Good day, and welcome to the Applied Optoelectronics Second Quarter 2020 Earnings Conference Call. All participants After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Monica Gould, Investor Relations for Applied Optoelectronics. Please go ahead, ma'am.
Thank you. I'm Monica Gould, Investor Relations for Applied Optoelectronic. And I'm pleased to welcome you to AOI's second quarter 2020 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter of 2020 financial results and provided its outlook for the third quarter of 2020. The release is also available on the company's Web site at a0 inc.com.
This call is being recorded and webcast live. A link to the recording can be found on an on the Investor Relations section of the AOI website that will be archived for 1 year. Joining us on today's call is Doctor. Tom and Lynn, AOI's Founder, Chairman and CEO and Doctor. Stefan Murray, AOI's Chief Financial Officer and Chief Strategy Officer.
Thompson will give an overview of AOI's Q2 results and Stefan will provide financial details and the outlook for the third quarter of 2020. 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 cases you can identify forward looking statements by terminology such as believes, anticipates, estimates, intends, predicts, specs, plans, may, should, could, would, will, or things.
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, continue markets and customer responses to our innovations, as well as statements regarding the company's outlook for the third quarter of 2020. 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 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 December 31, 2019, and the company's quarterly report on Form 10 Q for the period ended March 31, 2020.
Also with the exception 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 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 Jefferies 2020 20 Semiconductor IT Hardware And Communications Infrastructure Summit on September 2nd and at the H. C. Wainwright Twenty 2nd annual global investment conference on September 15th.
These discussions will be webcast live and a link to the webcast will be available on the Investor Relations of the earnings call Thompson Lynn, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?
Thank you, Monica. Thank you, everyone, for joining us today. 4th, our providers once again, sent out entire AOI team that has continued to support one another and our customers during the COVID 19 pandemic. Our condolences go out to all roles around the world who have been impacted by the virus and we send our thanks to the forced responders and essential workers
who
continue to protect and support our communities. Turning to the quarter, ARI delivered Q2 revenue of $65,200,000, which was above our guidance of $55,000,000 to $60,000,000. Tidue revenue grew 50% compared to the 2nd quarter last year and 61% sequentially. Marking the fourth quarter of year over year growth that AOI has recorded since the third quarter of 2017. Our performance was driven by improved demand from our data center customers, increased customer diversifications, and record revenue in our telecom segment led by 5G deployments in China.
Non GAAP gross margin of 23.1 percent was on the lower end of our expected guidance range due to product mix as well as some COVID-nineteen related expenses. This continued into the quarter while non GAAP net loss of $0.24 per share was in line with our expectations. We expect that continued improvement throughout cost reduction efforts and more favorable product mix will lead to improving gross margin over the next several quarters and we anticipate revenue to be up more than 20% sequentially at the midpoint of our guidance range. We are encouraged by the increased data center demand from our diverse set of customers and improving 5G related activity that began earlier this year and will continue into Q3. During the quarter, we had Epizan Wins including 4 with telecom customers, which are related to 5G network deployments, mainly in China.
The other 4 design wins were with existing customers in our data center segment. Additionally, we are pleased to report that We saw increased demand for our 1 100 Gig products in Q2. Total revenue for 1 100 Gig products increased almost 3 50% from same period last year, marking the 2nd quarter in a row of year over year growth in 100G sales. During the second quarter, we saw significant improvement in our telecom and cable sectors. Globally in our telecom segment more than doubled potentially and outpace our CATV business, driven by increased 5G activity Our Cable segment improved sequentially as we began to see increased order flow for product related to CAT grades in North America.
We are pleased to be project we received our 4th significant orders for CATV products related to MSO upgrades in Q2, which will begin to ship in Q3. As we stated in our previous earning calls, We have taken various action to ensure the safety and well-being of our employees who are continuing to support our customer needs and the needs of the communities in which we operate. Our offices and factories around the world effective normal operation due to our strict adherence to hails and safety recommendations. Looking ahead, we'll continue to physically enforce these health precautions to protect the welfare of our employees and our communities.
With that, I'll turn the call over to Stefan to review the details of our Q2 performance and outlook for Q3. Stephen. Thank you, Thompson. As you may recall, we had disruptions in operations in our China factory during Q1, However, as Thompson mentioned, due to the hard work and dedication of our employees and supply chain partners, we are back to normal operations. And have increased capacity in both our wafer fab and Sugar Land as well as our factories in China and Taiwan, compared to our capacity pre COVID.
