Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics' Second 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. All participants, again, have been placed on mute to prevent any background noise. 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 second quarter 2023 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2023 financial results and provided its outlook for the third 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 Murray, 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 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 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 third 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, all 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. Before moving to the financial results, I'd like to announce that AOI management will be attending the HD Winright Global Investment Conference on September 11 and the Northland Institutional Investment Conference on September 19. I'd like to note the date of our third quarter earnings call is currently scheduled for November 9, 2023. Now I would 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. Our second quarter revenue was in line with our expectations, while our non-GAAP gross margin and non-GAAP loss per share were better than our expectations. We are pleased by the continued progress we have made on improving our gross margin and are encouraged by the increased demand we saw for our 100G and 400G products in our data center business during Q2. Revenue for our 10G product increased 30% sequentially, while revenue for our 400G product doubled sequentially and accounted for 11% of our total data center revenue in Q2. During the second quarter, we did revenue of $41.6 million, in line with our guidance range of $40.5 million to $47.5 million. We’ve delivered a non-GAAP gross margin of 24.8%, above our guidance range of 20.5% to 23.5%, mainly driven by a favorable product mix and not targeted cost reductions. Our non-GAAP loss per share was $0.21, above our guidance range of a loss of $0.23 to $0.31. Total revenue in our CATV segment was $9.3 million, down 61% year-over-year and down 66% sequentially. As a reminder, our Q2 results were negatively impacted by some inventory buildup with certain CATV customers, which led to softer than expected CATV revenue. We believe that this inventory digestion will take some time, and based on what we have seen today, we expect our CATV revenue to increase slightly sequentially while being down year-over-year after a record strong Q3 of last year. Total revenue for our data center business totaled $27.6 million, an increase of 28% year-over-year and a 35% increase sequentially, largely due to increased demand for our 100G and 400G products as we continue to ramp up our 400G products. On our last two calls, we discussed an agreement we signed with Microsoft, a long-term key customer, for a development program to make next-generation lasers for their data centers for 400G and beyond. During the second quarter, we signed an additional agreement with Microsoft to provide design and assembly services for active optical cables. We view these contracts as validation of the strength and quality of our core laser fabrication ability. In total, we believe this award for AOI amounts to over $300 million over the next three years. With that, I will turn the call over to Stefan, to review the details of our Q2 performance and outlook for Q3. Stefan?

Thank you, Thompson. As Thompson mentioned, our second quarter revenue was in line with our expectations, while our non-GAAP gross margin and non-GAAP loss per share were above our expectations. We are pleased by the continued progress we have made to improve our gross margin and expect this trend to continue. Further, we are encouraged by the increased demand we saw for our 100G and 400G products in our data center business during Q2. Lastly, we are excited about our newly formed broadband access group, the strength of talent we have recently added to this team, and we believe that we are well positioned to execute on our new strategy to sell our CATV products directly to MSO customers. Before turning to discuss our results and outlook, I want to provide an update on the transaction that we announced last September with Yuhan Optoelectronic Technology. As we have previously discussed, we entered into an agreement 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 subassembly products for a purchase price of $150 million. This transaction is subject to customary closing conditions and regulatory approvals, including CFIUS and ODI. We continue to make progress in preparing the information that will be needed in order to file for the various regulatory approvals required to finalize the divestiture. While these filings are not yet complete, we do expect to submit our application to CFIUS within the next 45 days. While the timing of the regulatory approval process is uncertain, based on our current schedule, we expect the closing timeframe to be early 2024. Turning to the quarter, our total revenue for Q2 decreased 20% year-over-year to $41.6 million, which was in line with our guidance range of $40.5 million to $47.5 million. The decline in revenue was largely due to the inventory buildup with certain CATV customers that we discussed on our Q1 call. During the second quarter, 66% of our revenue was from our data center products, 22% from our CATV products, and the remaining 11% from FTTH, telecom, and others. CATV revenue in Q2 was $9.3 million, down 66% sequentially and 61% year-over-year, negatively impacted as a few of our CATV customers worked through excess inventory that had built up among their distribution channels. We expect that this inventory buildup will be transitory, and based on what we are seeing today, we expect our CATV business to increase slightly sequentially, although it will be down year-over-year compared to the historically strong Q3 of last year. Our CATV revenue in 2021 and 2022 was historically high compared to prior years. We do expect our CATV revenue to rebound to more normal levels, although near term, it will be down compared to those historic highs as the MSOs transition to next-generation architecture. Looking further ahead, we are closely monitoring MSO plans to move to DOCSIS 4.0 networks. While we are cautiously optimistic about this transition, it can be a lengthy process, but we continue to believe AOI remains well positioned to capture a portion of this new infrastructure spending and think our products are well suited for when the push to install amplifiers and other network elements for DOCSIS 4.0 begins, which we believe could happen in early to mid-2024. In line with our new strategy to offer CATV products directly to MSO customers, during the quarter, we announced the order availability of our Quantum Bandwidth line extender and system amplifier products. As one of the few companies with large-scale in-house manufacturing capacity for amplifiers, we believe our new products will expand AOI's product portfolio while maintaining the industry-leading quality and reliability of our renowned HFC products. We were excited about the strength of talent that we have added at the leadership level within our newly formed Broadband Access group. We are focused on executing our new strategy and believe we are well positioned with the right products and a deep bench of talent.

