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Operator
Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to applied OptinElectronics second quarter 2024 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, please press star then one on your telephone keypad. To withdraw your question, please press star then two. So, if you need assistance, please signal a conference specialist by pressing the star key followed by zero. Please also note, today's call is being recorded. I would now like to turn the call over to Lindsay Savarese, Investor Relations for AOI. Mrs. Savarese, you may begin.
Savarese
Thank you. I'm Lindsay Savarese, Investor Relations for Applied Optoelectronics. I am pleased to welcome you to AOI's second quarter 2024 Financial Results Conference call. After the market closed today, AOI issued a press release announcing its second quarter 2024 financial results and provided its outlook for the third quarter of 2024. 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 2024. 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 Statements. On today's call, management will make forward-looking statements. These forward-looking statements involve risks and uncertainties, as well as assumptions and current expectations, which could cause the company's actual results, levels of activity, performance or achievements of the company or its industry, to differ materially from those expressed or implied in such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as believes, forecasts, anticipates, estimates, suggests, intends, predicts, expects, plans, may, should, could, would, will, potential, or thinks, 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. 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 2024. 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 and the company's quarterly reports on Form 10-Q. Also, all financial results and other financial measures discussed today are on a non-GAAP basis unless specifically noted otherwise. Non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation between our GAAP and non-GAAP measures as well as a discussion of why we present non-GAAP financial measures, are included in our earnings press release that is available on our website. Before moving to the financial results, I'd like to announce that AOI Management will virtually participate at the Rosenblatt 4th Annual Technology Summit, The Age of AI, on August 20th, and is attending the Jeffries Semis IT Hardware and Communications Technology Summit on August 28th. I'd also like to note that the date of our third quarter 2024 earnings call is currently scheduled for November 7th, 2024. Now, I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics founder, chairman, and CEO. Thompson?
Thompson Lin
Thank you, Lindsay, and thank you for joining our call today, our revenue for the second quarter of E9 with our expectations. While our non-GAAP gross margin came in below our expectations, primarily due to product mix, our non-GAAP loss per share was favorable compared to our expectations. During the second quarter, we delivered a labeling of $43.3 million, which was within our guidance range of $41.5 million to $46.5 million. We delivered non-GAAP gross margin of 22.5%, which was below our guidance range of 25.5% to 27.5%. Our non-GAAP loss per share was 28 cents, which was favorable compared to our guidance range of a loss of 29 cents to 35 cents per share. Our revenue for our data center products of $34.4 million was up 25% year-over-year and 19% sequentially. Dribbling for our 100G products increased 21% year-over-year and dribbling for our 400G products more than doubled in the same period. We are pleased to report that we have begun to receive initial orders for 400G products from another large, hyperscale customer, and we are very excited about this new customer interaction. With this new customer, we now are shipping 400 products to three out of the five largest hyperscale data center customers in the U.S. Total revenue in our CATV segment was $5.8 million, which was down 38% year-over-year and 33% sequentially, largely driven by continued, generally slow sales of DOSIS 3.1 equipment. As the industry prepares to transition to DOCSIS 4.0, we believe that this transition is underway and expect our CATV-6 to begin to ramp in Q3s. With that, I'll turn the call over to Stephen to review the details of our Q2 performance and outlook for Q3, Stephen. Thank you, Thompson.