We continue to see high demand from our data center customers who remain focused on improving network performance in light of the increased traffic that we believe are related Looking ahead to Q3, we are expecting over 20 percent sequential growth at the midpoint of our guidance range and a continued improvement in our gross margin. Turning to our quarterly performance, total revenue for the second quarter was $65,200,000, which was above our guidance range. Our data center revenue rose 58 percent sequentially and 65% year over year to $52,600,000, and accounted for 81% of our total revenue. This was our highest data center revenue quarter in 2 years. In the second quarter, 33 percent of our data center revenue was from our 40 G Transceiver products and 64% was from our 100 G S.
As Thompson noted, this marks the 2nd quarter in a row of year over year growth in our 100 G transceivers. Importantly, we continued to Overall, for the quarter, our top 10 customers represented 86.9 percent of revenue, which is down from 90.9% in Q2 of last year. We had 3 10% or greater customers in the quarter, all of which were in the data center segment. These customers contributed 35%, 15% and 12% of total revenue, respectively. One of these data center customers was a new 10% customer for AOI, where we have been gaining share.
This new customer is a U. S.-based hyperscale cloud operator that has primarily been purchasing our 100g transceivers. We also have seen increasing revenue from a large U. S.-based switch router vendor who approached the 10% revenue mark this quarter. Rounding out our top 5 customers, was a data center customer in China.
Looking at our customer base as a whole, in addition to the 10% or greater customers, we had 3 other customers who each contributed between 5% 10% of total revenue. To put this in some context, In Q2 of last year, we had only 2 10% or greater customers and one customer between 5% 10%. Now we have 6 customers each over 5% and we are pleased to see that our efforts in diversifying our customer base continue to show tangible results and that many of these new our top 10 customers are also geographically diverse. Out of our 5% or greater customers in Q2, all but one were U. S.-based Multinationals.
And the remaining one was a China based switch router vendor primarily serving the data center market. Looking at our top 10 customer in Q2, 7 were U. S.-based Multinational Corporations, 2 were based in China and 1 in Europe. Turning to our Cable T Television Products segment, we were able to resume manufacturing at a normal capacity during the quarter, and recorded a sequential revenue increase of 45 However, CATB revenue remains below the $9,800,000 we recorded in Q2 of last year. The sequential increase was driven by an increased order flow in North America for cable CD upgrades.
As I noted earlier, we saw our first significant orders for CATV upgrades driven by the shift to working from home this quarter, which we will recognize as revenue For the remainder of the year, point $2,000,000 and accounted for 10% of total revenue, reflecting an increase of 141% from the 1st quarter, and 2 79% from Q2 of last year. These results continue to be driven by increased 5G demand in China. Based on current order trends, we expect to see continued strong sequential growth in CATV and telecom revenue in Q3. In Q2, we generated non GAAP gross margin of 23.1% compared to 27.2% in Q2 of the prior year. Gross margin was at the low end of our guidance range along with increased costs, including manufacturing and shipping costs related to COVID.
We expect gross margins to recover to pre COVID levels we implement cost reductions that were delayed by the pandemic. We also expect to see improvements in our product mix Total non GAAP operating expenses in the 2nd quarter were $20,600,000 or 31.6 percent of revenue compared with $19,500,000 or 44.9 percent of revenue in the same quarter last year. Operating expenses increased from last year due mainly to increased shipping costs, sales commissions and insurance costs. Non GAAP operating loss in the second quarter was $5,600,000 compared to an operating loss of $7,700,000 in Q2 of last year. GAAP net loss for Q2 was $18,600,000 or a loss of $0.89 per basic share compared with a GAAP net loss $11,400,000 or $0.57 per basic share in Q2 of last year.
On a non GAAP basis, net loss for Q2 was $5,000,000 or a loss of $0.24 per basic share, which was in line with our guidance range of a loss of $4,100,000, to $5,700,000 or a loss of $0.20 to $0.28 per basic share and compares to a net loss of $5,200,000 or loss of $0.26 per basic share in Q2 of last year. The basic shares outstanding used for computing the net loss in Q2 were $20,900,000. Turning now to the balance sheet. We ended the 2nd quarter with $58,900,000 in total cash, cash equivalents, short term investments and restricted cash. This compares with $62,500,000 at the end of the 1st quarter and reflects $15,500,000 we had $97,300,000 in inventory compared The increase was driven by additional raw materials purchased for production orders on hand and forecasted orders.
