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.

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…

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?

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…

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

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.

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.

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?

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.

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?

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.

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.

Terrific. Appreciate the time. Thanks.

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

Hey good afternoon. And congrats on the results and the positive EBITDA in particular. I have a question about the kind of pull in that we're seeing from Microsoft in terms of 400-gig AOC type demands. And I guess one would be, to what extent is that a factor in your guidance for Q4. And I assume, given you're ramping up production this month and through December, that looks like to set you up for a full quarter of production, perhaps in Q1. And I'd love if you can give us a sense of what that looks like for you guys from a revenue standpoint? Or what might that look like? Thanks.

Sure. So your question about Q4, I think, is -- the answer to that is that we're just beginning the production in Q4. So we don't expect it to meaningfully contribute to revenue in Q4. The reason for the commentary that we've been giving is just to illustrate the fact that the demand is still very strong for Microsoft. And in fact, I believe from other datacenter operators as well as we talked about. However, our ability to increase the production capacity is -- we're doing the best that we can, but it's going to take us a little bit of time to get there, right? So we're not going to be fully ramped right at the beginning of Q1 either. There'll be some continued ramp during Q1. And in fact, based on the production targets that they've asked us to meet, there will be some increasing production capacity pretty much throughout next year. It's not going to be done in a month or even a quarter. So there'll be some improvement throughout the year in terms of our capacity there. The encouraging thing for us really is, again, that Microsoft is really looking for us to make these products in greater quantities faster and that's an exciting thing for us. With respect to exactly how much will be in Q1, we haven't given guidance for Q1 yet. A lot will depend on the progress that we make over the next month or 2. But certainly, we believe this is incrementally positive in terms of timing and our overall production rate into Q1, and we're excited about that.

Great. Wanted to follow up on the 800 gig front where you noticed some progress in terms of customer samples and realizing you're probably in pretty early stages, but are you at a point -- or when do you think pending customer evaluation of these products? Is this something that could start to ship in calendar 2024?

Yes.

Okay. That was pretty clear. And then I'll try again then, which is -- or further, which is any sense of timing on that within calendar 2024.

Yes, that, I think it's a little too early to say right now. As you pointed out, I mean, we're in early stages on it. I would say the demand picture for 800G looks pretty strong, and we're certainly having very constructive discussions with the customers. But how long it will take and the qualification process and that is a little too early to say, but I do expect it to be in 2024.

Yes, so maybe sometime in Q2 or Q3 next year. The year of qualification, it will take easily, four to six months or longer. But the other thing that I want to emphasize is we are working very close with several big customers, about 1.6T with 200G per Lambda. And they all believe we are the technology leader. And I think the demand will be very strong too. Maybe it's from Q3, Q4 next year. So it's only 800G. There's a lot of things going on for the data center, especially the high-speed transceiver technology, because the AI, the AI demand is really, really strong. So we are jumping right now, not only from the 100G to 400G in volume, and we stay at 800, we get into volume sometime next year, Q2, Q3, but even 1.6T, we would be without a decent volume in Q4 next year.

Got it. And let's stay on this topic for a second. And Stefan, you described four customers evaluating the products. Can you give us any indications of the type of customers those might be large, cloud operators, networking OEMs, what have you?

Mostly large cloud operators with at least one OEM that supplies some of the large cloud operators. So it's all cloud, it's all hyperscale cloud related, whether it's directly or through an OEM that was supplied.

And one big AI company. You know what I'm talking about. So I don't know how you define it. It's not cloud operator, but it's really, that maybe they'll become the number one customer in the world for the data center transceiver.

Okay. Great. And last one for me and maybe kind of related to that, I mean, can you give us a sense of kind of -- I don't know whether it's unit volumes or revenue dollars, but how do you assess the kind of total opportunity for AI-related, would call it transceivers or AOCs? And how has that assessment of market opportunity evolve for you guys over the past quarter or so?

I don't know. The number sounds crazy, okay. What we heard is for AI under the, I think we are talking about maybe at least minimum six to eight million volume with very good ASP, more than $600, $700. So you can see opportunity next year.

Thanks, everyone.

So it's at $14 billion plus next year. And some people even come up to me, even higher than Verizon. As you can see, I'll be very happy if that's true. That's why we are putting our resource into AI and G and 1.6T business. For under G, I think we are very competent. That's very existing. The volume's coming up for sure, but really the big jump is AI under G and 1.6T for AI related business. And that's what we heard from the customers

Great. Thanks very much.

