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Operator
Good afternoon. My name is Chris and I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics Second Quarter 2021 Earnings Conference Call. Today, all participants have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. To ask a question during the Q&A session, you may press star then 1 on a touch-tone phone. To withdraw your question, please press star then two. Please note that this call is being recorded. I would now like to turn the call over to Lindsay Savarese, Investor Relations for AOI. Ms. Savarese, you may begin.
Chris
Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics. And I'm pleased to welcome you to AOI's second quarter 2021 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2021 financial results and provided its outlook for the third quarter of 2021. 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. Stephan Murray, AOI's chief financial officer and chief strategy officer. Thompson will give an overview of AOI's Q2 results, and Stephan will provide financial details and the outlook for the third quarter of 2021. 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 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, intends, predicts, expects, plans, may, should, could, would, will, or thinks, and by 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 third quarter of 2021. 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 factor 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, 2020. Also, with the exception of revenue, 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. Before moving to the financial results, I'd like to announce that AOI Management will virtually participate in one-on-one meetings at the Jeffrey Semiconductor IT Hardware and Communications Infrastructure Summit on August 31st. We hope to have the opportunity to interact with many of you virtually. Additionally, I'd like to note that the date of our third quarter 2021 earnings call is currently scheduled for November 4th, 2021. Now I'd like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics founder, chairman, and CEO. Thompson?
Lindsay Savarese
Thank you, Lindsay. Thank you for joining us today. We deliver revenue and get EPS. in line with our expectations. However, our gross margin came in slightly below our expectations, mostly due to unfavorable product mix in our CATB segment and increased costs from the component shortage we experienced in the quarter. Total revenue for the second quarter of $54.2 million decreased 16.9% compared to a strong second quarter in the prior years, but was up 9% sequentially. The strong sequential growth was led by our CATV segment, which this quarter eclipsed our data center business, accounting for 51% of total revenue. The overall CATV demand environment remains strong as MSO particulars in North America continue to upgrade their network. Total revenue for our CATV products increased more than four-fourths year-over-year in Q2 and increased 48.1% sequentially of a strong fourth quarter to a record $27.6 million. As we expected, we experienced generally soft Q2 conditions in the data center segment. As a result, total revenue for all data center products of $22.4 million decreased 57.4% year-over-year and 13.7% sequentially. We are pleased to report that we secured two new design wins with two customers for our 400GE products during Q2. In addition to the design wins, we had five technical qualifications of our 400GE products, which Stephen will discuss in more detail. We are encouraged by the traction we are seeing with our 400G products as our customers start to degrade. We expect that order will continue as our customers start to realize the benefit of the performance of our 400G solution. Based on this, we continue to expect our data center business to begin to increase in the second half of the year as our customers begin 400G upgrades and inventory issues around 100G normalized. Turning to our telecom segment, while we did see early signs of recovery in Q1, we saw mixed conditions in Q2, with some customers pressing new orders while others continued to use existing inventory. Overall, we see market conditions in the China telecom market as continuing to be patchy as the timing and cadence of the 5G rollout, they remain somewhat opaque. As a result, revenue from our telecom product of $3.3 million was down 46% year-over-year and 25.6% sequentially. Looking ahead, we believe China will continue to make investments in both their 5G and 5G home infrastructure, and we expect high revenue in the segment in the second half of this year compared to the first half. With that, I will turn the call over to Stephan to review the details of our Q2 performance and our role for Q3, Stephan.
