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Operator
Good afternoon, and welcome to the Applied Optoelectronics Second Quarter 2022 Financial Results Conference Call. All participants will be in a listen-only mode. Should you need any assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note that this event is being recorded today. I would now like to turn the conference over to Lindsay Savarese. Please go ahead.
Lindsay Savarese
Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics, and I'm pleased to welcome you to AOI's second quarter 2022 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2022 financial results and provided its outlook for the third quarter of 2022. 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. Stephen 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 2022. 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 innovations, as well as statements regarding the company's outlook for the third quarter of 2022. 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, 2021. Also, 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. I'd like to note the date of our third quarter 2022 earnings call is currently scheduled for November 3rd, 2022. Now I'd like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics founder, chairman, and CEO. Thompson?
Lindsay Savarese
Thank you, Lizzie, and thank you for joining our call today. I will begin with some highlights from the call before. I turn the call over to Stephen Murray who will discuss a more detailed review of our second quarter financial result and outlook for the third quarter. Our second quarter governing was adversely affected by a delay in the completion of several orders from a large CATB customer that we expect to ship in Q2. During the quarter, the customer requested certain change to several orders But due to the well-known supply chain issues, we were unable to adjust production and procure raw material to address these changes prior to quarter end and the revenue therefore slipped into Q3. We have since shifted substantially all of this order and also delayed. We have localized the resulting revenue These shipping delays negatively impact our Q2 revenue by approximately $6.7 million. As a result, our total revenue for the second quarter decreased 3.5% year-over-year to $52.3 million, which was below our expectations. According to the rate of our result, our gross margin was in line with our expectations. and non-GAAP EPS was above our expectations. Total revenue in our CATP segment of $23.7 million was down 14.1% year over year and was down 5.1% sequentially due to the region I mentioned above related to the delayed shipping. The overall demand environment remained robust as MSO, particularly in North America, continued purchasing additional network products in order to upgrade their network. Total revenue for our data center product of $21.5 million decreased 4% year-over-year and was essentially flat sequentially. As we have discussed previously, the slight year-over-year decline in data center revenue is due to a decline in 40G, which is nearly the end of its lifecycle. This decline was partially offset by an increase in 100G. As 400G continues to ramp later this year, we expect year-over-year growth for our total data center revenue to resume. We continue to see good customer traction on 400G. Today, we have received nearly $5 million in orders for our 400G products, most of which we expected to be shipped in Q3 and Q4 of this year. During the second quarter, we secured eight design wins. Of these design wins, two were for our 400G products, both with existing hyperscale DSN operator customers. We also had two design wins for our 1RG products with hyperscale customers. We had two 1RG wins with network equipment manufacturers supplying the data center industry. The remaining two design wins were in our fiber-to-home, telecom, and other categories. With that, I will turn the call over to Stephen to review the details of our Q2 performance.
Lizzie
Thank you, Thompson. As Thompson mentioned, our second quarter revenue was adversely affected by a delay in the completion of several orders from a large CATV customer that we had expected to ship in Q2. During the quarter, the customer requested certain changes to several orders, but due to the well-known supply chain issues, we were unable to adjust production and procure raw materials to address these changes prior to quarter end, and the revenue therefore slipped into Q3. We have since shipped substantially all of these orders, and although delayed, we have recognized the resulting revenue in Q3. These shipment delays negatively impacted our Q2 revenue by approximately $6.7 million. As a result, our total revenue for the second quarter decreased 3.5% year-over-year to $52.3 million, which was below our expectations and essentially flat compared to Q1. While our revenue came in below our expectations, we delivered gross margin in line with our expectations and non-GAAP EPS above our expectations. We're encouraged by the strong CATV environment, the recovery in the telecom market, and the traction we are seeing with our 400G