Capital investments in the quarter, including $5,000,000 in production equipment and machinery and an immaterial amount on construction and building improvements. This is lower than we had anticipated, primarily due to a COVID related pause in construction on our new China factory. Note that we expect to resume spending on our new facility in China in Q3, and we anticipate this to be reflected in increased spending on construction and building improvements. Including this resumption in building expenditures and other equipment necessary to increase our production capacity, we expect total 2020 capital expenditures to be approximately $42,000,000. Although I would caution as in years past, that this number is likely to be reevaluated as our plans continue to evolve.
Before we turn to our outlook, I would like to provide an update on the at the market offering we announced in February. To date, we have raised $22,000,000 in gross proceeds under this program, including $7,700,000 raised in July, which will be reflected in our Q3 financial statements. We intend to use these proceeds to continue to make investments in Moving now to our and non GAAP expected to be in the range of $4,600,000 to $600,000 and non GAAP loss per basic share between $0.20 3¢ using a weighted average basic share count of approximately 23,400,000 shares. With that, I will turn it back over to the operator for the Q and A session.
Thank you. And the first question will come from Alex Henderson with Needham And Company. Please go ahead.
I actually have two questions. So the first one, the new hyperscale customer, there was a other supplier into that customer, if I believe, which was in a light, and I'd heard that they had some supply chain disruptions do you think that that's a part of the reason that you got in, or do you think that, you would have been in regardless of what the competitor supply availability looks And does that have any impact on the way you're thinking about the outlook?
I can't say that there's anything specific about any of our competitors that would have impacted this customer's decision. I mean, it's a customer that we've been working with for some time to gain some traction there. And I think they've appreciated our ability to supply. And I've the complete profile that we bring to the table with cost and quality and delivery advantages, I think it was much more about us than about, some competitor losing that traction there.
Glad to hear that. The second question I wanted to delve into the telco piece, I mean, it seems pretty clear that what's driving this is the chipsets going into CIPRI and front haul for 5G that, is a huge build over time, not just in China, but globally. And I'm assuming that these are chipsets that are selling in there. Can you give us some sense of what the rate of chips that are going into that market looks like, how many are diodes some of your EMLs? And to what extent, you see that ramping from here?
And any sense of what the TAM is for that market over the next 3, 4, 5 years, as that 5G footprint gets filled out?
Yes. So there's a few questions embedded in there. As far as the ratio or the precise types of lasers, I don't have a breakdown on that. I mean, it's a combination of, DFP lasers that we're selling. Some EMLs, but very small and some transceivers.
The precise breakdown, I don't have available now. As far as the TAM there, it really remains to be seen. I think in China alone, which is where we're seeing the most activity right now. They're talking about tens of 1,000,000 of towers, which would be several many tens of millions of radios, each of which would require a front haul transceiver. So you can kind of get a an appreciation that the size of that market is really large.
Our anticipation is not that AOI is going to be a majority player or anything like that in that market. But I think that it's very reasonable for us to expect to get 10%, 20% of that market, and hopefully expand, over time. And as as the opportunities in the rest of the world outside of China begin to materialize to continue to grow that market share.
If I could just finish one last question on that same subject. The impact significant, do you expect to see a couple of points of margin expansion as these volumes ramp relative to the, other transceiver business, because of the overhead allocation associated with that?
Yes, I mean, I won't comment on the exact magnitude that we expect to see. We have given guidance, of course, that indicates, continued improvement in our gross margin. We mentioned that in our prepared remarks as well. You saw the improvement from Q1 to Q2 already. And that's due to a number of factors, but certainly cost reduction overall coming from higher fab utilization is a big part of that.
And we would expect that to continue as long as the growth in that chip market continues.
Thanks for the answers and thanks for the great quarter.
The next question will come from Simon Leopold with Raymond James. Please go ahead.
Great. Thank you guys for taking the question. First, just a very quick easy clarification. The percent of datacom that was 100 gig. Did you say 54 or 64?
I'm sorry, you cut out there just a little bit. I think you're asking about the data center revenue that was 100 gig. And if so, that's 64% 64.
Great. Thank you. Sorry about that. I'm a little bit internet and power disadvantaged Thanks for the tropical storm. So I'll try to speak up and be quick.
I wonder if you could maybe branch the gross margin. It was a little light this quarter on very good revenue. And similarly, like in the guidance, I'm just wondering if you could explain how much of the pressure is COVID expenses how much maybe is mix if the telecom products are dilutive to the gross margin? Just help us understand those factors.