Lindsay
Thank you, Thompson. As Thompson mentioned, we delivered revenue and non-GAAP EPS in line with our expectations. However, our gross margin came in below our expectations mostly due to unfavorable product mix in our CATV segment and increased costs associated with the component shortages we saw during the quarter. While we continue to see softness in the data center market and conditions in the China 5G market remained somewhat soft, we are pleased with the continued strength and record results we are seeing in the CATV market. And looking ahead, we are encouraged by the traction we are seeing with our 400G products, which we believe will drive growth in our data center business as order volumes ramp later in the year. Notably, we are pleased to report that we secured two design wins for our 400G products during Q2. In total for the second quarter, we secured three new design wins among three customers, all of which are existing AOI customers. All three of the design wins were in our data center business, and two of the three were for 400G, which I'll discuss in more detail shortly. Total revenue of $54.2 million decreased 16.9% compared to a strong second quarter in the prior year, and was up 9% sequentially. Our Q2 revenue was in line with our guidance range of $51 million to $56 million. As we expected, the headwinds we saw in Q1 continued into the second quarter in the data center market, related to the inventory normalization that followed the shift to working from home early last year. We believe these headwinds will begin to subside in the second half of the year, driven by several of our customers who will begin to ramp 400G deployments. Additionally, we believe that inventory conditions in our 100G business will begin to normalize later in the year. On the 400G front, as Thompson and I mentioned, We secured two new design wins with two customers for our 400G products during Q2. One of the design wins was with a data center equipment manufacturer, and the other was with a hyperscale data center operator. Both are US-based companies, and both are existing AOI customers. As a reminder, for AOI, a design win occurs when we have successfully completed both the technical qualification of the product as well as received an initial order from the customer. In addition to these two design wins, we also have successfully completed technical qualifications on five other 400G opportunities. We are optimistic that many of these qualifications will become design wins in the near future once we receive orders for these products from our customers. The technical qualifications are with two different data center operators and a data center equipment OEM. All are US-based companies. We are encouraged by the traction we are seeing and expect that 400G will begin its ramp with us later in Q3. In the second quarter, 51% of our revenue was from CATV products, 41% was from our data center products, with the remaining 8% from FTTH, telecom, and other. In our CATV product segment, the overall demand environment remains very strong, as MSOs, particularly in North America, continue to upgrade their networks. We generated revenue of $27.6 million in Q2, up 48.1% sequentially, and up 349% from $6.1 million in Q2 of the prior year. We are still seeing component shortages in our CATV business, and we continue to work with our suppliers to improve delivery schedules for these critical components, and in some cases, adding additional suppliers. we anticipate that these shortages will adversely affect our third quarter revenue by about $3 million. As we work to improve our supply chain, we may continue to have longer than usual backlog for several quarters. Our Q2 data center revenue came in at $22.4 million, compared with $52.5 million in the second quarter of the prior year. In the second quarter, 33% of our data center revenue was from our 40G transceiver products and 59% was from our 100G products. Turning to our telecom segment. Revenue from our telecom products of $3.3 million decreased 25.6% sequentially, primarily driven by continued slow demand in China for 5G upgrades there, and 46% from $6.2 million in Q2 of the prior year. Looking ahead, We continue to believe China will increase investments in both their 5G and FTTH infrastructure, and we believe we are well positioned to sell lasers into both of these markets. For the second quarter, our top 10 customers represented 86.8% of revenue, consistent with the 86.9% in Q2 of the prior year. We had four 10% or greater customers in the second quarter, two of which were in the data center market, and two of which were in the CATV market. These customers contributed 24.1%, 21.3%, 11.2%, and 10.9% of total revenue, respectively. In Q2, we generated non-GAAP gross margin of 25%, which was below our guidance range of 25.5% to 27.5% for the reasons I mentioned previously. and compared favorably to 23.1% in Q2 of the prior year. We expect the downward pressure on gross margin due to unfavorable product mix in our CATV segment