products. During the quarter, we secured eight new design wins. Of these design wins, two were for our 400G products, both with existing hyperscale data center operator customers. We also had two wins for our 100G products with hyperscale customers. We had two 100G wins with network equipment manufacturers supplying the data center industry. The remaining two design wins were in our FTTH, telecom, and other category. We continue to see good customer traction on 400G, and we expect orders will ramp up in the second half of this year. On our Q1 call, we had discussed how a major hyperscale data center customer selected AOI as a vendor for several of our 400G products. We are pleased to have completed the interoperability testing with the company's other prospective vendors, and we have begun to receive sizable orders for shipments beginning in Q3. This was in addition to the two new design wins for 400G in the quarter that I just mentioned. One was with a major hyperscale operator, and the other was with a smaller operator. These new wins further bolster our expectation for continued ramp in 400G later this year and into 2023. Turning to our second quarter results, 45% of our Q2 revenue was from our CATV products, 41% was from our data center products, and the remaining 14% from FTTH, telecom, and other. In our CATV product segment, the overall demand environment remains robust as MSOs, particularly in North America, continue purchasing additional networking products in order to upgrade their networks. However, for the reasons I mentioned earlier related to the orders that slipped from Q2 into Q3, we generated CATV revenue of $23.7 million, down 14.1% year-over-year and down 5.1% sequentially. Looking ahead, We currently expect strong sequential improvement in CATV revenue in Q3. Further up, we continue to have good visibility with CATV orders as we see our backlog stretching throughout 2022 and into 2023. We have significantly increased production capacity for CATV products, and we believe that we are well positioned to deliver on the demand that we are seeing. Our Q2 data center revenue came in at $21.5 million. down 4% year-over-year and up 0.4% sequentially. In the second quarter, 71% of our data center revenue was from our 100G products, 21% was from our 40G transceiver products, and 1.1% was from our 200G and 400G transceiver products. As Thompson noted earlier, we have booked nearly $5 million in orders already for 400G products. and with our production capacity ramping, we expect to ship most of these in Q3 and Q4 this year. Now turning to our telecom segments. Revenue from our telecom products of $6.3 million was up 88.3% year-over-year and up 19.2% sequentially. Our strong second quarter performance was driven by recovery in the China telecom market. Looking ahead, we continue to expect to see fluctuations in revenue in telecom as the outlook for China Telecom remains somewhat murky. For the second quarter, our top 10 customers represented 87.1% of revenue, up from 86.8% in Q2 of the prior year. We had two 10% or greater customers in the second quarter, one in the CATB market and one in the data center market. These customers contributed 40% and 22.2% of total revenue, respectively. In Q2, We generated non-GAAP gross margin of 16.7%, which was within our guidance range of 16.5% to 18%, and was down from 17.5% in Q1 of 2022 and 25% in Q2 of 2021. The decline in our gross margin was mostly due to continued challenges with the supply chain. Total non-GAAP operating expenses in the second quarter were $18.2 million, or 34.9% of revenue. down from $20 million, or 36.9% of revenue, in Q2 of the prior year. R&D expenses decreased year over year, reflecting the timing of certain R&D projects, which we believe will come back next quarter. And our sales and marketing expenses benefited from some reduced shipping costs, as well as lower personnel costs. Looking forward, we expect non-GAAP operating expenses to hover around $20 million per quarter for the rest of the year. Non-GAAP operating loss in the second quarter was $9.5 million, compared to an operating loss of $6.5 million in Q2 of the prior year. GAAP net loss for Q2 was $14.5 million, or a loss of 52 cents per basic share, compared with a GAAP net loss of $8.2 million, or a loss of 31 cents per basic share in Q2 of 2021. On a non-GAAP basis, net loss for Q2 was $7.6 million, or a loss of 28 cents per basic share, which was better than our guidance range of a loss of $8.4 million to $9.5 million, or a loss per share in the range of $0.30 to $0.34 per basic share, and compares to a net loss of $4.1 million, or a loss of $0.15 per basic share in Q2 of the prior year. The basic shares outstanding used for computing the net loss in Q2 were $27.6 million. Turning now to the balance sheet. We ended the second quarter with $40.7 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $40.1 million at the end of the first quarter. We ended the quarter with total debt of $63.8 million, down from $67.2 million last quarter. As of June 30, we had $98.2 million in inventory, compared to $92 million at the end of Q1. Inventory increased primarily