Q3 2019 Earnings Call

Good afternoon, everyone. My name is Jamie and I'll be your conference operator today.

At this time I would like to welcome everyone to applied Optoelectronics third quarter 2019 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 answer session.

To ask a question you May press Star then one.

For me yourself from the question can you maybe press star and too.

If at any time you need assistance during today's conference you May press star in zero.

Please also note today's event is being recorded.

At this time I'd like to turn the conference call ever to Monica Gould Investor Relations for a lie misquoted you may begin.

Thank you and Monica Gould applied Optoelectronics Investor Relations and I'm pleased to welcome you do a wide third quarter 2019 financial results Conference call.

Actually the market close today why issued a press release announcing its third quarter 2019 financially sound and provided its outlet for the fourth quarter of 2018.

Leases also available on the company's website at Aon Gosh Inc. dotcom.

This call is being recorded and webcast slide a linked to that recording can be found any investor relations page of D.A. website would be archived for one year.

Joining us on today's call is Thompson Lin Aways, founder Chairman and CEO Dr., Stephen Murray Aways, Chief Financial Officer in Chief Strategy Officer.

Thompson will give an overview of a wise Q3 results and Stephane will provide financial details in the outlook for the fourth quarter of 2019.

A question answer session will follow our prepared remarks.

Before we begin who'd like to remind you too if you Hey, why 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 anticipating such forward looking for.

<unk>.

In some cases, you may identify forward looking statements by terminology such as believes anticipates estimates intense predict expects plans me should could would well where things and by other similar expressions that convey uncertainty a 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 statements regarding the company's outlook for the fourth quarter of 2018.

Except as required by law, we just don't 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 the 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 FCC, including the company's annual report on Form 10-K for the year ended December 30 120 team.

Also with the exception of revenue all financial numbers disclosed today or in a non-GAAP basis, unless specifically noted otherwise non-GAAP financial measures are not intended to be considered an isolation or as a substitute for results prepared in accordance with gap.

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 know that eight why management what percent at the Needham Security networking Communications Conference in New York on November 12, the Raymond James Technology Conference in New York and December 10, and the Cowen networking Cyber security Summit on December 11.

We hope to have the opportunity to see many of you there.

Italy. Additionally, I'd like to know the data for fourth quarter 2019 earnings call is currently scheduled for February 25th 2020.

Now I'd like to turn the call over to Dr. Thompson Lin applied Optoelectronics, founder Chairman and CEO .

Thompson.

Thank you Marty call and said you everyone for joining US today, we're pleased with will continue as fusion in the quarter.

Well, it's a good quarter, you know load with the devaluation in like we saw Guy does not you better than expected to reach out on the bottom night.

Got it Eva revenue of $46.4 million non-GAAP gross margin of 28.8 per se.

non-GAAP net loss of 15 cents this year.

In looking at the dynamics in the quarter the death of demand environment remained consistent with expectations would cut into the early signs of recovery among two of all hyper scale data center customers.

Coach Palestine, and believe the fundamental need for high up in ways within Hyperscale data centers will drive long term goals.

However in the near term, we remain cautiously optimistic on the hyper scale market as demand continues to stabilize among our customers.

You can see a TV we remain encouraged by the going into is always more five product enough free to report awful.

Good remote phy order in the quarter.

Lets smoke, we're demonstrating our remote phy solutions.

He should trade show in new owning and had a very positive response from our current and potential customers.

However, the overall cable TV demand environment continues to be salt, resulting in case the men for some of our legacy production.

Additionally, the TV demand in China remain weak as a new job or trade patients.

We continue to make good progress in diversifying our customer base and during the quarter with cure you'd been new design wins, including four from new customers. In summary, we appreciate we started with jobs and the improving gross margin, which led to another quarter or better than it would take it.

The next chart, we do you meant focus on expanding our relationship with both new and existing customers.

And maintaining our penalize you need issues.

We believe all play fall proprietary and the geographically diverse make picture in and vertical integration.

Key competitive advantage and we do you mean public dent in the ability to execute.

Sure well ahead of us as a marquee improve.

With that I would turn the call although to stay open to review the details of our Q3 performers and notable Q4 seven.

Thank you Tom.