to persist through Q3 before starting to recover to a more normal mix in Q4. We are currently uncertain when the increased costs due to supply chain disruptions will subside, but we also see them persisting through Q3, which will also negatively affect gross margin. Total non-GAAP operating expenses in the second quarter were $20 million, or 36.9% of revenue, compared with $20.6 million, or 31.6% of revenue, in Q2 of the prior year. Non-GAAP operating loss in the second quarter was $6.5 million, compared to an operating loss of $5.6 million in Q2 of the prior year. GAAP net loss for Q2 was $8.2 million, or a loss of 31 cents per basic share compared with a GAAP net loss of $18.6 million, or a loss of 89 cents per basic share in Q2 of 2020. On a non-GAAP basis, net loss for Q2 was $4.1 million, or a loss of 15 cents per basic share, which was in line with our guidance range of a loss of $3.8 million to $5.6 million, or a loss in the range of 14 cents to 21 cents per basic share. and compares to a net loss of $5 million or a loss of 24 cents per basic share in Q2 of the prior year. The basic shares outstanding used for computing the net loss in Q2 were 26.9 million. Turning now to the balance sheet, we ended the second quarter with $50.5 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $49.3 million at the end of the first quarter and reflects $5.9 million in cash used for operations. As of June 30, we had $100.4 million in inventory compared to $106.3 million at the end of Q1. Inventory decreased primarily due to utilization of inventory for customer orders. This inventory reduction is consistent with our long-term plan as we focus on rationalizing inventory levels. We made a total of $3.2 million in capital investments in the second quarter, including $2.9 million in production equipment and machinery, and an immaterial amount on construction and building improvements. We continue to expect 2021 CapEx will be approximately $16 million, although, as we have noted in prior years, there can be significant variability in this estimate as the year progresses. As we disclosed in February of this year, we initiated a new at-the-market offering, To date, we have raised $0.9 million under this new program. 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 Q3 outlook. We expect Q3 revenue to be between $51 million and $56 million, and non-GAAP gross margin to be in the range of 19.5% to 21.5%. Non-GAAP net loss is expected to be in the range of $6.9 million to $9 million, and non-GAAP loss per basic share between 25 cents and 33 cents using a weighted average basic share count of approximately 27.7 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?
Operator
We will now begin the question and answer session. As a reminder, to ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw it, please press star then two. At this time, we will pause momentarily to assemble our roster.
spk03
Today's first question comes from Simon Leopold with Raymond James.
Operator
Please proceed. Thanks for taking the question.
Simon
I want to start out first just if you could clarify the CATV headwind. You quantified it as $3 million headwind due to supply constraints. I guess there are a couple ways one could interpret that, but I think what I'm imagining you're suggesting is looking at this quarter's sales of roughly $27.5 million and subtracting $3 million from that. But alternatively, I could sort of think of, hey, I was imagining it would be $30 million, but with $3 million of headwinds, it'll be $27 million. So I guess I'm trying to understand the baseline or maybe a little bit finer details, the impact of that headwind you highlighted.
Lindsay
Yeah, Simon, thanks for bringing that up. So I think the answer is it's more like the latter scenario that you had, not necessarily that those numbers are what we had in mind, but what we were saying is that relative to what we could otherwise deliver, that is based on orders and requested delivery schedules and shipping schedules and all that, we could have delivered $3 million more in our cable TV segment, but for the fact that those raw materials are constrained at this point.
Simon
And let me just clarify that. Is that $3 million hit in the June quarter, or is that $3 million headwind your forecast for September?
Lindsay
It's forecast for the September quarter. So we're saying in the next quarter, in the third quarter, the one that we're in currently, we would have been able to deliver, based on our current forecast, approximately $3 million more revenue than we now believe that we can due to component shortages.
Simon
Right. And I want to see if maybe you could help us understand how to think about your opportunities in the 400 gig market and where you see essentially competing with ZR products. Because I imagine there's, you know, your products are probably cheaper than the ZRs, but have shorter reach. And so just trying to get a better idea of how you're thinking about sizing that market opportunity in, let's say, 2022?
