Applied Optoelectronics, Inc. (AAOI) Q4 2022 Earnings Report, Transcript and Summary

Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics Fourth Quarter and Full-Year 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. [Operator Instructions]. Please note that this call is being recorded. I will now turn the call over to Lindsay Savarese, Investor Relations for AOI. Ms. Savarese, you may begin.

Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics, and I'm pleased to welcome you to AOI's fourth quarter and full-year 2022 financial results conference call. After the market close today, AOI issued a press release announcing its fourth quarter and full-year 2022 financial results and provided its outlook for the first 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 Q4 results and Stefan will provide financial details and the outlook for the first 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 statements. 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 industries, 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, forecasts, anticipates, estimates, intends, predict, expects, plan, may, should, could, would, will, potential or things, or by the negative of those trends or other similar expressions that convey uncertainty of future events or outcomes. The company updates these forward-looking statements on its current expectations, assumptions, estimate 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, including important factors, such as risks related to the company's ability to complete the transaction described on this call on the proposed terms and schedule or at all; the risk that certain closing conditions may not be timely satisfied or waived; the failure or delay to receive the required regulatory or other government approvals relating to the transaction; and the occurrence of any event, change or other circumstance that could give rise to the termination of the transaction. 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 first 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. Also, our 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 note the date of our first quarter earnings call is currently scheduled for May 4, 2023. Now, I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics’ Founder, Chairman and CEO. Thompson?

Thank you, Lindsay. Thank you for joining our call today. We are pleased to report fourth quarter results, with revenue in line with our expectations, gross margin above our expectations and non-GAAP loss per share better than our expectations. We continue to see strong demand in the CATV market and generated the highest quarterly CATV revenue in the company history in Q4. During the fourth quarter, we delivered revenue of $61.6 million, in line with our guided range of $58 million to $64 million. We delivered non-GAAP gross margin of 21.4%, above our guided range of 17.5% to 19.5%, driven by our targeted cost reductions and favorable product mix. Our non-GAAP loss per share was $0.19, about our guided range of a loss of $0.28 to $0.34. Our revenue in our CATV segment was a company record of $38.2 million, up 53% year-over-year and 22% sequentially, off a strong Q3, as we continue to see robust demand in the CATV market. Total revenue for our data center products of $16.5 million decreased 35% year-over-year and 7% sequentially as customer continues to manage inventory level of all the products during the transition to 400G. This was partially offset by an increase in 400G revenue, which more than doubled sequentially. In Q4, we signed an agreement with a major hyperscale data center operator for development program to make next-generation lasers for their data center, both for 400G and beyond. While the development of this new product will take several quarters to be complete, we view this counter award as validation of the value of our core laser fabrication ability. With that, I'll turn the call over to Stefan to review the details of our Q4 performance and outlook for Q1. Stefan?