Our Q3 results were broadly in line with our expectations and reflects 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 data center revenue came in at $34 million compared with $39 million in Q3 of last year.

In the third quarter, 69% of our data center revenue was from our 40 G transceiver products.

25% was from our one hundredg products.

We continue to make good progress with our customers as they work to qualify or four hundredg products for data center applications.

Data center market dynamics played out similarly to last quarter.

We continue 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.

All these improving dynamics are encouraging we remain cautiously optimistic in the near term.

We had seven design wins in the quarter and our data Center segment.

Of these seven to our new customers in the quarter and an additional two our incremental wins with the recent new customer.

Turning to our cable television product segment.

Revenue from sea ACB products decreased 38% year over year to $8.8 million from $14.3 million in Q3 of last year.

Primarily driven by we can 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 MSR was our delaying upgrades pending the availability of new technologies, such as DOCSIS 4.0.

Despite these near term challenges. We're pleased to report is significant order for a remote phy gear from our largest CTV customer.

We had a very positive reaction to our latest remote phy product at the society for cable Telecommunications engineers or S.C.T.E. conference last month, the New Orleans.

In addition to our standard for more five 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 finalized by the ended the year.

Once finalized we believe this latest DOCSIS standards 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 position 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 AOL is well positioned to grow share as fiveg continues to roll out and we're optimistic about the future.

We also believe that increased competition from Fiveg will be another catalyst to increased cable spending.

In addition to the seven design wins in the data Center segment, we had three design wins in our telecom segment during Q3.

Including one design win related to Fiveg optical modules with the major supplier of Fiveg networking equipment.

This fiveg went is also with the new customer to Hawaii.

For the quarter, 74% of our revenue was from datacenter products, 19% from sea ATP products with the remaining 6% from ft Th telecom and other.

In the third quarter, we had 310% or greater customers to in the datacenter market that contributed 44% and 20% a total revenue respectively and wanting to see TV market that contributed 10% of total revenue.

In total for the quarter, we secured 11, new design wins, among eight customers for whom are new to Hawaii.

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% and 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 inline with our expectations and we think reflects the 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%.

Generally driven by operational efficiencies and a favorable product mix.

Total operating expenses in the quarter declined to $18.4 million were 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 totaled $1.1 million and 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 44 cents per basic share compared with GAAP net loss of $11.4 million or 57 cents per basic share in Q2.

non-GAAP net loss after tax for the third quarter was $2.9 million or a loss of 15 cents per basic share, which was favorable to our guidance range of a loss of $4.2 million to $5.7 million or 21 cents to 28 cents per share and reflects an improvement over Q2 s net loss of $5.2 million or 26 cents per.

Basic share.

The basic shares outstanding use 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 and 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.

A modest increase was driven primarily by an increase in 40 G 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 data center transceivers in both our Taiwan and try to factories provides us with an ability to navigate the current trade tensions between the U.S. in China.

Looking forward, we believe we are well positioned to balanced production between both our Taiwan and China factories, as we look to minimize the impact for both our U.S. 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%.

GAAP net loss expected to be in the range of $4.3 million to $5.9 million and non-GAAP loss per share between 21 cents per share and 30 cents 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 and a session operator.

Ladies and gentlemen at this time will begin the question and answer session.

To ask a question you can press Star then one using a touched on telephone if you are using a speaker phone, we do I see please pick up your handset before pressing the keys.

So it's all your questions you mean press star into <unk>.

It's again that is fine then one to ask a question.

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

Yes, hi, guys. Thanks for taking my question. This is actually but up on for some Oh. So the first question I had was one of the networking equipment companies that reported in this earning season as highlighted dollar dealing spending and push out of the refresh cycle like you make one large hyperscale customer, which also happens to be all big customer So Joe.

Wanted to check does that dynamic impacting your way at all and any insight that you can provide that would be up and then I've a follow up thanks.

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, you know airwatch has been pretty consistent about saying that this this customer you know 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 thats the same situation that you're referring to.

Got it thanks for that and then some of the feedback that we want to hide from the supply chain is that guano fail or larger competitors is being more price aggressive in order to take more market share.

In fact, the same dynamic that you were seeing or are you seeing pricing in lemon more challenging than usual any any updates there. Thanks.

No we haven't seen.