Sure, Simon. Some of it is COVID, not a lot. I think the main factor is, well, really two things. It's it's product mix related and it's cost reduction related. In other words, those are the 2 things that we have, 2 levers that we can pull from here on to try to continue to see improved gross margin.
As I mentioned in the previous question or answer to the previous question, the fab utilization helps in terms of improving those to flow through because we have a significant amount of inventory and their cycle time associated with it. So the improvements that we expect to see We believe are real and they're coming, but it takes some time for them to actually materialize in the financial statements.
Great. And then just one last one, if I might. The new data center, 10% customer, which is really good news, Is this something you see as sustainable? Or basically as far as you can forecast, or was there something one times about this quarter?
No. I mean, this customer has actually been growing with us for some time. Slowly. And they just made it into that 10% category this quarter. But I would not expect that to be a flash in the pan type of thing.
I think we've done a good job with this customer. They all accounts seem to like us as a supplier and, barring unforeseen circumstances. I don't see any reason why they wouldn't continue to purchase from us.
The next question will come from Paul Silverstein with Cowen. Please go ahead.
Thanks for taking the questions. Hopefully, this is different than what Allison has asked you, but on the gross margin front, Stefan, do you have visibility to getting back to 30 plus percent? And if you do, can you give us a sense for when that is? I appreciate that it takes time to flow through for your previous responses, but any visibility right now?
I mean, I think our goal is to get to the 30 plus percent range. I could see us getting into the upper 20% range by the end of the year. Whether hit 30 in that timeframe. I mean, I suppose there's some scenarios that where that could happen, but that's probably not as likely. But I think we're talking about a matter quarters, not years for us to get back to that 30% level.
And I trust the competitive dynamics are not meaningfully different today than they were previously either better or worse?
No, I mean, we haven't seen any real changes in the competitive dynamic.
All right. And one other question on margins from a pricing perspective, I know there are resets once to twice per year depending on the customer. I assume that's still true, but in terms of those resets, any insight you can provide in terms of what it's looking like?
Nothing specific. Obviously, we don't give that type of guidance typically. I can't say that we are seeing pretty strong demand right now. And in past situations where we've seen that kind of strong demand, typically that provides a little more, a little more pricing leverage on the suppliers as opposed to the customers. But again, that's just an observation from prior periods.
I can't really speculate about the pricing resets that we might see in the future.
Understood. One last quick question. I assume my definition when we're talking about the China 5G opportunity, we're talking about 3, maybe 4 systems customers that you do or can sell into to access that opportunity in terms of Huawei's UT fiber home and perhaps was that the Telstra Line High Bell And Nokia? Does that go without saying?
Yes, just I think that's correct in terms of the end customer just to be clear, many of our customers manufacturers that then supply those transceivers. So we would supply laser diodes, for example, into those transceiver manufacturers. They would manufacture the transceivers and then sell them to the end customer. So much of our business is likely not to be directly with those big guys, but I would assume, based on my knowledge of the market there, that your list of end customers is accurate.
Got it. And did you say how many of those transceiver customers you're selling into or can you share that with us?
A lot of them. There's probably more than a dozen.
That's all I need. I'll pass it on. Thank you.
Our next question will come from Samik Chatterjee with JP Morgan. Please go ahead.
Yes, hi. Thanks for taking my question. This is Bharat on for Samik. So, if I could just start with the data center segment and I think it was just, I think, couple of quarters highlighted 100 gigawatts. So just wanted to understand what we're seeing there.
I mean, have you started shipping to that customer already has that started to do that and any update on probably when revenue can come from that. So, okay, can you think about what are the milestones there? Thanks.
Hey, Samik, I'm sorry to say that your line is very difficult to understand. So I missed that question. Can you try to repeat it?
Yes. Hi. So this is Bharat. So if I could just start on the data center segment and 400 giga specifically. So I think it was a couple of quarters ago that you highlighted a design win there with a NEM customer.
So I just wanted to get a sense of you started to shift to that customer already and any update on when new recognitions can come from that. So what are some of the milestones there that we can track?
Okay. So the question was regarding 400 G. We haven't shipped significant quantities to that customer or any other customer of 400 G yet. My sense is that the 400 G, because of COVID, I think some of the 400 G qualification efforts are are taking longer than expected. And I don't think that's anything unique to AOI.
I think for the information that we have is that a lot of particularly the hyperscale customers, many of them are working from home just like many of us. And That complicates qualification efforts because you've got engineers that can't come to the lab or they're otherwise constrained in their ability to complete those qualification efforts. So my sense is that that 400 G revenue is probably pushed out a little bit. But that's not necessarily a bad thing for us either. I mean, if you look at our results this quarter, we're seeing very strong uptick in 100g revenue.
