Applied Optoelectronics, Inc. (AAOI) Earnings Call Transcript & Summary

Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics' First Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I will now turn the conference 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 am pleased to welcome you to AOI's First Quarter 2023 Financial Results Conference Call. After the market closed today, AOI issued a press release announcing its first quarter 2023 financial results, and provided its outlook for the second 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 1 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 Q1 results, and Stefan will provide financial details and the outlook for the second 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 believe, forecast, anticipate, estimate, intend, predict, expect, plan, 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 second 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. I'd like to note that the date of our second quarter earnings call is currently scheduled for August 3, 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 fourth quarter revenue and non-GAAP gross margin were in line with our expectations. While our non-GAAP loss per share came in below expectations due mainly to unexpected foreign exchange losses due to faster than expected appreciation of the Chinese RMB currency relative to U.S. dollar. We are pleased by the progress we have made on improving our gross margin, and are encouraged by improving demand we saw for our 100G products in our data center business during Q1. We generated another quarter of good CATV results. However, recently, we are notified of some inventory buildout with certain CATV customers, which we expect will negatively impact our Q2 revenue. During the fourth quarter, we delivered revenue of $53 million, in line with our guidance range of $52 million to $55 million. We delivered non-GAAP gross margin of 23.2% in line with our guidance range of 23% to 24%, driven by our target cost reduction and favorable product mix. Our non-GAAP loss per share was $0.25 below guided range of a loss of $0.15 to $0.19 due to the foreign exchange impact I just mentioned. Total revenue in our CATV segment was $27.8 million, up 11% year-over-year and down 27% sequentially off a record Q4, largely due to the negative impact by the loss of production days that occurred during the Lunar New Year holidays in China. Total revenue for our data center product of $20.4 million decreased 5% year-over-year and increased 23% sequentially, largely due to the increased demand for our 100G products. On our last call, we discussed an agreement we have signed with a major hyperscale testing operator for development program to make next-generation lasers for its data center, both for 400G and beyond. Our recent 8-K filing give additional details on this agreement with Microsoft, who has been a long-term key customer of ours. While the development of these new products will take several quarters to be complete, we view this contract award as validation of the strength and the quality of our core laser fabrication ability. 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. Our first quarter revenue and non-GAAP gross margin were in line with our expectations. While our non-GAAP loss per share came in wider than our expectations due mainly to unexpected foreign exchange losses due to faster-than-expected appreciation of the Chinese renminbi currency relative to the U.S. dollar. We're pleased by the continued progress we have made to improve our gross margin and are encouraged by the increased demand we saw for our 100G products in our data center business during Q1. Further, we generated another quarter of good CATV results. However, recently, we were notified of some inventory buildup with certain CATV customers, which we expect will negatively impact our Q2 revenue. 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 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 multichannel optical subassembly products for the data center, telecom and FTTH markets for a purchase price of $150 million. During the quarter, both AOI and Yuhan made progress in preparing the information that will be needed in order to file for the various regulatory approvals that will be required in order to finalize the divestiture. As a reminder, this transaction is subject to customary closing conditions and regulatory approvals, including CFIUS and ODI. Although these filings are not yet complete, we do expect to submit our application within the next few months. The timing of the regulatory process is uncertain, but we believe based on our current schedule that closing the transaction before year-end is still possible, although approval could push the closing time frame into early 2024. Turning to the quarter, our total revenue for the first quarter increased 2% year-over-year to $53 million, which was in line with our guidance range of $52 million to $55 million. During the first quarter, we secured 1 design win in our CATV business. Looking ahead, due to our intentional efforts to better focus our R&D spend on projects that we expect to have higher revenue and gross margin potential, we expect the aggregate number of design wins to be reduced compared to prior periods. We do not view this reduction in design wins as indicative of reduced business activity, but rather as a result of the greater discipline we are applying to our R&D efforts. During the first quarter, 52% of our revenue was from our CATV products, 38% was from our data center products, with the remaining 9% from FTTH, telecom and other. CATV revenue in the first quarter was $27.8 million, which was down 27% sequentially off a record Q4 and was up 11% year-over-year driven by demand from CATV customers for products designed to improve upstream or return path bandwidth. As I mentioned earlier, recently, we were notified by certain CATV customers that they believe that some excess inventory has built up among their various distribution channels. As a result, these customers reduce their orders in Q2, which is reflected in our guidance. We are working to evaluate the future extent of this excess inventory. We