Lindsay
Sure. So, first of all, I mean, we're pretty excited about a progress that we made in the 400 gig market. We highlighted not only the two design wins that we had in the quarter, but also the fact that we have five technical qualifications, which, as we noted, is a significant milestone. I would say the technical qualification is typically the biggest hurdle to get over in logging a design win. The remaining hurdle would be really just receiving an order, which typically involves getting set up with proper purchasing codes and negotiating some pricing and things like that. So those hurdles are relatively low. The technical qualification is really the key piece that I think typically takes the longest. So we're pretty excited about the progress that we had with those two design wins and the five technical qualifications. With respect to your question about, you know, kind of where we fit in in the ecosystem, I think, as you mentioned, our products are positioned to be a lower-cost version of 400 gig that can be used primarily in intra-data center applications. So, you know, a distance is up to a couple of kilometers as opposed to longer distances than that, which is where ZR is typically targeted. Now, ZR, of course, will work at shorter distances, but at a higher price, as you noted. And as far as, you know, the market sizing for next year, you know, I can point you to some third-party estimates and things like that for the overall market size. I think what we're hearing from our particular customer base is that they're going to, you know, begin implementing 400 gig later in the third quarter and into the fourth quarter. My anticipation is that that will be a relatively slow process. incremental ramp throughout that time because that's typically how it goes with these customers when they try to implement a new technology like 400 gig. They don't instantly start to implement that technology. They put it in incrementally, test it, make sure everything's working as expected, and then begin to ramp up after that. So this kind of two-phase ramp is what I would expect there. And the second phase, which would probably be a stronger ramp, is probably sometime in the middle part of next year.
Simon
Great. And then just maybe a quick one, if I might, is we've seen awards coming out of China for 5G technology. There was the 700 megahertz award a few weeks ago. And then more recently, China Unicom and Telecom made tenders for RAN. Just wondering how we can maybe look at those events in terms of helping give us some sense of when your China business related to the 5G backhaul, fronthaul process. should improve?
Lindsay
Yeah, that's a great question, Simon. I mean, the 5G market is a little bit hard to make out right now. As we noted in our earlier remarks, some of our customers in China have begun ordering more products from us, which implies that their inventory levels are down to whatever level they think is comfortable and they're placing new orders. Other customers haven't yet started to place those new orders yet. So I think we're, the way I'm interpreting that is that we're in a period where new orders are starting to flow from, either new orders are starting to flow from the carriers like China Telecom and China Unicom, or that there's line of sight to those new orders and some of our vendors are getting ready while other vendors probably still have some buffer inventory that they want to draw down before they start to place new orders. So it feels like that should start to turn with more of our customers in this quarter or certainly by the fourth quarter. And the data points that you gave around the new bandwidth awards and new product orders coming out, of China Telecom and China Unicom. I think those are significant data points that point also in that direction of a gradual recovery in the next quarter or two.
Simon
Thanks for taking my questions.
Lindsay
My pleasure.
Operator
The next question comes from Alex Henderson with Needham.
Alex Henderson
Thanks. Stephen, can you give us a little bit of a granularity around you know, what your thoughts are between the data center and CATV and the guide for 3Q. What are we assuming there? Is the spike up in 2Q an abnormal spike and it's going to, you know, stabilize or decline sequentially back to a more normalized growth, you know, or revenue level? Or is that a new base that we'll be growing the CATV off of? And, you know, Clearly, it's nice getting 400 gig wins, but the data center business declining sequentially into what is normally a seasonally strong quarter. Is that now a trend line where you should expect the 40 gig to roll over a little bit faster going forward as people don't want a 40 gig product to put new into their networks? Yeah. little out there.
