Applied Optoelectronics, Inc. Q1 FY2022 Earnings Call

Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to the Applied Optoelectronics Fourth Quarter and Full Year 2021 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. Please note that this call is being recorded. I would now like to turn the conference over to Cassidy Fuller, Investor Relations for AOI. Ms. Fuller, you may begin.

Thank you. I'm Cathy Fuller, Investor Relations for Applied Optoelectronics. I'm pleased to welcome you to AOI's first quarter 2022 financial results conference call. After the market closed today, AOI issued a press release announcing its first quarter 2022 financial results and provided its outlook for the second 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 Q1 results, and Stefan will provide financial details and the outlook for the second quarter of 2022. A question-and-answer session will follow our prepared remarks. Before we begin, I'd 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. 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 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 second quarter of 2022. 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 filed with the SEC, including the company's annual report on Form 10-K for the year ended December 31, 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 the date of our second quarter 2022 earnings call is currently scheduled for August 4, 2022. Now, I'd like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?

Thank you, Cassidy, and thank you for joining our call today. Turning to the fourth quarter, we delivered revenue and gross margin in line with our expectations and non-GAAP EPS above our expectations. During the quarter, we continued to see strong demand in the CATV market and improving conditions in the telecom market. Total revenue for the fourth quarter increased 5.1% year-over-year to $52.2 million. Total revenue in our CATV segment of $25 million was up 34% year-over-year and was slightly higher compared to Q4. The overall CATV demand environment remains strong as we see increased activity and orders throughout the year and into early 2023. We are working to add additional capacity to meet elevated demand. Total revenue for our data center products of $21.4 million decreased 17.4% year-over-year and 15% sequentially as several of our customers continue to reduce their 400G and 100G purchases, while our run of next-generation 400G is still in the early stage. We can notice the strong customer balance sheet on 400G, and I'm very pleased to report that during the quarter, AOI was selected by a major hyperscale data center customer as a vendor for several of our 400G products. We have a long relationship with this customer and have historically been a significant supplier of their early 40G and 100G transceiver needs. Pending the completion of finer interoperability testing with the company's other prospective vendors, we expect orders to begin in Q3 with deliveries in Q3 or early Q4. During the fourth quarter, we secured one new design win, which was a 400G transceiver product for hyperscale data center operators. With that, I will turn the call over to Stefan to review the details of our Q1 performance and outlook for Q2. Stefan?

Thank you, Thompson. As Thompson mentioned, we delivered non-GAAP EPS above our expectations and revenue and gross margin in line with our expectations. During the quarter, we saw continued growth in the CATV market and improving conditions in the telecom market. We secured one new design win, a 400G transceiver product for a hyperscale data center operator. As Thompson mentioned, we are pleased to report that AOI was selected by another major hyperscale data center customer as a vendor for several of our 400G products. We have a long relationship with this customer and have historically been a significant supplier of their earlier 40G and 100G transceiver needs. Pending the completion of finer interoperability testing with the company's other prospective vendors, we expect orders to begin in Q3 with deliveries late in Q3 or early in Q4. Total first quarter revenue of $52.2 million increased 5.1% compared to the first quarter of 2021 and decreased 4% sequentially. Our Q1 revenue was in line with our guidance range of $51 million to $54 million. In the first quarter, 48% of our revenue was from our CATV products, 41% was from our data center products, with the remaining 11% from FTTH, telecom, and other. In our CATV products segment, the overall demand environment continues to grow as MSOs, particularly in North America, continue purchasing additional capacity to upgrade their networks. We generated CATV revenue of $25 million, up 34% year-over-year and up 0.2% sequentially. 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. The slight sequential growth reflects the increased capacity that we have added, which more than compensated for the loss in production days. Looking ahead, we continue to have good visibility with CATV orders as we see our backlog stretching throughout 2022 and into 2023. We are working to add additional capacity in both our China factory and our Taiwan factory to meet this growing demand. We believe the conditions in our CATV market are likely to remain highly favorable into 2023. Our Q1 data center revenue came in at $21.4 million, down 17.4% year-over-year and down 15% sequentially. In the first quarter, 73% of our data center revenue was from our 100G products, 18% was from our 40G transceiver products, and 1.4% was from our 200G and 400G transceiver products. Now turning to our telecom segment. Revenue from our telecom products of $5.3 million was up 17.5% year-over-year and up 6.1% sequentially. We were pleased to see telecom rebound this quarter as the China Telecom market recovered. Looking ahead, we expect telecom revenue to remain lumpy quarter-to-quarter, however, especially given the challenging environment in China due to COVID-19. For the first quarter, our top 10 customers represented 88.6% of revenue, down from 90.5% in Q1 of the prior year. We had two customers contributing 10% or greater in the first quarter, one in the CATV market and one in the data center market. These customers contributed 39% and 19.4% of total revenue, respectively. In Q1, we generated non-GAAP gross margin of 17.5%, which was at the high end of our guidance range of 15.5% to 17.5%, and was down slightly from 17.6% in Q4 of 2021 and 24.6% in Q1 of 2021. The decline in our gross margin was mostly due to continued challenges with the supply chain. Total non-GAAP operating expenses in the first quarter were $19.6 million, or 37.5% of revenue, down from $20.6 million or 41.4% of revenue in Q1 of the prior year. 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 first quarter was $10.4 million compared to an operating loss of $8.4 million in Q1 of the prior year. GAAP net loss for Q1 was $16.1 million, or a loss of $0.58 per basic share compared with a GAAP net loss of $15.6 million, or a loss of $0.59 per basic share in Q1 of 2021. On a non-GAAP basis, our net loss for Q1 was $7.9 million or a loss of $0.29 per basic share, which was better than our guidance range of a loss of $8.3 million to $9.5 million, or a loss per share in the range of $0.30 to $0.35 per basic share, and compares to a net loss of $5.5 million or a loss of $0.21 per basic share in Q1 of the prior year. The basic shares outstanding used for computing the net loss in Q1 were $27.5 million. Turning now to the balance sheet. We ended the first quarter with $40.1 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $41.1 million at the end of the fourth quarter. We ended the quarter with total debt of $67.2 million, up from $62.9 million last quarter. As of March 31, we had $92 million in inventory compared to $92.5 million at the end of Q4. Inventory decreased, primarily due to utilization of inventory for customer orders. We made a total of $1 million in capital investments in the first quarter, including $0.7 million in production equipment and machinery and $0.2 million in construction and building improvements. Before turning to guidance, I would first like to discuss the supply chain environment. We saw supply constraints continue to lessen throughout Q1, and we did not see significant impact from shortages in the quarter. However, towards the end of the quarter, lockdowns in Shanghai began to affect several of our suppliers for our CATV products. We expect that these shutdowns will negatively impact our revenue in Q2 by approximately $3 million. We do expect to recover this delayed revenue once conditions in China normalize. Moving now to our Q2 outlook. We expect Q2 revenue to be between $56 million and $59 million and non-GAAP gross margin to be in the range of 16.5% to 18%. Non-GAAP net loss is expected to be in the range of $8.4 million to $9.5 million and non-GAAP loss per basic share between $0.30 and $0.34, using a weighted average basic share count of approximately 27.6 million shares. With that, I will turn it back over to the operator for the Q&A session.