due to the delay in shipment of the CATV orders that we discussed earlier. We made a total of $1 million in capital investments in the second quarter, including $0.7 million in production equipment and machinery and $0.2 million in construction and building improvements. For the first half of the year, our total capex spend has been about $2 million. Looking ahead to the second half, we would expect flat to slightly higher capex spending So, for the year, we currently expect between $4 million and $6 million in total capex. Before turning to guidance, I would first like to provide an update on the supply chain environment. We continue to see challenges in some areas of our supply chain, particularly semiconductors. As in prior quarters, we have adapted to these challenges by purchasing materials from alternative, often higher-cost sources. In some cases, we are able to reduce the impact by redesigning products to utilize components with better availability and cost, but this is not always possible for every shortage. We currently see approximately $1 million to $3 million in potential revenue reduction in Q3 due to component shortages. However, this amount represents revenue that will be shifted to Q4 rather than lost revenue. Moving now to our Q3 outlook. We expect Q3 revenue to be between $57 million and $60 million, and non-GAAP gross margin to be in the range of 16.5% to 18.5%. Non-GAAP net loss is expected to be in the range of $7.6 million to $9.1 million, and non-GAAP loss per basic share between 27 cents and 32 cents, using a weighted average basic share count of approximately 27.9 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. To ask a question, you may press star, then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw a question, please press star, then 2.
spk01
At this time, we will pause momentarily to assemble our roster. Again, if you have a question, please press star, then one.
Operator
All righty, our first question will come from Tim Savageau with Northland Capital Markets. Please go ahead.
Tim Savageau
Hi, good afternoon. Question on your outlook and a comment you might have made about Datacom. So as you look at the sequential increase you're guiding for Q3. Should we assume that's principally all cable TV catch-up or is there anything else going on there on the one hand? And on the other, I think Thompson made a comment about returning to year-over-year growth in data center. Was that comment about Q3, the second half, or any particular color on that?
Lizzie
So the first question was about the nature of the sequential increase that we're forecasting in revenue. Yeah, a lot of that is related to the cable TV increase. Data center, we think, will be kind of flattish sequentially. And as far as the returning to sequential growth, that wasn't a specific statement on Q3 or Q4, but we said that at some point during the second half, so probably Q3 or Q4, we should return to year-over-year growth.
Tim Savageau
Okay, just to follow up on that, given the orders in hand and additional design wins for 400 gig, it sounds like you expect a that to ramp more material in Q4, or are you seeing any offsets in lower speed to kind of drive that flattish outlook for data center in Q3?
Lizzie
Yeah, I mean, a lot of the 400G orders are going to start shipping later in Q3, so there's not as much effect in Q3 as you might otherwise, you know, as you would otherwise expect if it was going to be for the entire quarter. And then there's always some fluctuation in some of the lower stuff as well. So So we do expect to see some ramp in 400G, but it'll be towards the end of the quarter, more material in Q4.
Tim Savageau
Okay, and then maybe just one more. When you talk about the 5,400,000 G orders, should we assume that's primarily from your kind of, well, not, I guess, recently historically top customer? Maybe you've just added your other historical top customer, but So we've seen that's concentrated with one major cloud operator, and how does that initial kind of batch of orders in hand compare to the kind of total opportunity that you see with either that cloud customer or the two major cloud customers?
Lizzie
Yeah, so the orders that we've gotten so far for 400G by and large are not for the major the largest, the most recent largest major customer. It is for a couple of other hyperscale operators. As far as how we look at this opportunity, I mean, this is very much the beginning. That $5 million represents, you know, an accumulation of orders that we've received, you know, during the quarter. So it's not, you know, it's not like that just all happened, you know, say this month or this week or something where we'd expect that to be some sort of run rate. But the purpose of that is really just to point out that we are starting to see a sizable backlog for orders. We're ramping our production capacity to be able to accommodate those orders and that we'll be delivering on those orders and presumably additional orders that we'll receive between now and the end of the year.
spk01
Okay, thanks.
Operator
Our next question will come from Paul Silverstein with Cowan. Please go ahead.
