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Applied Optoelectronics Inc (NASDAQ:AAOI)
Q3 2019 Earnings Call
Nov 6, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, everyone. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to Applied Optoelectronics Third Quarter 2019 Earnings Conference Call. [Operator Instructions]

At this time, I'd like to turn the conference call over to Monica Gould, Investor Relations for AOI. Ms. Gould, you may begin.

Monica Gould -- Investor Relations

Thank you. I'm Monica Gould, Applied Optoelectronics Investor Relations, and I'm pleased to welcome you to AOI's third quarter 2019 financial results conference call. After the market closed today, AOI issued a press release announcing its third quarter 2019 financial results and provided its outlook for the fourth quarter of 2019. 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 that recording can be found on the Investor Relations page of the AOI website and will be archived for one year.

Joining us on today's call is Thompson Lin, AOI's Founder, Chairman and CEO; and Dr. Stefan Murry, AOI's Chief Financial Officer and Chief Strategy Officer. Thompson will give an overview of AOI's Q3 results, and Stefan will provide financial details and the outlook for the fourth quarter of 2019. 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 may identify forward-looking statements by terminologies 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 fourth quarter of 2019.

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, 2018.

Also, with the exception of revenue, all financial numbers 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 note that AOI management will present at the Needham Security, Networking and Communications Conference in New York on November 12; The Raymond James Technology Conference in New York, on December 10th; and the Cowen Networking and Cybersecurity Summit on December 11. We hope to have the opportunity to see many of you there. Additionally, I'd like to note the date of our fourth quarter 2019 earnings call is currently scheduled for February 25th, 2020.

Now I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?

Dr. Thompson Lin -- Founder, President, Chief Executive Officer, and Chairman of the Board

Thank you, Monica, and thank you everyone for joining us today. We are pleased with our continued execution in the quarter. For the second quarter in a load [Phonetic], we delivered revenue in line with our guidance and achieved better-than-expected result on the bottom line, having delivered revenue of $46.1 million, non-GAAP gross margin of 28.8%, and a non-GAAP net loss of $0.15 per share.

In looking at the dynamics in the quarter, the datacenter demand environment remain consistent with our expectation. We are starting to see early sign of recovery among two of our hyperscale datacenter customers. We are encouraged by early sign and believe the fundamental need for higher bandwidth within hyperscale datacenter will drive long-term growth. However, in the near term, we remain cautiously optimistic on the hyperscale market as demand continue to stabilize among our customers.

In CATV, we remain encouraged by the growing [Phonetic] increase in our Remote PHY products [Indecipherable] to report our fourth significant Remote PHY order in the quarter. Less amount [Phonetic], we demonstrated our Remote PHY solution at SCTE [Indecipherable] and had a very positive response from our current and potential customers. However, the overall cable TV demand environment continues to be soft, resulted in tepid demand for some of our legacy products. Additionally, CATV demand in China remain weak as a result of trade tensions.

We continue to make good progress and diversify our customer base and during the quarter we secured 11 new design wins, including four for our new customers. In summary, we are pleased we our result and improving gross margin, which led to another quarter, our better-than-expected bottom line result. We remain focused on expanding our relationship with both new and existing customers and maintaining our technology leadership. We believe operable proprietary and geographically diverse manufacturing and vertical integration are key competitive advantages, and we remain committed in our ability to execute our opportunities to have us as the market improve.

With that, I will turn the call over to Stefan to review the details of our Q3 performance and outlook for Q4. Stefan?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Thank you, Thompson. Our Q3 results were broadly in line with our expectations and reflect improving performance compared with last quarter. During the quarter, we continued on our path of customer diversification, expanded our margins and tightly managed our expenses, leading to a narrower net loss than we had anticipated.

Total revenue for the third quarter was $46.1 million, which was within our guidance range. Our datacenter revenue came in at $34 million, compared with $39 million in Q3 of last year. In the third quarter, 69% of our datacenter revenue was from our 40G transceiver products and 25% was from our 100G products. We continue to make good progress with our customers as they work to qualify our 400G products for datacenter applications.

Datacenter market dynamics played out similarly to last quarter. We continued to see early signs of recovery among two of our hyperscale datacenter customers, while one customer continues to purchase product from us, but with reduced demand. While these improving dynamics are encouraging, we remain cautiously optimistic in the near term. We had seven design wins in the quarter in our datacenter segment. Of these seven, two are new customers in the quarter, and an additional two are incremental wins with the recent new customer.