Thompson
As Thompson mentioned, our revenue for the second quarter was in line with our expectations. While our non-GAAP gross margin came in below our expectations, largely due to product mix, our non-GAAP loss per share was favorable compared to our expectations. As a reminder, on our Q1 call, we discussed a number of key reasons why we felt optimistic about the second half of the year despite a slow start to 2024. Today, we're pleased to report that we have executed on many of these initiatives that we believe will position the company for long-term success and continue to give us optimism for the second half of the year and beyond. As Thompson mentioned earlier, we've begun to receive orders for 400 G products from another large hyperscale customer, and we expect to ship these initial orders in Q3. While the initial orders are relatively small, We are very excited about this new customer interaction. With this new customer, we are now shipping 400G products to three out of the five largest hyperscale data center customers in the US. We previously discussed on our Q1 call how we had begun to receive forecasted orders for the Vixel-based 400G active optical cables for which Microsoft provided development funding last year. As demonstrated by our Q2 data center results, we have started to see business improvement and expect to see continued improvement throughout the year. While the initial ramp has been slower than originally anticipated, recent forecasts indicate a substantial improvement in revenue in late Q3 and into Q4 and beyond. We anticipate that this will represent a longer-term, sustainable increase in business and are excited for this product to finally transition to wider usage within our customers' data centers. Lastly, In our CATV business, we have finalized the qualification testing with three out of the four individual 1.8 gigahertz amplifier models with one of our major MSO customers. The testing has gone well, and we have begun to negotiate our first orders for these new amplifiers and expect our CATV results to improve markedly in Q3 as a result. Turning to the quarter, our total revenue for the second quarter was $43.3 million, which was up 4% year over year, and 6% sequentially, and which was in line with our guidance range of $41.5 million to $46.5 million. During the second quarter, 79% of our revenue was from our data center products, 13% was from our CATB products, with the remaining 8% from FTTH, telecom, and other. In our data center business, our Q2 data center revenue came in at $34.4 million. which increased 25% year-over-year and 19% sequentially. In the second quarter, 73% of our data center revenue was from our 100G products, 18% was from our 200G and 400G transceiver products, and 7% was from our 40G transceiver products. As we have discussed on several prior earnings calls, We signed two agreements with Microsoft in 2023 for the development of 400G products and beyond. This included a development program to make next-generation lasers for its data centers and for the development of its 400G and next-generation active optical cables. While not guaranteed, we continue to believe that the revenue opportunity for our 400G and 800G products could be greater and a longer duration than the revenue contribution we saw from this customer during the peak of the 40G product cycle, which suggests that revenue from these products may exceed $300 million over the several years of these build-outs. In Q2, we began to see some business improvement, and we believe that this business will continue to ramp in Q3 and Q4. As our data center customers work on building out their next-generation AI-focused data center architectures, We have been very active in our 800G qualification efforts with several hyperscale customers. We believe that orders for 800G products will begin for us in Q4 of this year, with a ramp from that point. Turning to our CATV business, CATV revenue in the second quarter was $5.8 million, which was down 38% year-over-year and down 33% sequentially, largely driven by generally slow sales of DOCSIS 3.1 equipment as the industry transitions to DOCSIS 4.0. With the encouraging results from our customer qualification and our new 1.8 GHz amplifier products, we expect significant improvement in our CATV business starting in Q3, with an additional ramp in Q4 and into 2025, as we believe customer upgrades to their networks will begin in earnest. Now turning to our telecom segment. Revenue from our telecom products of $2.4 million was down 44% year over year and up 5% sequentially, largely driven by ongoing softness in 5G demand, particularly in China. Looking ahead, we continue to expect telecom sales to fluctuate from quarter to quarter. For the second quarter, our top 10 customers represented 94% of revenue, up from 88% in Q2 of last year. We had three greater than 10% customers, two in the data center market, which contributed 60% and 16% of our total revenue, respectively, and one in the CATV market, which contributed 12% of our total revenue. In Q2, we generated non-GAAP gross margin of 22.5%, which was below our guidance range of 25.5% to 27.5%, and was up from 18.9% in Q1 of 2024 and down from 24.8% in Q2 of 2023. The decrease in gross margin was driven mainly by product mix. Looking ahead, we expect continued improvement in gross margins throughout the year as product mix improves in our