continue to believe that overall demand for CATV products from the MSOs remains robust and expect that any inventory buildup will be transitory. Looking ahead, we are carefully monitoring MSO plans to move to DOCSIS 4.0 networks. While we are cautiously optimistic as the nature of these upgrade cycles can be lengthy, we believe AOI remains well positioned to capture a portion of this new infrastructure spend. Our product development team has met numerous times with several of the largest MSOs in the U.S., and we believe our products will be well suited to meet their demands when the push to install amplifiers and other network elements for DOCSIS 4.0 begins. We believe this could happen as early as later this year or in early 2024. Our Q1 data center revenue came in at $20.4 million, down 5% year-over-year and up 23% sequentially driven by increased demand for our 100G products, especially from our largest data center customer. In the first quarter, 78% of our data center revenue was from our 100G products, 6% was from our 40G transceiver products and 8% was from our 200G and 400G transceiver products. Looking ahead, we are encouraged by the increased demand we have been seeing and expect continued sequential growth of our data center business in Q2. As Thompson mentioned, on our Q4 earnings call, we discussed how we signed an agreement with a major hyperscale data center operator for a development program to make next-generation lasers for its data center both for 400G and beyond. Our recent 8-K filing gives additional details on this agreement with Microsoft, who has been a long-term key customer of ours. While the development of these new products will take several quarters to be completed, we view this contract award as validation of the value of our core laser fabrication ability. As a reminder, Microsoft 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. Now turning to our telecom segment. Due to the negative impact from the Lunar New Year and inventory buildup by some of our telecom customers, revenue from our telecom products of $3.7 million was down 30% year-over-year and down 42% sequentially. Looking ahead, we expect to see stronger sequential demand in Q2 as inventory begins to be drawn down to the point that new deliveries will be needed. For the first quarter, our top 10 customers represented 93% of revenue, up from 89% in Q1 of last year. We had 2 greater than 10% customers, 1 in CATV market and 1 in the data center market, which contributed 42% and 20% of our total revenue, respectively. In Q1, we generated non-GAAP gross margin of 23.2%, which was in line with our guidance range of 23% to 24% and was up from 21.4% in Q4 of 2022 and up from 17.5% in Q1 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 our intentional actions we took to improve our bottom line that we discussed on our Q4 call. These actions included the exit of several low-profit legacy products, shifting R&D resources away from some low-margin projects to focus our resources on areas where we can maximize margin and some success in executing price increases with some customers. In line with our expectations, total non-GAAP operating expenses in the first quarter were $19.6 million or 36.9% of revenue, which compared to $19.6 million or 37.5% of revenue in Q1 of the prior year. R&D expenses decreased 10% year-over-year to $8.2 million as a result of the more focused R&D investments I discussed a minute ago. Looking forward, we continue to expect non-GAAP operating expenses will range between $19 million and $20 million per quarter. Non-GAAP operating loss in the first quarter was $7.2 million compared to an operating loss of $10.4 million in Q1 in the prior year. GAAP net loss for Q1 was $16.3 million or a loss of $0.56 per basic share compared with a GAAP net loss of $16.1 million or a loss of $0.58 per basic share in Q1 of 2022. On a non-GAAP basis, net loss for Q1 was $7.1 million or a loss of $0.25 per basic share, which was below our guidance range of a loss of $4.4 million to $5.3 million or loss per share in the range of $0.15 to $0.19 per basic share, and compares to a net loss of $7.9 million or a loss of $0.29 per basic share in Q1 of the prior year. The basic shares outstanding used for computing the net loss in Q1 were $28.9 million. Turning now to the balance sheet. We ended the first quarter with $26.9 million in total cash, cash equivalents, short-term investments and restricted cash. This compares with $35.6 million at the end of the fourth quarter. Changes in current accounts included a decrease in accounts receivable of $4.4 million, along with an increase of payables of $9.4 million, which was offset by a decrease in inventory of $9.5 million. We ended the quarter with total debt, excluding convertible debt of $70.1 million, up slightly from $69.4 million at the end of last quarter. As of March 31, we had $70.2 million in inventory compared to $79.7 million at the end of Q4. Inventory decreased due to utilization of inventory for customer orders in the period. We made a total of $0.8 million in capital investments in the first quarter, virtually all of which was for equipment and machinery used in R&D and production. As we disclosed in March, we initiated a new at-the-market offering. We previously had an ongoing ATM program authorized by our Board to sell up to $35 million worth of shares under that program. Under the old program, we only sold approximately $2.7 million out of the $35 million authorized. When the S-3 expired in January 2023, this old ATM also expired, so we put a new program in place with a fresh $35 million authorization. We intend to use these proceeds to continue to make investments in the business, including new equipment and machinery for production and research and development use. Moving now to our Q2 outlook. We expect Q2 revenue to be between $40.5 million and $47.5 million and non-GAAP gross margin to be in the range of 20.5% to 23.5%. Non-GAAP net loss is expected to be in the range of $6.8 million to $9 million and non-GAAP loss per basic share between $0.23 and $0.31 using a weighted average basic share count of approximately 29.2 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?