Turning to our cable television product segment. Revenue from CATV products decreased 38% year-over-year to $8.8 million from $14.3 million in Q3 of last year, primarily driven by weaken demand from our North American MSO customers combined with a historically high revenue quarter last year. Given limited competition in their markets, we believe that MSOs are delaying upgrades, pending the availability of new technologies such as DOCSIS 4.0.

Despite these near-term challenges, we are pleased to report a significant order for our Remote PHY gear from our largest CATV customer. We had a very positive reaction to our latest Remote PHY product at the Society for Cable Telecommunications Engineers or SCTE Conference last month in New Orleans. In addition to our standard Remote PHY products, we also demonstrated a pathway to Extended Spectrum DOCSIS using our Remote PHY technology. Extended Spectrum DOCSIS represents a key technology behind the emerging DOCSIS 4.0 standard, which we believe will be formalized by the end of the year. Once finalized, we believe this latest DOCSIS standard will be a catalyst for future upgrades. We were a leader in technologies like Remote PHY that will enable DOCSIS 4.0, and we believe we are well-positioned to capitalize on this implementation once it begins.

Revenue from our telecom products increased slightly to $2.9 million from $2.7 million in Q3 of last year, reflecting the traction that we are making with our newer customer set as this business continues to incrementally grow. We believe that AOI is well-positioned to grow share as 5G continues to roll out and we are optimistic about the future. We also believe that increased competition from 5G will be another catalyst to increased cable spending. In addition to the seven design wins in the datacenter segment, we had three design wins in our telecom segment during Q3, including one design win related to 5G optical modules with the major supplier of 5G networking equipment. This 5G win is also with a new customer to AOI.

For the quarter, 74% of our revenue was from datacenter products; 19% from CATV products; with remaining 6% from FTTH, telecom and other. In the third quarter, we had three 10% or greater customers: two in the datacenter market that contributed 44% and 20% of total revenue, respectively; and one in the CATV market that contributed 10% of total revenue. In total for the quarter, we secured 11 new design wins among eight customers: four of whom are new to AOI, bringing our year-to-date new design wins to 22. As a reminder, for all of 2018, we secured a then-record 26 design wins. So our total of 11 wins this quarter demonstrates an acceleration of our design win activity and one that we believe derives from the effort that we have put into further diversifying our customer base.

Illustrating the effectiveness of our diversification efforts, in Q3, our top 10 customers combined to account for 88.3% of our revenue compared to 92.9% in the same quarter last year. On a year-to-date basis, the concentration of revenue among our top 10 customers decreased from 94% to 89%. This decreasing revenue concentration is in line with our expectations, and we think reflects a positive trend for our business.

In Q3, we generated a gross margin of 28.8%, up from 27.2% last quarter, and at the high-end of our guidance range of 27% to 29%, primarily driven by operational efficiencies and a favorable product mix. Total operating expenses in the quarter declined to $18.4 million, or 39.9% of revenue from $19.5 million, or 44.9% of revenue in the prior quarter, reflecting our efficient expense management.

In the third quarter, we also received economic incentives from the China Government, these [Phonetic] totaled $1.1 million in our accounted for as other income. Operating loss in the third quarter was $5.1 million, compared to an operating loss of $7.7 million in Q2. GAAP net loss for Q3 was $8.8 million, or a loss of $0.44 per basic share compared with GAAP net loss of $11.4 million, or $0.57 per basic share in Q2.

Non-GAAP net loss after-tax for the third quarter was $2.9 million, or a loss of $0.15 per basic share, which was favorable to our guidance range of a loss of $4.2 million to $5.7 million, or $0.21 to $0.28 per share and reflects an improvement over Q2's net loss of $5.2 million, or $0.26 per basic share. The basic shares outstanding used for computing the net loss in Q3 were $20 million.

Turning now to the balance sheet. We ended the third quarter with $72.4 million in total cash, cash equivalents, short-term investments and restricted cash, compared with $84 million at the end of the previous quarter. This reflects $5.8 million in cash used for operations.

As of September 30, we had $82.1 million in inventory compared to $81.5 million in Q2. The modest increase was driven primarily by an increase in 40G orders, which requires inventory additions to meet demand. We continue to believe that inventory levels will rationalize over the long-term. We made a total of $6.1 million in capital investments in the quarter, including $1.8 million in production equipment and machinery and $4.2 million on construction and building improvements.

Looking ahead, we now expect capital expenditures in 2019 to be approximately $46 million. The reduction in capex outlook for the year is largely related to delays in the construction of our plant in China. We still expect many of these expenses to be incurred in Q1 of 2020.

