribution -- significant contribution from some of our higher margin -- newer higher margin products. So a mix shift in addition to the supply chain normalization,

Specifically to 400 gig…

Okay. I’m sorry. No, go ahead, Paul. I’m sorry.

Specifically to 400-gig or you're thinking more generically in terms of new products?

More generically, but I mean, 400-gig can be a contributor there, that's certainly part of it, but other new products as well. And like I said, the timeframe on the supply chain normalization, we think is sort of Q4-ish. Again, barring any other things that happen. The new products, again, will start to kick in probably in Q4, but it'll probably contribute more meaningfully in quarters after that, so into 2023.

And then I'll pause, I know addresses in the past, but to get to breakeven, what does that assume in terms of volume and gross margin your assumptions?

Right. Well, we gave some guidance on operating expense. It's going to hover probably between $19.5 million, $20 million, something like that through the rest of the year. So, you can kind of -- and I don't expect that to change meaningfully next year really either. We've been fairly consistent in operating expense. So you can kind of do the math on the gross margin and revenue numbers that will take to get to breakeven. We said before, I think we can get back to the upper 20s or even 30, maybe touch 30%. At some point, it's not likely to happen in the next couple of quarters, given the trajectory that we just talked about. So if you kind of assume that and plug in a $20 million-ish operating expense, you can get a pretty rough idea on what the revenue level would need to be.

I appreciate it. Thank you.

There are no remaining questions at this time. And with that, we will conclude our question-and-answer session. I'd like to turn the conference back over to Dr. Thompson Lin for any closing remarks.

Again, thank you for joining us today. As always, we want to extend the thank to you, to our investors, customers and employees for your continued support. We look forward to updating you on our progress next quarter.

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