data center business and as our CATV business begins to ramp. We remain committed to our long-term goal of returning our non-GAAP gross margin to around 40% and believe that this goal is achievable. Total non-GAAP operating expenses in the second quarter were $26 million, or 60% of revenue, which compared to $19 million, or 46% of revenue, in Q2 of the prior year due to higher R&D spend to improve time to market for our 800G and 1.6 terabit data center products. Looking ahead, we continue to expect non-GAAP operating expenses to range from $24 million to $26 million per quarter to account for the acceleration of R&D expenses. Non-GAAP operating loss in the second quarter was $16.2 million, compared to an operating loss of $8.7 million in Q2 in the prior year. GAAP net loss for Q2 was $26.1 million, or a loss of 66 cents per basic share, compared with a GAAP net loss of $16.9 million, or a loss of 57 cents per basic share in Q2 of 2023. On a non-GAAP basis, net loss for Q2 was $10.9 million, or 28 cents per share, which was favorable to our guidance range of a loss of $11.6 million to $13.5 million, or a loss per share in the range of 29 cents to 34 cents per basic share. This compares to a non-GAAP net loss of $6.1 million, or a loss of 21 cents per basic share in Q2 of the prior year. The fully diluted shares outstanding used for computing the earnings per share in Q2 were 39.4 million. Turning now to the balance sheet, we ended the second quarter with $16.1 million in total cash, cash equivalents, short-term investments, and restricted cash. This compares with $17.4 million at the end of the first quarter. As was the case last quarter, we had significant cash collections that came in shortly after the end of the quarter, including roughly $15 million in collections within the two-week period following the end of the quarter. During the quarter, we also used some cash to pay down debt in order to control our interest expense. We ended the quarter with total debt, excluding convertible debt, of $27.5 million, compared to $34.8 million at the end of last quarter. As of June 30, we had $54.3 million in inventory, which was flat compared to $54.3 million at the end of Q1. We made a total of $4 million in capital investments in the second quarter, which was mainly used for production and R&D equipment. Moving now to our Q3 outlook. We expect Q3 revenue to be between $60 million and $66 million, and non-GAAP gross margin to be in the range of 24% to 26 percent. Non-GAAP net loss is expected to be in the range of $5.9 million to $8.6 million, and non-GAAP loss per share between 14 cents per basic share and 20 cents per basic share, using a weighted average basic share count of approximately 43.2 million shares. The gross margin in Q3 is somewhat lower than what we had earlier anticipated, mainly due to additional costs that we expect to incur due to the rapid ramp of our 1.8 GHz CATV products in the quarter. We believe the gross margin will expand for these products in Q4 as we gain efficiency and economies of scale in our manufacturing process for these new products. Looking ahead, we continue to be optimistic about the long-term demand drivers for both our data center and CATV businesses, and that we are well-positioned to benefit from these growing trends. At the midpoint of our third quarter guidance range, we are projecting in excess of 45% revenue growth sequentially. While we are not yet in a position to provide guidance for Q4, we believe that this growth rate will accelerate from Q3 to Q4, benefiting from the tailwinds driven by the adoption of generative AI, which we continue to believe will require our data center customers to deploy more infrastructure, including more optical interconnect. Due to our U.S.-based production ability and our automated manufacturing capabilities and experience, we believe we are uniquely positioned to help our customers meet these significant demands. Also, we believe that we are very well positioned with the right team, product portfolio, and strategy in place as our CATV customers transition to next-generation architecture and implement new technologies like DOCSIS 4.0. With that, I will turn it back over to the operator for the Q&A session. Operator?
Operator
Thank you. We will now begin the question and answer session. If you'd like to ask a question, please press star then one on your telephone keypad. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Please hold while we pull for questions. And today's first question comes from Simon Leopold with Raymond James. Please go ahead.
Simon Leopold
Great. Thank you for taking the questions. I've got a handful. Let me start out with the new hyperscale win, which sounds nice and I guess something you guys have been shooting for for a bit. Can you give us a little bit more color on the nature of this? Is this another AOC type of device or any kind of color you can give us on the, you know, the contents of what you're selling in this new project? And then I've got a follow-up on the CATV segment.
Thompson
Yeah, I mean, for confidentiality reasons, I really can't disclose too much about it, but it's a product that's more in line with our standard data center type transceiver product. And it is a 400-gig color. And there's a single mold.
Thompson Lin
Great. And then on the CATV... Lopez, if there's one more, you know the... Sorry, go ahead.