You know any any real change and the pricing dynamic and we've been in obviously and we continue to be in a competitive pricing environment, it's been that way since.

Since the data center market really.

Started to grow I take 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 than before.

If anything I think we're likely to see.

You know somewhat reduced price competition from some of the industry consolidation that we've seen you know less less suppliers.

You know makes makes the need for price competition, there somewhat last on the margin I'm not saying, we predict a big change there, but certainly I don't think it's getting any worse.

Right. Thanks for taking my question. Thank you.

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

Great. Thanks, I have two first one is around the cable space on the cable weakness I I'm imagining there there are two headwinds and I want to see if you can help me understand the effective of of each one being the overall weaker capex spending the other is some indication that 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 so just trying to get a sense of how much of this is sort of the the top down spending challenges versus maybe bottoms up.

You know changes or adjustments in your customers product portfolios.

Yes, I mean thats. Good question. Thank you I think the the overall effect is really being driven right now by just the weaker spending environment.

I think that weaker spending environment, a along with you know 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 as getting out of business.

But there certainly looking it at a which product lines makes sense and how that fits into their overall business strategy and so you know anytime there's these kind of shifts going on.

I think it represents a combination of.

You know some some risks and some opportunities I.

I think the the risks.

Is that you know customers may exit certain products that that a that were involved in.

The other hand that doesn't result result in an overall reduction in demand for those products necessarily it just means that that those products have to go somewhere else and so we're pretty.

Were actually pretty optimistic that as all of this plays out that there will be new opportunities for us.

Whether there 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, a significant opportunities and when the cable industry begins to grow again, I think those opportunities will become apparent.

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 I want to get your impressions of is one or one of the large Oems.

Suggested that 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 at 400 gig happened 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 happened 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.

Sure So I think the.

The schedule on on four Hundredg again, you know I want to cautioned not not every OEM not every supplier.

Or every end customer is on the exact same scheduled of course, so we have to keep that in mind, but I do think that I'm not unlike what we saw at 100 gig and indeed, even at 40 gig where you know the initial expectations for deployment schedules were were a little bit optimistic I think we're seeing the same same thing at 400 gig where there were a lot of.

Okay and customers of network equipment operators that.

That wanted to have 400 gig in their network sooner I think that you know as we've seen with previous cycles, sometimes those the amount of work in the technology that needs to be.

Ready doesn't always move according to their their 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 it's a fair statement that it's perhaps later than you know what some of the operators may have otherwise like when it comes to what's that effect on A.O. I think you're right we.

We would expect to see a continuation of business for us for Fortyg and one hundredg.

Until the 400. She is there I don't I don't think the delay is a bad thing for you I think you know certainly we've got a good a good footprint in the 40 gig and 100 gig space, we expect to be of a good player a a leading player in the 400 gig space as well.

But you know the delay if there is one to the extent that there is a delay I think it's it's sort of neutral for us and we'll look forward to continued strong sales of one energy and 40 G until that time.

Great. Thank you for taking those.

A pleasure site.

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

Well Thompson Stephen Thanks for taking my questions I guess first one on your design win should I think you talked about sevens and last quarter seven from data center and for that were new customers, maybe she's a within the data center could you characterize.

The types of wins here, they 400, or excuse me 100 gig or above and and anything about the new customers you can tell us whether tier one tier twos or cloud guys or anything like that.

Yes, so the design wins in the quarter were for the data center space, we're pretty much all 100 gig type of design wins, we continued to be very very active in the 400 gig qualifications those are ongoing.

As the previous question was asked about the schedule you know we would expect those qualifications to be wrapping up here in the next quarter or two and then maybe some limited trials and then a a wider spread deployment.

The second half of 2020.

And so you know that schedule again, it's sort of broadly in line with what we expected, but the design wins that we're seeing now are largely for 100 gig and we did disclose the fact that several of those were with new customers, which I think is is very important because it represents or it reflects rather the fact that all the efforts that we've put in and all the information.

We've 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 data center space that is we're becoming less.

Less dependent on just a few large data center operators, but.

You know, but the branching out to a wider.

Swath of the data center space, but we also talked about the fact that some of our design wins are coming from areas outside of the data center like telecom and in particular the fiveg.

