Applied Optoelectronics, Inc. Q4 FY2022 Earnings Call

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. 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 that involve risks and uncertainties, including the company's actual results, levels of activity, performance or achievements that may 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, predicts, expects, plans, may, should, could, would, will, potential or similar expressions that convey uncertainty of future events or outcomes. The company updates these forward-looking statements based on current expectations and projections. While the company believes these expectations and projections are reasonable, these forward-looking statements involve known and unknown risks and uncertainties beyond the company's control. Important factors may include the company's ability to complete the transaction described on this call on the proposed terms and schedule, risks related to regulatory approvals relating to the transaction, and other circumstances that may lead to the termination of the transaction. Forward-looking statements also include management's beliefs and expectations related to the expansion 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 changes in the company's expectations. More information about other risks that may impact the company's business is 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. Our financial results and other financial measures discussed today are on a non-GAAP basis unless specifically noted otherwise. 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 available on our website. 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's 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 a 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 within 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, following 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 customers continue to manage inventory levels 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 a 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 completed, 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 expectations, gross margin above expectations, and a non-GAAP loss per share that performed better than 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 regarding our 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. 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. Yuhan has disclosed additional details regarding their financials, including new information regarding their ownership group composition, and we remain optimistic that regulatory approval of this transaction both in the U.S. and China is achievable. Regarding the quarter, our total revenue for the fourth quarter increased 13% year-over-year to $61.6 million, which aligned 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 signed an agreement with a major hyperscale data center operator for a development program to produce 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 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. The financial investment made by this customer provides further validation of our strategy of focusing on our core high-margin laser business while we advance our plans to divest the data center optical transceiver business to Yuhan. In Q4, we secured two design wins, both in our CATV business. For the full year, we secured 12 new design wins compared to 20 in 2021. During the fourth quarter, 62% of our revenue was generated from our CATV products, 27% from our data center products, and the remaining 11% from FTTH, telecom, and other. Demand remains robust as MSOs, especially in North America, continue purchasing additional networking products to upgrade their networks. CATV revenue inQ4 was a record of $38.2 million, which was up 53% year-over-year and 22% sequentially. Looking ahead, our CATV results are typically negatively impacted in Q1 due to the loss of production days during the Lunar New Year holiday in China, where most of our CATV products are produced. However, we have good visibility throughout the first half of the year and are monitoring MSO plans to transition to DOCSIS 4.0 networks, which may occur as early as later this year. We are encouraged by commentary regarding the DOCSIS 4.0 transition and the related long-term continued investment in network upgrades. For example, Charter announced plans to spend approximately $5.5 billion over the next several years on network upgrades. We believe much of this spending will focus on outside plant equipment, such as nodes and amplifiers, which are driving AOI's cable TV business growth. Our Q4 data center revenue was $16.5 million, down 35% year-over-year and 7% sequentially, as customers managed inventory levels during the transition to 400G. However, we saw a partial offset with a significant increase in 400G revenue, which doubled sequentially. In the fourth quarter, 71% of our data center revenue came from our 100G products, 11% from 40G transceiver products, and 8% from 200G and 400G transceiver products. Now, turning to our telecom segment, revenue from our telecom products for Q4 was $6.4 million, up 94% year-over-year but down 7% sequentially. Looking ahead, we expect telecom revenue in Q1 to be slightly down due to Lunar New Year but anticipate gradual improvement as 5G deployments continue. For Q4, our top 10 customers accounted for 90% of revenue, up from 88.4% in the previous year. We had two customers contributing over 10% of revenue, one in the CATV market and one in the data center market, which provided 58% and 16% of total revenue, respectively. Over the full year, our two major customers constituted 47% and 18% of total revenue, respectively. In Q4, our non-GAAP gross margin reached 21.4%, exceeding our guidance of 17.5% to 19.5%, up from 18% in Q3 and 17.6% in Q4 of 2021. This increase was driven by a favorable product mix and our cost reduction efforts. We remain committed to improving our bottom line and focus on enhancing our gross margin performance. During the quarter, we exited some low-profit legacy products and redirected R&D resources to projects with greater margin potential. We have also successfully executed price increases, which will help alleviate some recent margin pressures. Our total non-GAAP operating expenses in Q4 were $21 million, or 34.2% of revenue, 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 mentioned in our last earnings call, our Q4 non-GAAP operating expenses included approximately $3 million in additional employee bonus approval related to the China divestiture, which were intended to retain key employees critical to this success. These additional bonus payments are not expected to recur in 2023. We expect non-GAAP operating expenses to moderate this year between $19 million and $20 million per quarter. Our non-GAAP operating loss for Q4 was $7.9 million, compared to an operating loss of $7.3 million in Q4 of the previous year. The 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, the net loss 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. This compares favorably to a net loss of $5.5 million or a loss of $0.20 per basic share in the prior year. We had 28.5 million basic shares outstanding for computing the net loss in Q4. Regarding our balance sheet, we concluded the fourth quarter with $35.6 million in total cash, cash equivalents, short-term investments, and restricted cash, compared to $34.6 million at the end of Q3. Our total debt, excluding convertible debt, was $69.4 million, up from $65.1 million last quarter. As of December 31, we had $79.9 million in inventory, down from $94.3 million at the end of Q3, primarily due to utilizing inventory for customer orders along with foreign exchange impacts on our international inventory. We made $0.8 million in capital investments during Q4, bringing our total CapEx for the year to $3.4 million, down from $11.6 million in 2021, reflecting lower capital needs given our previous investments in production equipment. Looking ahead to Q1, we expect revenue to be between $52 million and $55 million, and our non-GAAP gross margin is projected to range from 23% to 24%. We anticipate non-GAAP net loss in Q1 to be between $4.4 million and $5.3 million and a non-GAAP loss per basic share between $0.15 and $0.19, based on an estimated 28.9 million basic shares outstanding. With that, I will turn it back over to the operator for the Q&A session.