The next question is from Dave Kang with B. Riley FBR. Please go ahead.

Thank you, good afternoon. First question is on cable TV. So you said by middle of next year, we should be expecting very strong recovery. So are we talking about like prior peak of, like, say, $30 million or so per quarter? Is that what we should be expecting or not quite there yet?

I mean without putting a specific quarter on it, yes, certainly, the expectation is that we can exceed the prior peak levels because at that point, we weren't really in even an upgrade cycle, right? It was just a sort of a business as usual case. As we move into an upgrade cycle, which is what we think will happen that portends the growth in DOCSIS 4.0, I would say the opportunity there is significantly larger than the previous peak for sure. Not to mention the fact that because of the business model change, our ASPs are going to be higher because we're not selling through a middleman essentially. And so not only will have higher unit demand, but ASPs will be higher as well.

Well, let me say that I would say by Q4 next year, our CATV business should be, I would say more than $40 million in Q4 next year, which very good cost margin, I would say around 40%.

Okay. And then just on the data center, 100 gig, little surprised why that was so strong because others are saying it's really 800 gig that's enjoying strong demand, whereas 100 gig, which is not really not considered to be part of AI, 100 gig is weak. So are you just gaining market share? And how should we think about going forward? Should we be expecting 100 gig to be flat and eventually decay? Can you just talk about the next, what to expect over the next couple of years?

Sure. So I think in 100 gig, we're taking market share. I think there's been some increase in purchasing with maybe a couple of customers, but I think we're gaining market share there. We've talked about some of the dynamics, for example, that being a U.S.-based manufacturer gives us some advantages there in terms of being able to attract, I would say, more interest maybe than in the past relative to some of our competition in China. And that's helpful for us in gaining this market share. As far as how that plays out in the future, I mean -- I think, look, what we saw at 40 gig is that the older technology has a very long tail. I mean it's -- it lasts a long time, and that's what I expect with 100 gig as well. I mean, I think that eventually, 100-gig will decline as 400-gig begins to grow but I don't think it's going to be dramatic. I mean, I kind of feel like we tell the same story every time there's a technology transition, right? Wall Street tends to think, well, one technology comes on and the other one goes away immediately. And we always try to caution that, no, that's not what happens, right? It's a gradual shift. The new technology tends to come on relatively quickly, but the old one tends to last a long time because there's already a number of switches, for example, that are out there that haven't been fully populated yet. They're going to fill out those ports and those switches. And that portends a long period of, I would say, relatively flattish maybe down slightly, but relatively flattish demand. So I would caution not to remove 100 gig from the picture as quickly as you might be tempted to.

Got it. And just wanted to clarify, did you say that for -- regarding fourth quarter, expect similar revenue mix with third quarter? Did I hear that right?

We're just saying that the datacenter portion of it will be consistent with Q3, right?

No, but yes, we're going to see some growth, but the mix will be different because we're going to see much more 400 gig than 100 gig.

Okay, okay. Actually, yes, that's what I was after.

The financial are not the same. It's the 400 gig we call up, but 400 gig we call down.

Got it. And my last question is regarding the termination, the fee of $3 million, who is responsible for that?

We believe that Yuhan is responsible for the breakup fee. We're pursuing them for the payment of that.

Okay, got it. Thank you.

Next, we have a follow-up question from Jeff Coach [Ph] with Raymond James. Please go ahead.

Yes. Just really quickly, I just want to talk about your thoughts on datacenter going into March. Is it ridiculous to think that you could be up sequentially, again, I know historically, that's not the strongest seasonally?

I mean I think it's not ridiculous to think because, again, the 400-gig business that we're talking about, the new programs with Microsoft will be ramping during the quarter. So you're correct historically that ordinarily Q1 is sort of a challenging quarter, just seasonally. A large part of that is because historically, most of our datacenter products have been made in China, and we do have Chinese New Year, both in China and Taiwan. In this case, we're producing more of these products in Taiwan and even in the U.S. And so the impact of Lunar New Year should be less for us. That in combination with the fact that the 400-gig will be ramping in terms of production capacity paints a pretty good picture in the March quarter for us, I think.

Great. Thank you so much.

At this time, we have no further questions. And I will turn the call over to Dr. Thompson Lin, AOI's Founder, Chairman and CEO, for closing remarks.

Okay, thank you for joining us today. As always, what we want to extend a thank you to our investors, customers and employees. We will continue to support. We look forward to updating you on our next earnings call.

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