Simon Leopold
Thank you. On the CATV side, I kind of thought we were bottoming last quarter, so a little bit surprised, but everything suggests that the ramp of DOCSIS 4 is still coming... maybe just slower than we once expected. So I'm wondering if you could level set us in terms of how you expect that product segment to develop. And maybe this is a little bit of an artificial metric, but I'm just trying to figure out where do we kind of get back to maybe a 25 million quarterly run rate? Is that a second half 25 event or can that happen Earlier than that, any kind of guidance you could give us around the timing of the CATV ramp would help.
Thompson
Well, as we said in our prepared remarks, I expect a substantial improvement in CATV revenue in Q3. So I expect we'll be back at the $25 million number before the end of the year on that ramp. The challenge that we have right now, as we noted in the cable TV section, is really on the gross margin in Q3. Based on the guide, what we expected was cable TV gross margin to come in significantly higher than our data center business. And in Q3, we had some cost overruns and things as we start to ramp this product. So we're expecting that and not be where we want it to ultimately settle off. So for us, the excitement in Q3 around the revenue ramp in CATB is real. It's a little bit muted because of the additional expenses that we're incurring, but those are temporary.
Simon Leopold
Great. And just the last one, hopefully easy. The share count is jumping in the guidance for the third quarter. Could you just help explain that? Thank you.
Thompson
Yeah, I mean, it's a combination of, you know, stock grants that have already been made and some provision for additional issuance of shares. Thank you.
Operator
Thank you. And as a reminder, if you would like to ask a question, please press star then 1 on your telephone keypad. Our next question comes from Tim Savigo with Northland Capital Markets. Please go ahead.
Tim Savigo
Hey, good afternoon, and congrats on the outlook in particular and the new wins. Just to go back on, well, kind of the guidance, I guess. It sounds like, based on your answer to the last question, that maybe as we look into this, you know, solid increase for Q4, the expected seller rate, sorry, Q3, the expected seller rate into Q4, It seems like maybe it's 50-50, data center and cable, but any more color for this $20 million sequential increase they're looking for. Is that about right? I'm thinking about where it's coming from, and then I have a follow-up.
Thompson
In Q3, more of the additional revenue is coming from cable than data center, and in Q4, the opposite we think will be true. That is datacenter.gov, cable TV, and a dollar base. Thank you. All right.
Tim Savigo
New button there. It sure did. And that's super helpful. And then just on the quarter, you had a new 10% customer pop up in datacenter. So I assume not a new customer. Yep. And it looks like Microsoft is pretty flat from an absolute dollar standpoint, but you did see an increase in 100 gigs. So should we assume that one of the maybe not hyperscale, but big kind of internal, I guess running data centers for internal capabilities, you've had a few of those guys, or not necessarily internal, but associated with the business, I can think of a few names that might fit that bill than doing a lot of AI investing and maybe pulling along 100 gig or any more color on that new customer joining the list there.
Thompson
No, the customer that topped up above 10%, it has been a customer of ours for a while, so that's not the new customer that we were referring to. However, it is another hyperscale customer, and they're predominantly buying 400 gig, not 100 gig. and they're doing that because they're aggressively building out their AI infrastructure as well.
Tim Savigo
Okay, and well, not to be dense here, but this is not... By the way, that customer's up on a revenue basis.
Thompson
They've grown almost 4x since Q1 in terms of their purchasing.
Tim Savigo
Great, awesome color bits. But that's not the new hyperscaler that you're referencing, or is it? Correct. It's not. It's not. Okay. And I guess last question. Sorry to parse semantics so much here, but you mentioned the newer 400 gig customer. I think Thompson referred to that as a new customer, but is it better referred to as a historical customer that's come back, or this is a net new customer for Applied Office?
Thompson
So, you know, we would classify a customer that hasn't stayed on business with us in a while, a few years or something, as a new customer because it really is a new interaction for us.
Tim Savigo
Okay, great.
Operator
All right. Sorry, please go ahead.
Tim Savigo
Am I still there? I guess the last one was on, I hear you on the gross margin with the ramp in Q3 and the pressure coming out of cable and you've given, not guidance, but at least some directional idea on Q4 for revenue. Do you think, and maybe you said this, do you think you'll be able to resolve some of those gross margin issues in cable in Q4 to drive gross market time. Sorry, that's it for me.
