This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
Operator
Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to the Applied Optoelectronics Third Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. To ask a question, then, you may press star then 1 on your touchtone phone. To withdraw your question, please press star then 2. Please note, this event is being recorded. I now would like to turn the call over to Lindsay Savarese, Investor Relations for AOI. Ms. Savarese, you may begin.
Lindsay Savarese
Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics, and I'm pleased to welcome you to AOI's third quarter 2021 financial results conference call. After the market closed today, AOI issued a press release announcing its third quarter 2021 financial results. and provided its outlook for the fourth 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 Q3 results, and Stefan will provide financial details and the outlook for the fourth 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 product into new markets and customer responses to our innovation, as well as statements regarding the company's outlook for the fourth 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 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, 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 at the Needham Networking Security and Communications Conference on November 16th, the Raymond James Technology Investors Conference on December 6th through 8th, and the D.A. Davidson Semicaps Laser and Optical Conference on December 15th. We hope to have the opportunity to interact with many of you virtually. Additionally, I'd like to note the date of our fourth quarter and full year 2021 earnings call is currently scheduled for February 3rd, 2022. Now I would 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 our call today. The third quarter played out largely as we expected. We delivered inline revenue and gross margin and a narrow non-game net loss relative to our expectations. During the quarter, we continued to see strong demand in the CATB market and improving conditions in the data center and telecom markets. However, as we anticipated, our revenue in the third quarter was adversely impacted by approximately $3 million as a result of the well-known global component shortage. And our Q3 growth margin came in at the low end of our expectations, mostly due to the unfavorable product mix in our CATB segment and increased costs from component shortage. We achieved total revenue for the third quarter of $53.3 million, which decreased 30.5% compared to the third quarter of 2020 and was down 1.7% sequentially. Total revenue in our CATB segment of $23.1 million was up 98.4% year over year, but was down from the record $27.6 million in the second quarter of 2021. The overall CATV demand environment remains strong, and we continue to see good new customer traction with a number of our products. Total revenue for our data center product of $23.9 million decreased 56.8% year-over-year and increased 6.9% sequentially. During the third quarter, we secured nine design wins among seven customers. One of the design wins in the quarter was a new 400G transceiver design win with an existing customer. That is a network equipment manufacturer supplying enterprise and hyperscale data center customers. In addition, two of the design wins are related to 25G Pong, and now with a large multinational network equipment manufacturer focused on the telecom markets. Now turning to our telecom segment, ready meal came in at $5.1 million, down 42% year-over-year and up 54.5% sequentially. While we are pleased to deliver sequential growth in this segment, during the third quarter, we see continued volatility in the market condition in the China telecom market. As the timing and cadence of the 5G rollout there remains somewhat opaque. Looking ahead, we do expect quarter-to-quarter variability until the pace of 5G rollout in China becomes more predictable. With that, I will turn the call over to Stephen to review the details of our Q3 performance and our route for Q4. Stephen.
Lindsay
Thank you, Thompson. As Thompson mentioned, the third quarter played out largely as we expected, and we delivered revenue and gross margin in line with our expectations and a narrower non-GAAP net loss relative to our expectations due to slightly lower than expected operating expenses. During the quarter, we continued to see strong demand in the CATV market and improving conditions in the data center and telecom markets. However, as we anticipated, our results were adversely impacted by approximately $3 million due to the well-known component shortages and supply chain disruptions. And our Q3 gross margin came in at the low end of our expectations, mostly due to unfavorable product mix in our CATV segment and increased costs from component shortages. While we were able to mitigate some of these anticipated impacts, we saw additional component shortages later in the quarter due to the shutdown in Vietnam. As we work to improve our supply chain, we may continue to have longer than usual backlog for several quarters. Looking ahead, we expect that the component shortages could adversely affect our fourth quarter by approximately $2 million to $3 million. We also expect increased costs associated with the shortages to persist through Q4. Turning to our quarterly performance, we secured nine new design wins among seven customers. Of the nine design wins, four were with data center customers, two were with telecom customers, two were with FTTH customers, and one was with the CATV customer. As Thompson mentioned, one of these design wins was a new 400G transceiver design win with a network equipment manufacturer supplying enterprise and hyperscale data center customers. In addition, Two of the design wins are related to 25G PON and are with a large multinational network equipment manufacturer focused on the telecom market. All of the design wins in Q3 were with existing customers of AOI, so these design wins represent deeper penetration within our existing customer base. Total third quarter revenue of $53.3 million decreased 30.5% compared to the third quarter in the prior year. and was down 1.7% sequentially. Our Q3 revenue was in line with our guidance range of $51 million to $56 million. In the third quarter, 45% of our revenue was from our data center products, 43% from CATV products, with the remaining 12% 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 $23.1 million in Q3, up 98.4% from $11.6 million in Q3 of the prior year, and down 16.3% sequentially from record results in Q2-21, due largely to the component shortages and reduced sales of certain node transmitter products as inventory rebuilding for these products has largely been completed by one of our customers. Notably, in early October, we virtually attended the Society