Before turning to our outlook, I would like to provide an update on the ongoing China trade and tariff dynamics. During the quarter, one of our largest customers qualified our Taiwan factory for shipments of datacenter products. As we have discussed previously, we believe that our ability to manufacture datacenter transceivers in both our Taiwan and China factories provides us with an ability to navigate the current trade tensions between the US and China. Looking forward, we believe we are well-positioned to balance production between both our Taiwan and China factories as we look to minimize the impact for both our US-based customers, as well as our customers in China.

Moving now to our Q4 outlook. We expect Q4 revenue to be between $46 million and $49 million and non-GAAP gross margin to be in the range of 26.5% to 29%. Non-GAAP net loss is expected to be in the range of $4.3 million to $5.9 million and non-GAAP loss per share between $0.21 per share and $0.30 per share using a weighted average basic share count of approximately 20.1 million shares.

With that, I will turn it back over to the operator for the Q&A session. Operator?

Questions and Answers:

Operator

[Operator Instructions] Our first question today comes from Samik Chatterjee from JP Morgan. Please go ahead with your question.

Bharat Daryani -- JP Morgan -- Analyst

Yeah. Hi, guys. Thanks for taking my question. This is actually Bharat on for Samik. So the first question I had was one of the networking equipment companies that reported in this earning season as highlighted delayed spending and push out of the refresh cycle at like one large hyperscale customer, which also happens to be your big customer. So just wanted to check does that dynamic impact AOI at all and any insight that you can provide that would be helpful? And then I have a follow-up. Thanks.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

If I understand your question correctly, and I think we're talking about the same customer that I think, yes, that, that reflects the same thing that we've seen. I will note, I mean, AOI has been pretty consistent about saying that this customer was facing some oversupply, over inventory conditions for the last several quarters. And I think we're just starting to hear that maybe now from some other companies. So yes, I think that's the same situation that you're referring to.

Bharat Daryani -- JP Morgan -- Analyst

Got it. Thanks for that. And then some of the feedback that we've also heard from the supply chain is that one of your larger competitors is being more price aggressive in order to take more market share. Is that the same dynamic that you are seeing, or are you seeing pricing environment more challenging than usual, any updates that would be helpful? Thanks.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

No. We haven't seen any real change in the pricing dynamic. And we've been and obviously and we continue to be in a competitive pricing environment, it's been that way since -- since the datacenter market really started to grow, I think a few years ago, but we haven't seen any change. I wouldn't say that -- I wouldn't characterize any of our other competitors is being more price-competitive than before. If anything, I think we're likely to see somewhat reduced price competition from some of the industry consolidation that we've seen, less suppliers makes the need for price competition there, somewhat less on the margin. I'm not saying we predict a big change there, but certainly I don't think it's getting any worse.

Bharat Daryani -- JP Morgan -- Analyst

All right. Thanks for taking my question. Thank you.

Operator

Our next question comes from Simon Leopold from Raymond James. Please go ahead with your question.

Simon Leopold -- Raymond James -- Analyst

Great, thanks. I have two. First one is around the cable space and the cable weakness, I'm imagining there are two headwinds, and I want to see, if you can help me understand the effect of each one being the overall weaker capex spending. The other is some indication that at least some of your customer cable OEMs are trying to exit some of their legacy products, which I presume you've been involved in. So just trying to get a sense of how much of this is sort of the top down spending challenges versus maybe bottoms up changes or adjustments in your customers product portfolios?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Yes. I mean, that's a good question. Thank you. I think the overall effect is really being driven right now by just the weaker spending environment. I think that weaker spending environment along with particular business challenges for various of the OEM suppliers has resulted, I think in some of the suppliers, taking a hard look at what their strategy is going to be moving forward. I wouldn't necessarily characterize that is getting out of business, but they're certainly looking at which product lines makes sense and how that fits into their overall business strategy.

And so, any time there's these kind of shifts going on, I think it represents a combination of some risks and some opportunities. I think the risk is that customers may exit certain products that we're involved in. On the other hand that doesn't results in an overall reduction in demand for those products necessarily, it just means that those products have to go somewhere else. And so we're pretty -- we're actually pretty optimistic that as all of this plays out that there will be new opportunities for us whether with our same partners or other partners or how that's going to play out remains to be seen. But I think it's going to present significant opportunities and when the cable industry begins to grow again, I think those opportunities will become apparent.