Thank you, Thompson. As Thompson mentioned, we are pleased to report our fourth quarter results, with revenue in line with our expectations, gross margin above our expectations and a non-GAAP loss per share of better than our expectations. We continue to see strong demand in the CATV market and generated the highest quarterly CATV revenue in the company's history from Q4. Before turning to the quarter, I wanted to provide an update on the transaction that we announced last September that we have entered into an agreement with Yuhan Optoelectronic Technology for the sale of our manufacturing facilities located in the People's Republic of China and certain assets related to our transceiver business and multi-channel optical sub-assembly products for the data center, telecom and FTTH markets for a purchase price of $150 million. As a reminder, we continue to anticipate that the transaction will be completed in 2023 and is subject to customary closing conditions and regulatory approvals, including CFIUS and ODI. We continue to advance work on these required regulatory approvals. As part of this process, Yuhan has disclosed additional details regarding their financials, including new details regarding the composition of their ownership group. And based on this new information, we continue to be optimistic that regulatory approval of this transaction both in the U.S. and China is achievable. Turning to the quarter. Our total revenue for the fourth quarter increased 13% year-over-year to $61.6 million, which was in line with our guidance range of $58 million to $64 million. As Thompson noted earlier, we made progress on our strategy to focus our efforts on our higher-margin laser business during Q4. We are pleased to announce that, during the fourth quarter, we signed an agreement with a major hyperscale data center operator for a development program to make next generation lasers for their data center, both for 400G and beyond. This customer has agreed to provide approximately $4 million in R&D funding for the first phase of this project, with the first $3 million paid in Q4. Currently, this is reflected on our balance sheet as deferred revenue. We expect to recognize this revenue throughout the next several quarters as we progress through the development program. We believe that the significant financial investment made by this customer provides further validation of our strategy of focusing on our core high-margin laser business, even as we advance with our plans to divest the data center optical transceiver business to Yuhan, as discussed above. Turning back to the quarter. We secured two design wins, both of which were in our CATV business. For the full year, we secured 12 new design wins compared to 20 design wins in 2021. During the fourth quarter, 62% of our revenue was from our CATV products, 27% was from our data center products, with the remaining 11% from FTTH, telecom and other. In our CATV product segment, the overall demand environment remains robust as MSOs, particularly in North America, continue purchasing additional networking products in order to upgrade their networks. CATV revenue in the fourth quarter was a company record of $38.2 million, which was up 53% year-over-year and 22% sequentially. Looking ahead, as a reminder, our CATV results are typically negatively impacted in Q1 by the loss of production days that occurs during the Lunar New Year holiday in China, where most of our CATV products are produced. We continue to have good visibility throughout the first half of the year, and are carefully monitoring MSO plans to move to DOCSIS 4.0 networks, perhaps as early as later this year. Broadly speaking, we're encouraged by some of the commentary that we have heard regarding the DOCSIS 4.0 transition, as it relates to long-term continued investment in network upgrades. For example, as you may have seen in December, Charter announced plans to spend approximately $5.5 billion over the next several years on network upgrades. We believe much of the spending will be on outside plant equipment, such as nodes and amplifiers, which are the products that have been driving AOI's cable TV business growth over the last several years. Announcements like that from Charter bolster our belief that the network upgrades that have begun will continue for the next several years, which we believe will continue to drive our CATV business. Our Q4 data center revenue came in at $16.5 million, down 35% year-over-year and 7% sequentially, as customers continued to manage inventory levels of older products during the transition to 400G. This was partially offset by an increase in 400G revenue, which more than doubled sequentially. In the fourth quarter, 71% of our data center revenue was from our 100G products, 11% was from our 40G transceiver products, and 8% was from our 200G and 400G transceiver products. Now turning to our telecom segment. Revenue from our telecom products of $6.4 million was up 94% year-over-year and down 7% sequentially. Looking ahead, we currently expect telecom revenue in Q1 to be slightly down due to the Lunar New Year and then expect to see slow improvement in this segment as deployments of 5G products continue. For the fourth quarter, our top 10 customers represented 90% of revenue, up from 88.4% in Q4 of last year. We have two greater than 10% customers, one in the CATV market and one in the data center market. These customers contributed 58% and 16% of total revenue respectively. For the full year, we had two 10% or greater customers, one in the CATV market and one in the data center market. These customers contributed 47% and 18% of total revenue respectively. In Q4, we generated non-GAAP gross margin of 21.4%, which was above our guidance range of 17.5% to 19.5% and was up from 18% in Q3 of 2022 and up from 17.6% in Q4 of 2021. The increase in gross margin was driven mainly by our favorable product mix and our cost reduction efforts. We continue to be very focused on improving our bottom line. We believe the key to this is improving our gross margin performance. In addition to our ongoing cost reduction efforts, during the quarter, we exited several low profit legacy products. Additionally, we have shifted R&D resources away from some low margin projects to focus our resources on areas where we can maximize margin. Recently, we've also had some success in executing price increases with some customers, which will help to relieve some of the margin pressure we've been experiencing. Together, we expect these efforts to cumulatively improve our gross margin and bottom line performance over the next several quarters, and our management team and operating teams are all focused intensely on this improvement. Total non-GAAP operating expenses in the fourth quarter were $21 million or 34.2% of revenue, which compared to $16.9 million or 31% of revenue in Q4 of the prior year. R&D expenses increased 7% year-over-year to $8.9 million. As we noted in our last earnings call, our non-GAAP operating expenses in Q4 included approximately $3 million or $0.11 per share of additional employee bonus approval related to the China divestiture. These payments were authorized by the board in order to retain key employees who are critical to the success of the divestiture. These additional bonus payments are not expected to occur in 2023. Looking forward, we continue to expect non-GAAP operating expenses will moderate this year to between $19 million and $20 million per quarter. Non-GAAP operating loss in the fourth quarter was $7.9 million compared to an operating loss of $7.3 million in Q4 of the prior year. GAAP net loss for Q4 was $20.3 million or a loss of $0.71 per basic share compared with a GAAP net loss of $14.5 million or a loss of $0.54 per basic share in Q4 of 2021. On a non-GAAP basis, net loss for Q4 was $5.4 million or a loss of $0.19 per basic share, which was better than our guidance range of a loss of $8.1 million to $9.8 million or loss per share in the range of $0.28 to $0.34 per basic share and compares to a net loss of $5.5 million or a loss of $0.20 per basic share in Q4 of the prior year. The basic shares outstanding used for computing the net loss in Q4 were 28.5 million. Turning now to the balance sheet. We ended the fourth quarter with $35.6 million in total cash, cash equivalents, short term investments and restricted cash. This compares with $34.6 million at the end of the third quarter. We ended the quarter with total debt excluding convertible debt of $69.4 million, up from $65.1 million last quarter. As of December 31, we had $79.9 million in inventory compared to $94.3 million at the end of Q3. Inventory decreased primarily due to utilization of inventory for customer orders, along with the impact of exchange rates on our foreign inventory. We made a total of $0.8 million in capital investments in the fourth quarter, bringing our total CapEx for the year to $3.4 million, which is down from $11.6 million in 2021, reflecting lower capital needs as most of the equipment necessary to produce our current generation products was purchased last year. Moving on to our Q1 outlook. We expect Q1 revenue to be between $52 million and $55 million and non-GAAP gross margin to be in the range of 23% to 24%. Non-GAAP net loss is expected to be in the range of $4.4 million to $5.3 million and non-GAAP loss per basic share between $0.15 and $0.19, using a weighted average basic share count of approximately 28.9 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?