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

So a couple of things I wanted to get a little bit of better insight on. One is around this Microsoft deal in terms of -- I understand you're going to get some R&D funding in the fourth quarter. But can you give us some other indication of the scope of this arrangement, and if it's affected at all by the transaction -- the pending transaction of the asset sale in China. Because I guess I saw some language that change of control, which I assume means the entire company. Just a little clarification there would be helpful.

Sure, Simon. Regarding your first question, with respect to kind of the scope of it, the announcement that we made, really in December, but recently released more of the details on it, has to do with the fabrication of a new type of laser device that's going to be used in the creation of certain data center transmission products for use within Microsoft's data center, specifically for 400G and beyond, as we noted in our prepared remarks. As we also said, we think that it starts to ramp really later on this year and then should grow along with the future 400G deployments into 2024 and beyond. With respect to your second question regarding does anything change with respect to the transaction, clearly, given the time frame of this announcement and everything, it was subsequent to the announcement of the transaction. So clearly, Microsoft was aware of the transaction and the details that we presented about that transaction. So no, nothing changes with respect to that. With respect to the change of control, you can read the provisions there. That does refer to change in control of the entire company, which this transaction would not -- I mean, that transaction alone would not represent a change of control of the company based on our analysis so far.

That's what I thought. I want -- that's what I was checking exactly that. So thank you for that. Then the other thing I wanted to ask about was your debt schedule because I believe you've got $53 million that was current last quarter and now the total current debt, I think, is over -- is around $130 million. Could you help me understand sort of the road map or plan to how you're going to pay down debt?

Yes. I mean I think the transaction that we noted, the proceeds from that should be $150 million minus some amount of hold back. And that certainly gives us the ability to service that debt in the time frame in which it's going to come due. And of course, we're also exploring other options in terms of other things that might be possible if that transaction gets pushed out or what have you. But certainly, the cash from the transaction would be very instrumental to servicing that debt.

So is there a scenario where you'd get maybe a bridge loan, if essentially the -- I guess there's $50-some-odd million that comes due during this year -- this calendar year? So with the deal with -- it doesn't close until next year, you'd have a gap. Am I misunderstanding that?