Lindsay
Sure. So I'll take your first question first, which is what's the trajectory for cable TV? As I noted in our prepared remarks, our cable TV revenue is limited over the next quarter or perhaps beyond by component availability. And we talked about the magnitude of that in the third quarter being about $3 million. So you can get a pretty good picture that at least in Q3, and I would say that after that, in subsequent quarters after that, depending on component availability, we should be at about that level as well. So I think we're kind of at a new level in cable TV, and there's opportunities to grow from there, particularly as we overcome some of these supply constraints, which is currently the limiting factor to deliver revenue there. At the same time, then, your second question is about, you know, the trajectory in Datacom. And I do think Q2 probably represents the low point in Datacom revenue for us, at least the local minimum. That is, I think we'll see some incremental improvement in Datacom. And as we noted in our prepared remarks, that's going to be driven by two factors. One is the 400G design wins and our beginning, that first phase ramp that I spoke with Simon about earlier in the 400G business. And at the same time, I also expect to see some recovery in our 100G business as some of the customers that had previously purchased inventory are finally getting that inventory back down to a level that they think is appropriate to begin placing new orders. So those two factors, I think, can drive some incremental growth in the data center business.
Alex Henderson
So it sounds like data center up modestly a couple million dollars. You're talking about The other one's probably telecom. It sounds like it's up a little bit sequentially off of a fairly low base. So that would suggest that you do expect a little bit of a retrenchment in the CATB to get to your guide, I would assume.
Lindsay
Yes, that's correct. And we highlighted that that's largely due to component shortages.
Alex Henderson
Okay. I get it. That's perfect. I wanted to go back to the inventory. Your inventory carry rate is very high relative to your revenue base and relative to industry standards. And I get it that in this environment that's probably not a bad thing, but do we have any concerns about having potentially any issues of having too much of, say, older product or lower speed products that might not be applicable to the future demand picture? Do you have the right inventory in that mix?
Lindsay
I think we do. You know, if you remember in some prior quarters, we've talked a lot about the fact that our 400G platform and our 100G platform and our 40G platform share a lot of commonality in terms of the design and the parts. And so to that extent, there's inventory of raw materials and things that that may have been applicable to even 40G products that we could still continue to use in 100G. And certainly, cable TV wall, some of the older generation products are maybe slower selling than the current stuff. There's still a lot of demand even for older generation products. So we feel pretty good about the inventory that we have. I should say, we feel good about the quality of the inventory that we have. Now, your point about inventory level being high is well taken. We did bulk up on inventory quite a bit in the – actually, even prior to COVID in the Chinese New Year period going back last spring. And, you know, I think that that probably – you know, we probably got a little bit out ahead of our skis in terms of the amount of inventory that we have. To your point, it's – comforting to have that inventory around with all the uncertainties that we've endured in the last year. But we do want to continue to draw that inventory level down. We've made some significant progress in that regard. I mean, we've pulled our inventory, I think it maxed out at around $113 million, and we're down to just about $100 million at the end of the quarter. So, I mean, that's good progress. I want to continue to make progress on that regard and bring that inventory level down to a number that I think would be you know, more appropriate for the business, which is probably in the $80 million vicinity.
Alex Henderson
One technical question. You said $0.9 million at the market issued. Was that shares or was that revenue, you know, the cash in?
Lindsay
That's dollars. That's the amount of net proceeds.
Alex Henderson
The dollar. Okay. Net proceeds. Okay. That's what I needed. Thanks. All right, Alex, thank you.
Operator
The next question comes from Sam Peterman with Craig Hellam.
Sam Peterman
Hi, guys. Sam on for Richard here. A couple questions. I think I'll start with data center. I know you guys have talked about inventory burns ending in the second quarter and starting to recover from there, which it looks like is going to happen. But even given that data center's down, it looks like a little bit more than expected? I mean, was there kind of worse inventory burns than expected or something else in data center that can kind of explain the weakness there this quarter?
Lindsay
Well, I don't think that the weakness is kind of a long-term thing. It has to do with just the confluence of order patterns across a couple of different customers. And, you know, as we As we discussed, I think that probably represents a local minimum in terms of data center revenue. And I think the catalyst going forward is, again, inventory normalization with our 100G customers, especially one of our large 100G customers, as well as some tailwinds from the 400 gig as that starts to ramp.
