Good day, and welcome to the Applied Optoelectronics First Quarter 2019 Earnings Conference Call. All participants will be in a listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Maria Riley, Investor Relations for AAOI. Please go ahead.
Thank you. I'm Maria Riley Applied Optoelectronics Investor Relations, and I'm pleased to welcome you to AOI's first quarter 2019 Financial Results Conference Call. After the market closed today, AOI issued a press release announcing its first quarter 2019 financial results, and provided its outlook for the second quarter of 2019. The release is also available on the company's website at a0 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 Web site and will be archived for 1 year. Joining us on today's call is Doctor. Thompson Lin, 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 Q1 results and Stefan will provide financial details and the outlook for the second 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 company's actual results to differ materially from those anticipated in such forward looking statements. In some cases, you can identify forward looking statements by terminology such as believes, anticipates, estimates, intends, predicts, expects, plans, may, should, could, will, or think 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 as well as statements regarding the company's outlook for 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 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 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 attend the Stifel Cross Sector Insight Conference in Boston on June 11th.
We hope to have the opportunity to see many of you there. Additionally, I'd like to note the date of our second quarter 2019 earnings call is currently scheduled for Wednesday, August 7, 2019. Now I'd like to turn the call over to Doctor Thompson Lynn, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?
Thank you, Maria, and thank you, everyone, for joining us today in reviewing our 4th quarter result. You had a delivered revenue of $52,700,000. Non GAAP gross margin of 25.5 percent and a non GAAP net loss of $0.27 per share. In looking at the dynamic in the quarter, the demand environment remained consistent with our expectations. Certain of our data center customer in the US continue to work through excess inventory.
And some of our customers in China remain conservative in their approach to CapEx Deployment. Wireless dynamics will influence our performance in the short term. We continue to believe the fundamental lead for higher bandwidth within data center remain intact. We've ongoing constructive relationships with our customer to help them address this need and we'll continue to forge ahead and however to drive further growth. As we had discussed previously, diversifying our customer base, is a top priority.
We are having ongoing discussion with a new customer about our innovative fiber optics access products. And in a quarter with cable. If design win, including 3 with new customers, all of these customers are outside of our core hyperscale customer base, and we are pleased with the progress we continue to make on this front. We also continue to make strides in diversifying and expanding the reach of our innovative products into new markets such as 5 g for mobile telecommunications. While we are still early in the 5 g cycle, we believe it will be an important driver of the high speed optical component markets.
In CATV, we remain encouraged by the customer activity and increase interest we are seeing for our Remote PHY products. As a reminder, AOI pioneered this innovative technology, and we continue to believe you will play a significant load as cable MSOs evolve and transition to next generation node and head in architectures. We continue to have strong technical engagement with our customers and our inactive qualifications with our next generation 400g product We have a question and obviously where we demonstrated our suite of next generation technology and the customer response was very positive. We believe our Praful proprietary manufacturing process and vertical integration our keys to our success in this market, and we remain competent in our ability to monetize our innovation as the market improves and move to next generation technology. With that, I will turn the call over to Stefan to review the detail of our Q1 performance and outlook for Q2.
7. Thank you, Thompson.
Overall, $1,000,000, which was at the midpoint of our guidance range of $50,000,000 to $55,000,000. Our data center revenue came in at 38 point $5,000,000 compared with 49% of our data center revenue was from our 40 g transceiver products and 48% was from our 100 g products. As we discussed in February, we are seeing softness in the data center market as customers work through excess inventory due in part to the transition to 100 g. As well as customers in China taking a more conservative approach with their CapEx deployment due to concerns of slowing economic growth. These dynamics played out in q 1 as expected, and we anticipate this softness to continue into q 2 at a more elevated level.
However, I will reiterate that we believe that we continue to have good relationships with all of our hyperscale data center customers and that their need for high speed optical connectivity remains fundamental to their business. We are focusing our efforts on continuing to foster relationships with both new and existing customers and expanding our technology leadership, which we believe will We continued to have success in diversifying our customer base. And in the quarter, we secured a total of 6 new design wins. Of which 3 were with new customers and include an OEM supplier to the hyperscale and enterprise markets, a telecom equipment manufacturer for 5 g, and a provider of chemical sensors. Additionally, and building upon our strong foundation as a leader in advanced optical technology.