Turning to our data center business. In Q2, data center revenue came in at $27.6 million, up 28% year-over-year and up 35% sequentially, largely due to increased demand for our 100G and 400G products. In the second quarter, 75% of our data center revenue was from our 100G products. 12% was from our 200G and 400G transceiver products, and 5% was from our 40G transceiver products. Notably, revenue for our 100G products increased 30% sequentially, while revenue for our 400G products doubled sequentially and accounted for 11% of our total data center revenue in Q2. Looking ahead, we're encouraged by the increased demand we have been seeing and expect continued sequential growth of our data center business in Q3. As I mentioned, on our last two earnings calls, we discussed how we signed an agreement with Microsoft for a development program to make next-generation lasers for its data center both for 400G and beyond. During the second quarter, we signed an additional development agreement with Microsoft to provide design and assembly services for active optical cables. Our recent 8-K filings provide additional data. We expect to begin shipping initial quantities of these products to Microsoft by the end of this year for their testing, with production ramping early next year. We view these contract awards as validation of the strength and quality of our core laser fabrication ability and our expertise in design and manufacturing for these advanced high-speed interconnect products. As many of you know, Microsoft has been a long-term key customer of ours. While not guaranteed, we believe that the revenue opportunity for our 400G and 800G products could be greater and have a longer duration than the revenue contribution we saw from this customer during the peak of the 40G product cycle, which implies revenue from these products exceeding $300 million during these upcoming build-outs. We also believe that the value proposition we offer to Microsoft is strong with other data center operators, and we are working with several of them to evaluate our technology and qualify our products. We're also seeing positive inbound interest from other potential customers for our lasers, and we believe we are well positioned to grow this business. I'd like to particularly highlight one new source of laser revenue in this quarter. During the quarter, we received our first volume order for LIDAR lasers to be used in a transportation application. The order was approximately $1 million worth of lasers to be delivered over the next few quarters. While it's not immediately material financially, we feel that the LIDAR business has the potential to grow significantly in the three- to five-year time frame, and we view this initial volume order as indicative of the success of the development program for our Frequency Modulated Continuous Wave or FMCW, LiDAR lasers. We believe that we will secure additional orders for these lasers over time as other customers begin to roll out FMCW LiDAR technology. Now, turning to our Telecom segment. Revenue from our telecom products of $4.2 million was down 33% year-over-year, and up 14% sequentially. Looking ahead, we expect telecom sales to remain roughly flat to slightly up in Q3.