Simon Leopold -- Raymond James -- Analyst

Great. And then my follow up is to get your perspectives on the 400-gig market in terms of timing and how that plays into your business? And couple of thoughts, I want to get your impressions of this one -- one of the large OEMs suggested that 400-gig would happen later suggesting it begins in the second half of '20, but becomes material in '21. I didn't think that was any different, but they suggested that was later. And then, I presume for you, if 400-gig happens later, is that a good thing, because you get to reap the sales of 100-gig longer and 40-gig longer, or do you want it happen sooner to be able to participate in that market? Could you help us understand your expectations and sort of the implications for you? Thank you.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Sure. So, I think the schedule on 400G, again, I want to caution not every OEM, not every supplier or every end customer is on the exact same schedule of course. So we have to keep that in mind. But I do think that not unlike what we saw 100-gig and indeed even at 40-gig where, the initial expectations for deployment schedules were a little bit optimistic, I think we're seeing the same thing at 400-gig, where there were a lot of end customers of network equipment operators that wanted to have 400-gig in the network sooner. I think that -- as we've seen with previous cycles sometimes those -- the amount of work and the technology that needs to be ready, it doesn't always move according to their plans. So I would agree with you, I don't really think that's necessarily later than what we had expected, but I think it's a fair statement that it's perhaps later than what some of the operators may have otherwise liked.

When it comes to what's that effect on AOI, I think you're right. We would expect to see a continuation of business for 40G and 100G, until the 400G is there. I don't think the delay is a bad thing for AOI. I think certainly, we've got a good footprint in the 40-gig and 100-gig space. We expect to be a good player, a leading player in the 400-gig space as well, but the delay, if there is one to the extent, if there is a delay, I think it's sort of neutral for us and we will look forward to continued strong sales of 100G and 40G until that time.

Simon Leopold -- Raymond James -- Analyst

Great. Thank you for taking those.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

My pleasure, Simon.

Operator

Our next question comes from Richard Shannon from Craig-Hallum. Please go ahead with your question.

Richard Shannon -- Craig-Hallum -- Analyst

Well, Thompson and Stefan, thanks for taking my questions. I guess, first one on your design wins. I think you talked about seven in last quarter, seven from datacenter and four that were new customers. Maybe, within the datacenter, could you characterize the types of wins here. The 400 -- or excuse me, 100-gig or above and anything about the new customers you can tell us for their Tier 1, Tier 2s, or cloud guys or anything like that?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Yeah. So the design wins in the quarter were -- for the datacenter space we're pretty much all 100-gig type of design wins. We continue to be very -- very active in the 400-gig qualifications, those are ongoing. As the previous question was asked about the schedule, we would expect those qualifications to be ramping-up here in the next quarter or two. And then maybe some limited trials, and then a wider spread deployment in the second half of 2020.

And so that schedule again is sort of broadly in line with what we expected, but the design wins that we're seeing now are largely for 100-gig. And then we did disclose the fact that several of those were with new customers, which I think is very important, because it represents, or it reflects rather the fact that all the effort that we put in, and all the information that we talked to you about in the past, regarding the efforts that we put into diversifying our customer base are actually playing out not only within the datacenter space that is we're becoming less dependent on just a few large datacenter operators, but branching out to a wider swath of the datacenter space. But we also talked about the fact that some of our design wins are coming from areas outside of the datacenter like telecom and in particular the 5G-related telecom qualifications. And I think those are also important for customer diversification going forward.

Richard Shannon -- Craig-Hallum -- Analyst

Okay. Thanks for that detail. One more question from me on the cable TV side, you mentioned a large order. And I believe you said it's something that would be recognized outside this quarter. Maybe just a couple of things, or maybe you can kind of give us a sense of the size of the order. And to the extent you think this conveys a much better environment for at least for your cable business as it relates to [Indecipherable] get into next year, because obviously this year, hasn't been the best for the cable TV business?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Yeah. So the order was actually, I mean, it's the beginning of several orders and we expect to be hopefully a more or less continuous stream of new orders for the Remote PHY. In the quarter, I think those magnitude of the orders in sum was in the low single digit millions, and it will be delivered over the next couple of quarters. So maybe that amount of revenue doesn't necessarily move the needle that much, although it's relatively significant for our Cable TV segment given where it's at right now.

But I think more than that, it reflects a strong statement about the acceptability and the necessity of Remote PHY as a new technology and the fact that is starting to get adopted by MSOs. I believe there was at least two end customer MSOs who were involved in this order, so it's not just coming from one MSO, but there's some -- at the beginning some broad-based demand for Remote PHY among the MSO community. So, I think that's probably, maybe the message more than the revenue from that specific group of initial orders.