Sam Peterman
Okay, fair enough. Second question on 400 gig. I'm curious what those five technical qualifications that you talked about. Are those with new customers or existing customers? Can you break that down?
Lindsay
All of the 400 gig technical qualifications are with existing customers.
Sam Peterman
Okay. Great. Thank you. And then the last one for me on cable TV. I know I think last call you talked about having, you know, visibility in the order book out through the end of the year. I know, you know, supply constraints are going to cap that a bit, but can you talk about where you sit in terms of visibility today and if that order book is extending out into next year at all? And, yeah, any color there would be helpful.
Lindsay
Yes, the order book is extending out into next year. The component availability situation, I mean, I was listening in on Comscope's call, and they're saying – similar things about component availability. So I think it's kind of an industry-wide trend. So we're not seeing customers sort of pulling back on orders and shifting order patterns. I think it's quite the contrary. What we're experiencing is that customers are, you know, working with us to try to pull in inventory as quickly as they can rather than, you know, trying to move orders to somebody else or something.
Sam Peterman
Okay, great. Thanks. That's all for me.
Operator
As a reminder, if you do have a question, please press star then 1 on your touch-tone phone. Our next question comes from Dave Kang with B Reilly.
Dave Kang
Thank you. Good afternoon. My first question is on gross margin. Revenue is going to be kind of flat-ish sequentially in third quarter, and yet you are expecting course margin to decline about five points sequentially. Can you just go over some of the factors?
Lindsay
Sure. There's two factors. One is some product mix within our cable TV segment, just different customers sort of waxing and waning in terms of what they're buying. And then the other factor is related to the component shortages that we're experiencing. And so we are experiencing increased cost as we try to pull in those components. So we're paying, for example, expedite fees to suppliers. We're, in some cases, qualifying new suppliers that may even be higher-cost suppliers just because they have availability, things like that that are also negatively impacting our gross margin in the quarter. So we discussed that we think that the cable TV industry Mix is probably a one-quarter thing. I think it'll shift more back towards more favorable product mix in the fourth quarter. The component availability is a little bit unclear how long that is going to last. I think it'll certainly last through the third quarter. It may last into the fourth quarter, but it's not totally clear exactly how fast we're going to be able to recover from that. It's a very fluid situation. Some of those component availability situations are caused by, for example, COVID shutdowns in certain parts of the world where suppliers have factories and things. And how those things play out in terms of timing is a little bit difficult to project at this point. But I think it's fair to say it should persist through the third quarter, and hopefully we'll find ways around it in the fourth quarter, but it's not totally clear at this point.
Dave Kang
Regarding component shortages, is that just mainly in cable TV? I mean, you're not experiencing a similar situation in the data center market?
Lindsay
Yeah, and I think a lot of that has to do with the inventory that we talked about earlier. I mean, Alex had a very good point that our inventory levels are rather elevated, and that's a point that we've made also on our last few calls. You know, that's a double-edged sword. Of course, we're tying up cash, and there's always – some risk of obsolescence, although as I mentioned in response to Alex's question, I don't think that's a major concern for us at this point. But the bright side to that is that if you do have inventory, then you're not as likely to suffer from supply shortages. So in the data center business where we have a longer history and a better track record in terms of order patterns, We were able to bulk up on those products ahead of Chinese New Year last year, and that inventory is continuing to help us out when it comes to component shortages in the present time. The cable TV part of our business, as you can appreciate, was significantly smaller a year ago, and we didn't have the same bulk of inventory going from pre-COVID times into the first or second quarter of last year. And therefore, you know, we don't have that same cushion of inventory there. And that's where we're sort of scrambling to try to find the inventory that we need to continue to grow the revenue in that segment.