Thank you. We will now begin the question-and-answer session. The first question comes from Richard Shannon with Craig-Hallum. Please go ahead.

Thank you, Thompson and Stefan, for including me in the discussion. I have a couple of questions. First, regarding the sales guidance for the second quarter, Stefan, you mentioned a $3 million impact from supply chain issues. I'm curious if this is primarily related to cable TV. Can you confirm this? Additionally, could you provide a general overview of the growth trends for each of your main sales segments this quarter?

Sure. Yes. So the supply chain issues that we called out that we expect to result in about a $3 million revenue hit compared to what we would otherwise have due to that supply chain constraint. That was in China, and it was related to our Cable TV product, as you mentioned.

Okay. That is helpful. Following up on one of your comments about 400-gig, you mentioned that you expect to be a supplier for a major hyperscale. Can you provide more details on whether this is a U.S. or international hyperscaler? Can you specify which versions of 400-gig are involved? Additionally, how would you characterize the dollar opportunity over time from this win?

Sure. It's a U.S. customer and has historically been one of our largest data center customers. We haven't disclosed the specific types of 400-gig products for competitive reasons. Regarding the dollar opportunity, it should be significant, but we can't provide an exact figure yet as we are still finalizing interoperability testing. Until that's complete and we understand the competitive landscape and our positioning, it's challenging to project the potential dollar figure for AOI. However, this customer has historically relied on us as their largest supplier for certain applications, including 100-gig, and now they are moving to their next-generation product. So, it represents a substantial opportunity for us.

Okay. I appreciate that perspective. Just one last kind of big picture question for you, Stefan, obviously, I think the big question for a lot of investors is thinking about your path to breakeven, obviously, if you going to require some sales scale, some growth here from these levels. And then, presumably with that, we should see some gross margins improve here. Maybe you can talk a little bit about how you kind of see your breakeven model now? What's the kind of the possibility of seeing that happen maybe next year or something like that? Just kind of give us a sense of how you see that happening?

Well, as we said in our prepared remarks, I mean, I expect the operating expenses to be kind of stabilized at about $20 million a quarter, where they have been historically for a while. So doing the math, obviously, getting to breakeven then will require growth in sales, as you mentioned, and some growth in gross margin. We discussed last time on the call that we think we can get back to the mid-20% gross margin range. It's difficult to project when given all the supply issues that we've had and lingering COVID concerns and all that, it's hard to put an exact time frame on that, but we certainly need to be back in the mid-20% range in terms of margin. And then revenue, you can figure out from there, but it certainly needs to be $70 million or higher under any reasonable circumstance for gross margin. So that's kind of the puts and takes on it.

Okay. That's great for me. I'll jump out of line and give the queue away. Thank you.

Okay. Thank you.

Thank you. The next question comes from Richard Shannon with Craig. Please go ahead.

Thanks, Stefan. I'd like to ask another question regarding your data center segments. I understand you're mentioning some weakness in the 40-gig area. It's likely that many anticipate this will experience a plateau or decline over time. However, could you elaborate on your 100-gig business? It appears to have been relatively stable over the past few quarters. Some in the market view this as a gradually expanding market. I'm interested in your perspective on that revenue stream.

Yes. I mean, it's been relatively flat. I mean, we're not expecting large drops. However, as I noted, one of our customers, a very large customer, is in the process of planning their transition from 100-gig to 400-gig. And we've been selected, as I mentioned in our prepared remarks, as a 400-gig supplier. So in the meantime, we expect their 100-gig business will decline somewhat in anticipation of that 400-gig, and that's pretty much what we expect to see.

Okay. Perfect. That's all from me again. Thank you.

Okay. Very good.

Thank you. At this time, we have no further questions. And I will turn the call over to Dr. Thompson Lin for closing remarks.

Again, thank you for joining us today. As always, we want to extend our thanks to our investors, customers, and employees for your continued support, and we will look forward to seeing many of you virtually at our upcoming Investor Conference.

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