For the second quarter, our top 10 customers represented 88% of revenue, up from 87% in Q2 of last year. We had two greater than 10% customers, one in the data center market and one in the CATV market which contributed 29% and 13% of our total revenue, respectively. In Q2, we generated a non-GAAP gross margin of 24.8%, which was above our guidance range of 20.5% to 23.5% and was up from 23.2% in Q1 of 2023 and up from 16.7% in Q2 of 2022. The increase in gross margin was driven mainly by our favorable product mix, our cost reduction efforts, and the benefit of some of the intentional actions we have taken to improve our bottom line as we have discussed on our prior couple of earnings calls. These actions included exiting several low-profit legacy products, shifting R&D resources away from some low-margin projects to focus on areas where we can maximize margin, and some success in executing price increases with some customers. We are pleased with the execution we've made on increasing our gross margin and expect this trend to continue. We remain committed to the long-term goal of returning gross margin to around 40%, and we believe we can achieve this goal. In line with our expectations, total non-GAAP operating expenses in the second quarter were $19 million or 45.8% of revenue, compared to $18.2 million or 34.9% of revenue in Q2 of the prior year. With the new additions in our broadband access group and additional activity we plan to promote our CATV products, we expect a modest uptick in non-GAAP operating expenses to $20 million to $21 million per quarter starting in Q3 of 2023. The non-GAAP operating loss in the second quarter was $8.7 million, compared to an operating loss of $9.5 million in Q2 of the prior year. The GAAP net loss for Q2 was $16.9 million or a loss of $0.57 per basic share, compared with a GAAP net loss of $14.5 million or a loss of $0.52 per basic share in Q2 of 2022. On a non-GAAP basis, the net loss for Q2 was $6.1 million or a loss of $0.21 per basic share, which was better than our guidance range of a loss of $6.8 million to $9 million or a loss per share in the range of $0.23 to $0.31 per basic share, and compares to a net loss of $7.6 million or a loss of $0.28 per basic share in Q2 of the prior year. The basic shares outstanding used for computing the net loss in Q2 were $29.5 million. Turning now to the balance sheet. We ended the second quarter with $28.6 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $26.9 million at the end of the first quarter of this year. We ended the quarter with total debt, excluding convertible debt of $46.9 million, down from $70.1 million at the end of last quarter. As of June 30, we had $66.3 million in inventory compared to $70.2 million at the end of Q1. Inventory decreased due to consumption of inventory for customer orders. We made a total of $1 million in capital investments in the second quarter, mainly used for production and R&D equipment. As we disclosed in March, we initiated a new at-the-market offering. To date, we have raised $9.9 million net of commissions and fees under this new program, all raised in Q2. Moving now to our Q3 outlook. We expect Q3 revenue to be between $60 million and $66 million, and non-GAAP gross margin to be in the range of 29.5% to 31%. Non-GAAP net income is expected to be in the range of a loss of $1.9 million to income of $0.2 million and non-GAAP income between a loss of $0.06 per basic share, and income of $0.01 per basic share using a weighted average basic share count of approximately 33.1 million shares.

We will now begin the question-and-answer session. The first question comes from Simon Leopold with Raymond James. Please go ahead.

Thanks for taking my question. You've given us a lot of good modeling information here, and I'd like to clarify something I think is implied in that you suggested that the CATV business would be up a little bit sequentially. Telecom would be flat to slightly up. And so backing out that into your total revenue forecast suggests your data center business is up sequentially by something on the order of 70%. And you didn't mention that explicitly, but you kind of guided us this way. Can you just clarify what your expectation is there?

Sure, Simon. You're pretty good at math. The uptick there is mainly from the data center business, as you surmised.

Great. Thank you. And you talked about the Microsoft project timing being the end of this year. So it's not coming from the new Microsoft awards, could you give us some color on what's driving this big jump?

Well, I mean, we've continued to see very strong results in our existing 100G and 400G products, and that's where this uptick is coming from. We've talked about over the last, I would say at least a year that we felt like our 400G was starting to ramp, and we are indeed seeing that right now. 400G is continuing to ramp, while at the same time, we're seeing very strong results from 100G as well. So – both of those elements are firing on all cylinders. As you noted, the revenue increase is primarily not coming from the new Microsoft contracts; it is mostly coming from existing products.