Dave Kang
Okay. And my last question is on 400 gig. I'm trying to, you know, kind of gauge what kind of trajectory we should be expecting. First of all, just wanted to clarify, do you say 400 gig will ramp end of third quarter or fourth quarter and then Can you just talk about your expectations, maybe when does it become like 10%, 20% of revenues?
Lindsay
So I think I said that the 400 gig will start to ramp at the end of the third quarter, which means it's probably not going to be a big amount of revenue in the third quarter, but it should start to become more meaningful in the fourth quarter. I did also highlight in answer to I believe it was Simon's question earlier that we typically see in these scenarios a sort of two-phase ramp, right? So there's an initial phase of ramp where we go from zero to some relatively small number that's associated with initial orders from customers who are trying out, you know, putting these products into their actual live networks and making sure that they perform as well in that environment as they did in all the lab testing that they've been doing in the qualification phase. They tend to be appropriately circumspect when it comes to ordering in that first phase. And then once they become more comfortable that everything's working correctly, then there's a second phase where the ramp becomes more substantial. And we expect that phase would probably be sometime in the middle part of next year.
Dave Kang
And if I can just squeeze in one more regarding 400 gig, how should we think about margins between 100 gig versus 400 gig?
Lindsay
Broadly similar. There can be variations in gross margin among that product family, either the 100 gig or 400 gig, based on the particular customers and the particular types of transceivers that are being ordered. But overall, I would expect the margins to be, you know, broadly similar between 100 gig and 400 gig.
Dave Kang
Got it. Thank you.
Operator
The next question comes from Tim Savigo with Northland Capital Markets.
Tim Savigo
Good afternoon. Not a lot left here, but maybe I'll follow up on 400 gig timing and maybe some kind of the magnitude of the opportunity. It seems that the one area where discussion of 400 ZR would be relevant for you guys would be at Microsoft, where they've stated pretty plainly that they need to get that DCI rollout going before they can upgrade inside the data center. And I'm not saying that's one of your design wins, but you're free to add some color on that. But with a scenario like that, you know, explain a, why your design wins are coming, you know, kind of maybe a little late in the game and be, you know, kind of support the kind of small ramp and then, and then bigger ramp and mid year type scenario, uh, that you're discussing.
Lindsay
Uh, yeah, I mean, I think, I think you're, you're right in the sense that, um, for all of our customers, and Microsoft certainly has historically been one of, if not our largest data center customer, it has been, recently it's been our largest data center customer. And so, you know, anything that would affect the timing and magnitude of the rollout of Microsoft's 400G efforts, you know, would certainly be of interest to us and could be a partial explanation for some of the ramp rates that we have talked about earlier. That's not to say, you know, certainly not all the design wins or technical qualifications that we had or even necessarily any of them were with Microsoft, but we have multiple customers that are involved in that. But certainly we're watching the situation with Microsoft and any of the factors that affect their rollout would likely be affecting us as well.
Tim Savigo
Got it. And you know, in terms of the magnitude of that opportunity, you know, should things go reasonably well for you at 400 gig? I mean, can you imagine a scenario sometime next year where your 400 gig business is, you know, approaching the size of your current overall data center business on a quarterly basis?
Lindsay
Uh, you know, I could imagine that scenario. I think, as you pointed out, a lot of things have to go right. I would expect that 400 gig can approach, you know, say 10% of revenue at some point next year, which would put it at, you know, roughly the level of our current data center business. So I think that that's, you know, achievable. Clearly, we're a seeing that actually happen and having a tremendous amount of confidence in that, but I think it's certainly possible.
Tim Savigo
Okay, thanks very much, and congrats on the design wins.
Lindsay
Thank you.
Operator
This concludes our question and answer session. At this time, I would like to turn the conference back over to Dr. Thompson Lin for any closing remarks.
Lindsay Savarese
Okay, and thank you for joining us today. As always, thank you. to our investors, customers, and employees for your continued support, and we look forward to seeing many of you virtually at our upcoming investment conference.
Operator
The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.
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