Related telecom qualifications and when it goes we're also important for customer diversification going forward.

Okay. Thanks for that detailed one more question for me on the out of the cable TV side are you mentioned a large order.

I believe you said, it's something I'd be recognize 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 ER to the extent you think this conveys a.

A much better environment for for at least for your cable business as it relates room ultimate Pfizer get into next year, because obviously this year hasn't been the are the best for the cable TV business.

Yes. So you know the order was actually I mean, it's the beginning of several orders and we expect to be hopefully a a more or less continuous stream of new orders for the remote phy.

In the quarter I think the magnitude of the orders in some was in the low single digit millions.

And it will be delivered over the next couple of quarters. So you know maybe that Mount of revenue doesn't necessarily move the needle that much although it's relatively significant for our cable TV segment, given you know where is that 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.

By Misos I believe there was at least two and customer Misos, who are involved in this order. So it's not just coming from one MISO, but there's.

Some some of the beginnings of some broad based demand for remote five among the MSR community. So I think thats probably.

Maybe the message more than the revenue from that specific a group of initial orders.

Okay I appreciate the detail.

Right.

I'm sorry, you asked also about kind of the what does this mean for the overall cable TV business I guess with they are and I would say you know certainly 2019 has been a challenging year in the cable space. As you noted and you know as others, who have already reported even this cycle have also reported.

Relatively weak results, perhaps even unexpectedly weak results.

You know as we talked about in our prepared remarks earlier I think whats happening in cable right now is really accommodation of.

Have you.

Misos, just kind of reducing their overall spending largely because you know the competitive threat.

It is probably somewhat less than they would have proceeded to be a year or two ago.

But the other factor that is at stake here is the fact that you know 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 you know those new technologies as we as we as it's a vendor community start to two to bring those new technologies to two availability you.

You know episodes or justifiably reluctant to invest in older technologies when they know that the new technology is imminent.

So I think it's a combination of competitive dynamics and and new technology development that that's leading to a relatively weak condition right now now all that being said.

Fiveg I think as it starts to become a real maybe not.

Actual threat, but at least the perception of that being a near term threat, we'll start to drive the m. Assos and I think the availability of.

Technologies like DOCSIS 4.0 that will enhance the bandwidth dramatically enhanced the bandwidth.

Delivery capability of HFC networks that will also spur a desire by the misos to invest and upgrading their networks.

Okay I appreciate the perspective, Stephan that's all the questions from me. Thank you.

Thanks, Richard once again, if you would like to ask a question. Please press star and then one to withdraw your questions you May press star and too.

Our next question comes from Tim Savageaux from Northland Capital markets. Please go ahead with your question.

<unk>.

Thanks, Good afternoon, a couple of questions first with regard to 100 gig.

Transceivers, which remains that are pretty.

A 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 the fear recovery, there or do something you'd to happen on the market share aside.

No I think market share has been very stable Tim I don't think that's that's meaningfully changed in fact, if you. If you look at the bigger picture as we highlighted in our prepared remarks were actually gaining new customers for one hundredg.

A number of the design wins that we had as we talked about in the previous with the previous question has to do with energy design win. So you know I think actually we're seeing very positive dynamics and energy. The one hundredg business. This quarter. The actual unit sales were up.

49% sequentially. So you know quite apart from it being a.

Reduction I mean, if you can look at year over year decline and that's that's that's a true statement, but I think on a sequential basis as we talked about last quarter. You know, we thought that that Q2 represented kind of the.

A low point in particular for 100, GE sales, but but for data center overall.

And I think thats, so far at least proven to be true hundredg sales were up sharply and in terms of units and and.

Well as we as we see is a third of our three large datacenter customers starting to.

Starting to pull out of the reduced ordering cycle that they've been in I think that will be positive for the energy business and certainly the new customers that we one this quarter was to be positive for the one energy business.

Okay and are 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 to 400 gig.

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 a lot of those products right now and things are going well so.

Okay. Thanks.

Well.

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

Okay. Thanks for joining us today as always within all investors customers and employees. So you can use the pull into cool to see many of you and I'll comment you made some encumbrance.

[noise].

Ladies and gentlemen that does conclude today's conference call would you. Thank you for joining you may now disconnect your lines.