Thompson
Yeah, I think a lot of the extra costs that we're incurring in the production are really Q3. I think by Q4 we'll have most of that recovered. It may take us another quarter to get entirely back to where we expect it to settle out longer term, which would be, you know, circa 40%, maybe a little bit higher. So I think the bulk of the extra expense will be resolved by Q4. That's driving gross margin. Thanks very much.
Operator
Thank you. And once again, if you'd like to ask a question, please press star then 1 on your telephone keypad. Our next question comes from Dave Kang with B Riley FBR. Please go ahead.
Dave Kang
Yes, thank you. First question is just a follow-up on Tim's question about third quarter as well as fourth quarter for that matter. You expect Datacom to drive strong growth, especially in fourth quarter. Just can you provide a little bit more color, more flavor, whether it's 100 gig, 400 gig, 800 gig, any additional color would be appreciated.
Thompson
Sure. It's expected to be mostly 400 gig and some contribution from 800 gig. Got it. Got it.
Dave Kang
And then just Microsoft AOC program sounds like it's starting to ramp, and you're still sticking with $300 million. Just wondering if you think maybe by exiting at what level to give us some comfort, maybe you can do $100 million next year. I mean, you think you can do $20 million, $25 million exiting this year? Or I guess what are they forecasting?
Thompson
I mean, I think it'll... It remains to be seen. I think it would be tough to get all the way up to $25 million, let's say, in Q4. Things, as we noted in our prepared remarks earlier, things in that project have gotten off to a slower start than what we had expected. They are starting to ramp, however, so we're still sticking with that $300 million aggregate number. It's just a little bit later to get started than we had expected.
Dave Kang
Got it. And then 800 gig, in our previous meeting, you talked about two hyperscalers ramping in third quarter. Now, I think you said in prepared remarks, now it's push to fourth quarter. Did I hear that correctly? And are we talking about same two hyperscalers or different customers?
Thompson
Yeah, if I remember correctly, the commentary I had was that we would expect 800 gig sales for one or two hyperscale customers in late Q3 or early Q4, and that's pretty consistent with what we're saying now. There are scenarios where we could still literally get some orders in Q3, but I think it would be small enough that I'm more comfortable putting it as a Q4 thing. But it's not a dramatic change from what we had talked about earlier.
Dave Kang
And my last question is on gross margin. I think you said the long-term target is 40%. Are we talking, you know, like, maybe second half next year? And if so, what kind of a volume would you require for you to hit your target?
Thompson
It's not as much about volume as it is about product mix. Dave, that's what we were talking about earlier. I mean, you know, the products that we have in our portfolio or will have in our portfolio, you know, within the next year or so have gross margins that range from in excess of 40% to somewhere in the low 20s. Actually, there's probably a few products that are even below that, but in terms of the major products. So it's the mix between those products. And in particular, the cable PV products generally come in, especially the DOCSIS 4.0 products are going to come in at a higher gross margin towards that upper end of the range that I mentioned a minute ago. And some of the 800 gig products will come in at pretty high gross margins as well. And The third factor that's going to drive the gross margins up is the shift in 400 gig from predominantly multi-mode optics to single-mode optics. So we've seen some customer interest, in particular some of the new customer interactions that we talked about earlier, those have been for single-mode 400 gig optics, which are significantly more expensive and have better gross margin than the multi-mode optics. So all three of those things are what will combine to drive gross margins for you.
Dave Kang
Got it. Thank you.
Operator
Thank you. And ladies and gentlemen, this concludes our question and answer session. I'd like to turn the call back over to Dr. Thompson-Lynn for closing remarks.
Thompson Lin
Okay. Thank you for joining us today. As always, we want to extend a thank you to all investors, customers, and employees. For your continued support, as we discussed today, we believe the long-term demand drivers remain strong for both our data center and CATB business. And we believe we are well positioned to capitalize on this opportunity. Thank you.
Operator
Thank you, Dr. Lin. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful evening.
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