Richard Shannon -- Craig-Hallum -- Analyst

Okay. I appreciate the details.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

I'm sorry, you asked also about kind of the -- what does this mean for the overall cable TV business, I guess with AOI. And I would say, certainly 2019 has been a challenging year in the cable space, as you noted. And as others who have already reported even this cycle have also reported relatively weak results perhaps even unexpectedly weak results. As we talked about in our prepared remarks earlier, I think what's happening in cable right now is really a combination of MSOs just kind of reducing their overall spending, largely because the competitive threat is probably somewhat less than they would have perceived it to be a year or two ago.

But the other factor that's its stake here is the fact that -- new technologies continue to become available and we highlighted DOCSIS 4.0 and in particular extended Spectrum DOCSIS, which is a subset of the DOCSIS 4.0 standard. And those new technologies as we have a vendor community start to bring those new technologies to availability. MSOs are justifiably reluctant to invest in older technologies when they know the new technology is imminent. I mean, so I think it's a combination of competitive dynamics and new technology development that's leading to a relatively weak condition right now.

Now all that being said, 5G, I think as it starts to become a real maybe not an actual threat, but at least the perception of that being a near-term threat. We'll start to drive the MSOs, and I think the availability of technologies like DOCSIS 4.0 that will enhance the bandwidth -- dramatically enhance the bandwidth delivery capability of HFC networks, that will also spur a desire by the MSOs to invest and upgrading their networks.

Richard Shannon -- Craig-Hallum -- Analyst

Okay. I appreciate the perspective, Stefan. That's all the questions for me. Thank you.

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Very good. Thanks, Richard.

Operator

[Operator Instructions] Our next question comes from Tim Savageaux from Northland Capital Markets. Please go ahead with your question.

Tim Savageaux -- Northland Capital Markets -- Analyst

Thanks, good afternoon. A couple of questions. First, with regard to 100-gig transceivers, which remains that are pretty reduced level. I wonder, if you could characterize that or update us as a function of overall spending at customers or a function of market share and kind of competitive intensity, should we be focused on a broad return in spending to this year recovery there or just something need to happen on the market share side?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

No. I think, market share has been very stable, Tim, I don't think that's meaningfully changed. In fact, if you look at the bigger picture, as we highlighted in our prepared remarks we're actually gaining new customers for 100G, a number of the design wins that we had as we talked about in the previous -- with the previous question has to do with 100G design wins. So, I think actually we're seeing very positive dynamics in 100G. The 100G business this quarter, the actual unit sales were up 49% sequentially. So quite apart from it being a reduction. I mean, if you can look at year-over-year decline and that's a true statement. But I think on a sequential basis, as we talked about last quarter we thought that Q2 represented kind of a low point in particular 400G sales, but for datacenter overall. And I think that's so far at least proven to be true 100G sales were up sharply. And in terms of units. And as we see the third of our three large datacenter customers starting to pull out of the reduced ordering cycle that they've been in, I think that will be positive for the 100G business. And certainly the new customers that we won this quarter will also be positive for the 100G business.

Tim Savageaux -- Northland Capital Markets -- Analyst

Okay. And kind of unrelated question here, I'm talking about 400-gig. Do you expect to be able to maintain a vertically integrated strategy with regard to lasers as we move 400-gig?

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Yes, that's our expectation. We believe we have the right devices for the 400-gig products. As we talked about we're in qualification on lot of those products right now and things are going well.

Tim Savageaux -- Northland Capital Markets -- Analyst

Okay, thanks.

Operator

And ladies and gentlemen, at this time I'm showing no additional questions. I'd like to turn the conference call back over to Dr. Thompson Lin for closing remarks.

Dr. Thompson Lin -- Founder, President, Chief Executive Officer, and Chairman of the Board

Okay. Thank you for joining us today. As always, we thank our investors, customers and employees for your continued support, and look forward to see many of you at our upcoming investment conference.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Monica Gould -- Investor Relations

Dr. Thompson Lin -- Founder, President, Chief Executive Officer, and Chairman of the Board

Dr. Stefan Murry -- Chief Financial Officer and Chief Strategy Officer

Bharat Daryani -- JP Morgan -- Analyst

Simon Leopold -- Raymond James -- Analyst

Richard Shannon -- Craig-Hallum -- Analyst

Tim Savageaux -- Northland Capital Markets -- Analyst

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