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 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 would 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 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 next year and how that will 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 are more complex due to the greater frequency response associated with them. The products, especially the amplifier products, will contain a greater deal of intelligence, which has not really been incorporated into those products before. So the bottom line is that the cost and price of those products is higher than the current generation DOCSIS 3.1 products. Accordingly, independent of volume plans by the MSOs, the cost increase alone would certainly 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 successfully pushed through some price increases, which is rather unusual for our industry. We will start to see the impact of these price increases during the quarter, along with our continued cost reduction efforts. I've consistently mentioned that because of the nature of cost reductions, specifically product redesigns or replacing components with lower-cost alternatives, this takes time to materialize due to the necessity of using up older inventory at higher cost before the new inventory with lower costs comes in. Therefore, these cost improvements won't happen all at once, but rather over several quarters. So, there will be additional cost reductions impacting Q1 as well.

So it sounds like if you're in a situation where revenue rebounds after 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 potentially build on that with higher volumes.

Yeah, I think that's right. We've been planning to return to a gross margin in the upper 20s, mid to upper 20 range. We can certainly see—a pathway to achieving that later this year.

Tim, this is Thompson. I certainly believe Q4 this year should have a gross margin of 30% for us. In the next year, with DOCSIS 4.0, the unit prices should be significantly higher. For us, it’s a very new product, and I think that AOI has a strong advantage in technology and performance. The costs may also improve. This is how we currently see the situation and we observe very strong demand from 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 that the timing of 4.0 activities 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.

At the moment, we're somewhat limited in terms of production capacity. Until we have a clearer understanding of how fast the adoption of 4.0 is going to progress, I do not expect we will add significant production capacity for the 4.0 products. So, for the next several quarters, we are likely to be capacity constrained. As I mentioned earlier, Q4’s numbers were somewhat inflated due to customer demand pushing revenue into Q4 that may not be sustainable as a quarter-on-quarter run rate. Going back a quarter may provide a reasonable estimate of our capabilities this year, given the demand picture remains unchanged barring any impact from 4.0.

There are no more questions in the queue. 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 you on our next earnings call.

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