And I would expect that to continue to be there until such time as 400G is ready.
Got it. And if I could just ask a follow-up on the telecom end market, I mean, can you help us think about what's the run rate revenue you're expecting from that business as we look into the second half. And the reason I asked that is, how should we think about like the capability of demand of 5G from China because that some of the equipment peers have called out that there's a high inventory across OEMs that may clear back some purchasing in the region in the second half. So I just wanted to understand what the drivers are there as you look into the second half.
Yes, we don't give, breakdown by segment on a forward looking basis, but, I imagine this will be just like any other market, right? There'll probably be some ups and downs as we go forward, but I think the, on a quarter by quarter basis, you may see some variability there, but I think the overall trend towards increased volumes with this 5G deployment that's happening, I think, is pretty clear.
Okay, got it. Thank you for taking my questions.
My pleasure.
The next question will come from Dave King with B. Riley. Please go ahead.
I was wondering if you guys, if you guys could provide more color around new customer wins. Are there any 400 GE customers that you guys have in the pipeline? Or is that Is that, does that push out still, kind of how you guys are trending?
Well, as I mentioned before, I think a lot of the 400 G qualification efforts are getting pushed out. We did not have any 400 G wins this quarter. But I also, to be clear, we didn't have any, any notifications that we are no longer under consideration. 400G. In other words, we're kind of at the status quo that is.
I think that the qualification efforts have just gotten pushed out and slowed down a little bit. With our customers. And that's true for us, as well as for any of our competitors. And so, as I said earlier, I think our business is in 100 gig is growing very nicely. And so the 400 G delay isn't necessarily a bad thing for us.
That gives us some time to, work on the cost and manufacturer ability of those devices. And that can only be a good thing for us, when the time comes.
Okay. Thank
Our next question will come from fahad Najam with Cowen. Please go ahead.
Hi, Stephan. Tom, thank you for taking my question. Much of my questions have already been answered, but I'll ask you, a question in terms of any trends you're seeing amongst your largest hyperscale the U. S. Based hyperscale customers for need to push, pull the supply chain out of China into outside of China, maybe in the U.
S. Especially given the fact that Microsoft and Amazon tool fewer customers have or have been vying for this significant U. S. Government DOD are you seeing a request or pull in from your customers to move some of your supply chain out of China? Can you provide some color there?
Well, sure. As we've noted for the last few quarters, we've been producing more and more of our products in Taiwan as opposed to China. And the customers are certainly aware of and supportive of that. I think right now the focus has largely been, due to the tariff situation. Not because they necessarily have a mandate to move out of China.
As the political situation with China continues to evolve, that could become more of a factor. But for now, I think it's mainly just the cost reason, why they want us to produce more in Taiwan. But it's certainly been a factor of conversation with the customers. Yes.
Can you share with us today how much of your production is outside of China now versus before the Powder situation?
It's a really difficult question to answer Fahad because what we've been doing is we've been moving certain parts of the manufacturing from China to Taiwan, and we've been doing other earlier parts of the manufacturing process in China. So it's not like we've completely moved production from China to Taiwan. It's been more of a reassignment of manufacturing activities between the two plants.
Related to previous questions around gross margin, do you think that moving your production or if you settle on to a more several routine and supply chain payout out of Taiwan. Do you think that that would help your gross margin cost structure going forward? Is that what you were alluding to when you said your cost structure kind of depend on? Is that driven by the fact that you're still transitioning a lot of your production out of China into Taiwan and that's driving up some incremental costs over the near term?
There's some incremental cost in there. But I actually think, look, the labor cost, for example, in Taiwan is more expensive than China. So on balance, once we hit a steady state here, the gross margin, if we can't do significant cost reduction, like we have been doing, then the gross margin would tend to trend down because of that. The reason why we think it's going to go up is, again, product mix and very attention, very, very good attention that we're paying to our cost, cost of production. And ability to continue to improve our manufacturing, improve our supply chain to get that cost to come down.
And that's a big part of what we're expecting in order to see the gross margins get back to that upper 20% and then ultimately 30% range.
This concludes our question and answer session. I would like to turn the conference back over to Thomas Lynn, Chief Executive Officer for any closing remarks. Please go ahead.
Again, thank you for joining us today. As always, thank you to our investors, customers and employees for your continued support and we look forward to virtually seeing many of you at our upcoming investor conferences.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.