for Cable Telecommunications Engineers, or SCTE Expo. Commentary from customers continues to be positive. Looking ahead, we have good visibility with CATV orders well into next year, and we continue to believe that our technologies will play a key part in MSO's upgrade plans over the next several quarters. Notably, in the quarter, we began to see an increase in orders associated with so-called high split upgrades, which several MSOs are using to increase CATV network bandwidth. Our amplifier products and certain of our node products are used in these high split networks, and we are seeing particular order strength in this area. Our Q3 data center revenue came in at $23.9 million, compared to $55.3 million in the third quarter of the prior year. In the third quarter, 36% of our data center revenue was from our 40G transceiver products, and 57% was from our 100G products. Our data center revenue was up 6.9% sequentially. We remain optimistic about our ability to see sequential growth in the data center in the second half of this year. However, we are seeing some supply constraints that are beginning to impact other parts of the 400G ecosystem, which may in turn impact the timing of the 400G rollout, and this may limit the extent of the sequential growth we can see in the back half of this year. Now turning to our telecom segment. Revenue from our telecom products of $5.1 million increased 54.5% sequentially and declined 42% from $8.9 million in Q3 of the prior year. While we are pleased to deliver sequential growth in this segment during the third quarter, we see market conditions in the China telecom market as continuing to be lumpy, as the timing and cadence of the 5G rollout there remain somewhat opaque. Looking ahead, we do expect quarter-to-quarter variability until the pace of 5G rollouts in China becomes more predictable. Also, we are excited about the design wins in 25G PON that I mentioned earlier, as over time this will provide an additional growth driver to our FTTH revenue. For the third quarter, our top 10 customers represented 86% of revenue, up from 84.9% in Q3 of the prior year. We had two 10% or greater customers in the third quarter, one in the CATV market and one in the data center market. These customers contributed 29.4% and 15.5% of total revenue, respectively. In Q3, we generated non-GAAP gross margin of 19.9%. which was at the low end of our guidance range of 19.5 percent to 21.5 percent and was down from 25 percent in Q2 of 2021 and 27.4 percent in Q3 of 2020. Total non-GAAP operating expenses in the third quarter were $19.3 million, or 36.3 percent of revenue, compared with $22.3 million, or 29.1 percent of revenue, in Q3 of the prior year. The reduction in operating expenses is due to a decrease in R&D spend as some of the costs associated with our 400G development have begun to subside along with decreased shipping expenses due to lower shipments to one of our customers. Non-GAAP operating loss in the third quarter was $8.7 million compared to an operating loss of $1.3 million in Q3 in the prior year. GAAP net loss for Q3 was $15.8 million or a loss of 58 cents per basic share, compared with the GAAP net loss of $9.6 million, or a loss of 42 cents per basic share in Q3 of 2020. On a non-GAAP basis, net loss for Q3 was $5.3 million, or a loss of 20 cents per basic share, which was better than our guidance range of a loss of $6.9 million to $9 million, or a loss in the range of 25 cents to $0.33 per basic share due to lower operating expenses than forecast and compares to a net loss of $1.4 million or a loss of $0.06 per basic share in Q3 of the prior year. The basic shares outstanding used for computing the net loss in Q3 were $27.1 million. Turning now to the balance sheet. We ended the third quarter with $48.9 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $50.5 million at the end of the second quarter. As of September 30, we had $94.5 million in inventory compared to $100.4 million at the end of Q2. 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 $3.8 million in capital investments in the third quarter, including $3.4 million in production equipment and machinery and an immaterial amount on construction and building improvements. We now expect 2021 CapEx will be approximately $15 million. As we disclosed in February of this year, we initiated a new at-the-market offering. To date, we have raised $1 million under this new program, including $0.1 million raised in Q3. 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 Q4 outlook. We expect Q4 revenue to be between $51 million and $55 million, and non-GAAP gross margin to be in the range of 18.5% to 20%. Non-GAAP net loss is expected to be in the range of $5.5 million to $6.6 million, and non-GAAP loss per basic share between 20 cents and 24 cents using a weighted average basic share count of approximately 27.4 million shares. With that, I will turn it back over to the operator for the Q&A session. Operator?
Operator
Yes, thank you. As mentioned, we now will begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble the roster. And the first question comes from Simon Leopold with Raymond James.
Simon Leopold
Thank you for taking my question. This is Mauricio for Simon today. Stefan, can you please give us an update on your traction with your 400 gig opportunity? I think you previously disclosed expectations for 400 gig to ramp on the third quarter and become more meaningful in the fourth quarter. Maybe you can elaborate on the 400G traction this quarter, and how should we think about the opportunity going forward?
Lindsay
Yeah, so as we noted in our prepared remarks, what we've seen is that at least one of our customers, one of the early customers that qualified our 400G products, seems to be seeing some component shortages in other parts of the market. of the 400G network. That is, it's not optical products, it's not AOI's inability to supply those products, but they're seeing shortages of some other component that's making it difficult for them to ramp their 400G efforts as quickly as they would like. So, as we noted in our prepared remarks, we continue to expect to see growth overall in the data center market, but the 400G rollout may be a little bit later pending, you know, how long this supply disruption that they're seeing lasts.
spk03
Okay, thank you. And once again, please press star, then 1 if you would like to ask a question. And once more, pressing star then 1 will allow you to speak. All right.
Operator
As it is, there is nothing else at the present time. I would like to hand the floor to Dr. Thompson. Lynn, for any closing comments.
Lindsay Savarese
Okay. Thank you for joining us today. We want to extend a thanks. 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
Thank you. The conference has now concluded. Thank you for attending today's presentation.
Disclaimer