[Operator Instructions]. Our first question comes from Simon Leopold from Raymond James.

I appreciate the seasonal factors in terms of the Chinese New Year effect on the March quarter. And so, I guess what I'm struggling with is how to really think about maybe the normalized run rate, given that you didn't provide a full-year forecast. Can you give us some color or quantification about how you're thinking about the full year, particularly for the cable unit?

Well, as we noted in our prepared remarks, we had an all-time record in terms of cable TV production in Q4. I think part of that is probably some orders that were pulled into Q4 from Q1 just because they knew that there would be an impact from Lunar New Year and wanted to make sure that they had adequate inventory on hand. So, that number is probably a little bit high for an average run rate, but it's certainly what we were able to produce in Q4. So, consistent with demand. I'd say we'd probably come in at a number that's slightly less than that, perhaps, but not too far off after we finish off – after we get out of the Lunar New Year period. That being said, we're actually monitoring pretty carefully the activity around DOCSIS 4.0, or at least specifically the MSO plans to move to upgraded networks. It's something that we spent a lot of time developing products for, and we're excited about that transition. So we're waiting to see whether that occurs later this year or early in the next year, and how that'll impact volumes, both on the current generation of 1.2 gig products and the next generation 1.8 gig products.

And just to make sure I understand what you're alluding to there, if we were to make the assumption that DOCSIS 4.0 spending were to ramp in 2024, the activity in 2023 seems like maybe preparation for that, and therefore, 2024 should give you further growth if we think that's when DOCSIS 4.0 ramps. Is that the right interpretation?