And don't forget, I think the increase due to AI, the customer demand is growing, and AOI at the same time is gaining strong market share.

Great. And then just pivoting now to the cable business. Other market players have talked about some of the transitional effects. You've been clear in talking about excess inventory as a factor. Could you discuss the transitions of technology and how that might be playing into specifically the deployment of DOCSIS 4.0 and the debate between full duplex and extended spectrum? Is that a factor that's amplifying or creating a greater pause in this market as we work through old technology ahead of new technology?

I don't think that's a big factor right now. I think that the bigger factor just has to do with the distribution channel, and as I mentioned on the previous earnings call, with the interest rate environment, many distributors are taking a hard look at how much inventory they carry. It has more to do with financial effects and the raw amount of inventory rather than concerns about upcoming technology like DOCSIS 4.0. There's going to be a long tail, I would anticipate, with the existing 1.2 gigahertz DOCSIS 3.1 type of products. So, I'm not hearing from distributors that they're concerned about their inventory levels due to pending upgrades to DOCSIS 4.0.

Great. Thanks for taking the questions.

The next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead.

Hi. Good afternoon. And congratulations on the outlook, in particular. I wanted to follow up with some questions there. I see there's a good bit of deferred revenue that has been added to your balance sheet here, both short-term and a little long term. I was wondering if part of that revenue increase might be some of the NRE or project development payments coming out of Microsoft in addition to product revenue. If that's the case, could you try and quantify that? I imagine that would have a real positive impact on gross margins as well, or is this just all module revenue driving this increase?

You're referring to the guidance. How much NRE revenue or project development payments might be included? For nondisclosure reasons, I can't provide the exact total, but there is some of that included. However, the bulk of the increase in margin is from improved margins on our product sales, not primarily driven by NRE revenue. That portion is relatively small in our guidance.

Great. Would you say the same thing about product revenue being the bulk of the increase in the sequential growth of data center revenue? And within that, do you expect these dynamics to continue around 400G and 100G in terms of where you expect, I guess, over the next few quarters, your 400G revenue to go or 200G plus as a percent of total data center revenue?

Yes, I expect the 400G, and you're correct in saying it's 200G plus, but for us, that's almost entirely 400G; we don’t have much 200G business. We expect that to continue to grow, both in absolute dollars and as a percent of data center revenue. That being said, I think 100G is tracking well as well. So I think both of those segments are looking good. As I mentioned when Simon asked earlier, the increase in revenue and margins is indeed product revenue that is driving this growth. We’re selling more 100G and 400G in the data center space. Cable TV revenue is down slightly, but we anticipate an uptick sequentially as indicated in our guidance, and that is driving the overall growth.

Great. I have a question about Microsoft, your biggest data center customer. You seem to be developing this active optical cable product, likely for very high-speed applications, possibly 800G associated with AI build-outs. Yet you're also seeing strong increases in volumes and, potentially, pricing with existing module products. What’s happening short-term versus medium-term there regarding data center connectivity demand?

Without going into too many details that would be difficult to disclose due to our relationship, I think your observation that Microsoft has been investing heavily is accurate. The fact that AI is driving their network needs is critical to their operations. They're certainly adding a lot of optical modules and interconnect modules right now, with expectations based on our contracts indicating they anticipate strong demand, mostly due to AI applications and general-purpose compute as well. This suggests continued robust demand from Microsoft for several years, and our forecasts suggest revenue exceeding $300 million over the next few years from those products, not including existing business.

Great. Thanks very much.

Thank you.

At this time, I will turn the call over to Dr. Thompson Lin for closing remarks.

Okay, thank you for joining us today. As always, we want to extend a thank you to our investors, customers, and employees. We look forward to seeing many of you at our upcoming investment conference and updating you at our next earnings call.

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