Paul Silverstein
Yeah. Stephan, what's the visibility, if any, to margin improvement? What needs to happen? I recognize everyone's being impacted by supply chain, yourself included, but what needs to happen for gross margin to get up to a more meaningful level from here?
Lizzie
Yeah. You know, I think as we highlighted in our prepared remarks earlier, you know, the biggest factor that's been affecting us recently has been just, you know, a There's not one particular supply chain issue that I can point to. There's been a lot of various different issues that we've had. I think this is not untypical for other companies, of course, not that that's an excuse, but it's a little bit difficult to predict exactly what the trajectory of those pricing is going to be. As we noted in our prepared remarks, we've done quite a lot of work on qualifying second sources, finding alternatives, in many cases, redesigning products or portions of products to be able to accommodate components that are either more available or available at a lower cost or hopefully both. So there's been a lot of activity that we've had. The difficulty in translating all that activity into improved gross margin is that we have to, if it's a redesign or something like that, we have to burn through the existing inventory. In some cases, the inventory that we're getting or the products that we're able to get are actually higher costs, so that kind of offsets what would otherwise be cost savings from other areas. So, I mean, I think we're going to see improvement in gross margin towards the end of the year based on, you know, some of the new products that we have kicking in more meaningfully, contributing to revenue at that time, and also some of the, you know, anticipated cost reduction, the culmination of some of the cost reduction efforts that we have had So our current expectation is from sort of an uptick in gross margin in Q4. But I will hedge that a little bit by saying that that assumes that the supply chain situation doesn't, you know, get materially worse, which it seems like is unlikely at this point, but one never knows.
Paul Silverstein
But it's what you're talking about getting back to the mid-high 20s before the incremental impact of supply chain. or you're not even talking about getting back to that level. And I guess where I was trying to get to was to get to 30-plus beyond supply chain, what needs to happen? What can supply, just reparation supply chain, what can that get you back to? And then to get to 30-plus, what needs to happen beyond supply chain normalization?
Lizzie
Yeah, I think the supply chain probably gets us back into the low to mid-20s. to get to 30%, you know, we would need to see contribution, significant contribution from some of our higher margin, newer higher margin products. So a mixed shift in addition to the supply chain normalization.
Paul Silverstein
Specifically to 400 gig or you're... I'm sorry.
Lizzie
No, go ahead, Paul. I'm sorry.
Paul Silverstein
Specifically to 400 gig or you're speaking more generically in terms of newer products?
Lizzie
More generically, but I mean, 400 gig can be a contributor there. That's certainly part of it, but other new products as well. And like I said, the timeframe on the supply chain normalization, we think, is sort of Q4-ish, again, barring any other things that happen. The new products, again, will start to kick in probably in Q4, but it will probably contribute more meaningfully in quarters after that, so into 2023.
Paul Silverstein
And again, I'll apologize. I know you've addressed this in the past, but to get to break even, what does that assume in terms of volume and gross margin, your assumptions?
Lizzie
Right. Well, we gave some guidance on operating expense. You know, it's going to hover probably between $19.5 million, $20 million, something like that, through the rest of the year. So, you know, you can kind of – and I don't expect that to change meaningfully next year really either. We've been fairly consistent in operating expense estimates. So, you know, you can kind of do the math on the gross margin and revenue numbers that it would take to get to break even. You know, we said before, I think we can get back to the upper 20s or even 30, maybe touch 30% at some point. It's not likely to happen in the next couple of quarters, given the trajectory that we just talked about. So if you kind of assume that and, you know, plug in a, say, $20 million-ish operating expense, you know, you can get a pretty rough idea on what the revenue level would need to be.
Paul Silverstein
I appreciate it.
Operator
Thank you. There are no remaining questions at this time. And with that, we will conclude our question and answer session. I'd like to turn the conference back over to Dr. Thompson-Lynn for any closing remarks.
Lindsay Savarese
Okay. Singapore joined us today. As always, we want to extend the same. You did. To our investors, customers, and employees, for your continued support, we look forward to updating you on our progress next quarter.
spk01
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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