Yeah, I think that's an accurate description. The DOCSIS 4.0 components, in addition to being just kind of more complicated in their own right because of the greater frequency response associated with DOCSIS 4.0, the products also – especially the amplifier products contain a great deal of intelligence in the products, which is something new that hasn't really been incorporated into those products. So, the bottom line is that the cost and price of those products is higher than the current generation DOCSIS 3.1 products. And so, independent of volume plans by the MSOs, just the cost increase alone would certainly tend to drive higher revenue numbers.

Can you give us the names of the customers that were over 10%, the cable TV vertical and the data center vertical?

Sure. ATX Networks and Microsoft.

Our next question comes from Tim Savageaux from Northland Capital Markets.

Congrats on the results, especially on the gross margin side. And I guess I'll start there. And I think your drivers for Q4 are pretty straightforward. In talking about mix, I guess that's more cable and less datacom. My first question, though, is on the Q1 gross margin guide, which is higher still, despite this seasonal pullback in revenue. I don't know if that's some of that NRE funding coming in or if you can talk about what the drivers might be there.

There's not much in the NRE funding in Q1 actually in terms of the forecast. I mentioned in our prepared remarks that we've actually been successful in pushing through some price increases, which is rather unusual for our industry. And so, we'll start to see the impact of some of those price increases during the quarter and then the continued cost reduction efforts. I've mentioned this pretty consistently over the last, I don't know, three or four quarters that because of the nature of the cost reduction, and specifically when you're talking about product redesigns or substituting components that maybe have lower costs, that takes some time to play out because you have inventory that you have to – older inventory at a higher cost you have to use up before the new inventory at a lower cost comes in. And so, those cost improvements don't happen all at once. They tend to happen over a period of a couple of quarters. So there'll be some additional impact from those cost reductions in Q1 as well.

So it sounds like if you're in a situation where revenue comes back post your seasonal quarter, it doesn't seem like there's a lot of one-time stuff in that Q1 – gross margin guide seems like you could possibly build on that with higher volumes.

Yeah, I think that's right. We've certainly been talking about returning to certainly upper 20s, mid to upper 20 range gross margins. And I think we can definitely see – especially over the last couple quarters, we can certainly see a pathway to that later this year.

Tim, this is Thompson. I certainly believe Q4 this year gross margin should be 30% for us. And next year with DOCSIS 4.0, I think the unit price should be much higher. For us, it's a very new product. And I think that AOI has – we believe we have very strong advantage in technology and performance. And the cost might be better. So, the next year, costs might be even better. This is how we see right now. And we see very strong demand from the key customers.

And I want to kind of follow – that was - my next question actually, is we seem to be talking about cable TV infrastructure demand in two different ways, which is, one, your current demand profile, which seems pretty strong and maybe some of that got pulled into Q4, but you grew 25% or so in cable TV in calendar 2022 and obviously, much faster than that in Q4. But does that represent a normalized growth rate? Can you maintain double digits there regardless of the timing of 4.0? It sounds like what you were trying to say is to the extent we see when some of this 4.0 activities start to really happen in the second half of 2023 versus 2024, that could be a swing factor for your cable TV growth. I'm just trying to set a baseline for how you see the current demand picture and what might be incremental to that.

So at the moment, I mean, we're sort of capacity limited in terms of production. And so, until we get a more clear line of sight on exactly how fast the adoption of 4.0 is going to go, I'm not anticipating that we're going to add a lot of production capacity for the 4.0 products. And so, for the next several quarters, I would say we're likely to be capacity constrained. Now, I mentioned earlier that Q4 was a little bit higher than I think we would do on an average basis. We sort of – as I said, the customer pulled in some revenue and we did some things to try to ship out as much product as we could. So, I wouldn't necessarily predict that number exactly in Q4 as a fourth quarter run rate. But going back a quarter or so probably is a reasonable estimate of what we would be able to do quarter-on-quarter this year, absent any change in the demand picture due to 4.0.

There are no more questions in the queue. And this concludes our question-and-answer session. I would like to turn the conference back over to Dr. Thompson Lin for any closing remarks.

Okay, thank you for joining us today. As always, we want to extend a thank you to our investors, customers and employees for your continuous support. We look forward to seeing many of you at IC and updating on you on our next earning call.

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