We announced the availability of a 100 gigabit per second per Lambda pin photodiode that can be leveraged for 100 g and 400 g optical transceivers. With the development of this new technology, AOI now has in house manufacturing for the 2 most critical active optical component required to produce 100 g and 400 g transceivers. This will enable us to maintain low cost and reduce our time to market for these products. We remain focused on building industry leading products and had a great showing at OFC with our suite of next generation technology. Including our 200 g and 400 g modules, as well as our Remote PHY product and 5 g products.
At OFC, we launched a 400 g optical module that adheres to the requirements of onboard optics. We were first to market with this technology, and we are very encouraged second eight channel VCSEL based short reach transceiver that utilizes PAM4 encoding to deliver 50 gigabits per second of data throughput on 8 separate multimode optical channels. Our large data center customers will need 400g solution that cover distances as short as a few meters to as long as several kilometers. Our growing line of 400 g products is designed to meet these customer needs while offering the cost advantages of our manufacturing expertise and vertical integration. Turning to our CATV market.
Revenue from CATV products increased 13% year over year to $12,000,000. Compared with $10,600,000 in Q1 of last year. Demand for our CATV products was in line with expectations. We continued to ship orders for our Remote PHY product and remain in active qualification trials with 3 additional customers for this technology. Our telecom products delivered revenue of $1,700,000 compared with $3,600,000 in Q1 of last year.
In telecom, we see 5 g network deployments poised to become a large driving factor for the optical industry as a whole. The motivation behind the 5 g network upgrade cycle is to offer much higher bandwidth and lower latency to support a higher density of mobile users and enable connectivity to billions of new devices, services, and applications. In order to enable this ubiquitous coverage, mobile operators will need to install a large number of small antennas and a much larger number of optical devices to handle the front haul connections between the antenna and a centrally located base station. Additionally, a midhaul link may be required from a centralized cloud radio access network back into an aggregation point where it connects to the Internet. The types of products required for the front haul and mid haul applications are 25 gigabits per second, 50 gigabits per second, and 100 gigabits per second optical transceivers.
The same data rates used in our data center business. Additionally, just like our CATV products, many of these devices will be required to withstand harsh outdoor environment. We have significant experience and resources available to us to develop the types of optical modules required for this application. And we have a highly automated production process for producing such modules, which we believe will be important when volumes begin to ramp. We are currently in qualification with a number of vendors for both front and mid haul applications.
That said, Please keep in mind that given this is an emerging market, the timing of qualification, and deployment schedules can be difficult to predict. For the quarter, 73% of our revenue was from data center products, 23% from CATV products, with the remaining 4% from FTTH, telecom, and other. In the first quarter, we had 4 10% or greater customers, 3 in the data center business that contributed 32%, 19% 18% of total revenue, respectively. And 1 in the CATV business that contributed 12 percent of total revenue. Moving beyond revenue, generated a gross margin of yet was slightly below our guidance due to somewhat higher than expected production costs on a certain of our transceiver products.
Total operating expenses in the quarter were $20,300,000 or 38.4 percent of revenue compared with $18,700,000 or 31.8 percent of revenue in the prior quarter. We continue to be targeted with our investments with an emphasis on developing and enhancing our next generation of optical products, while also tightly managing expenses. Operating loss in Q1 was $6,800,000, compared with an operating loss for the first quarter was $5,400,000 or a loss of $0.27 per basic share compared with a net income of $5,600,000 or $0.28 per diluted share in Q1 of 2018. GAAP net loss for Q1 was $10,500,000, or a loss of $0.53 per basic share compared with GAAP net income of $2,100,000 or $0.11 per diluted share in Q1 of last year. The basic shares outstanding used for computing the net loss in q 1 were 19,900,000 shares.
Turning now to the balance sheet. We ended Q1 with $77,500,000 in total cash, cash equivalents, short term investments, $76,400,000 from the convertible notes due in 2024, which priced at 5% coupon in February. We incurred approximately $4,100,000 in fees and expenses associated with the offering, which we anticipate amortizing ratably over the 5 year life of the notes in accordance with GAAP. Our cash balance was offset by a paydown of $38,200,000 to extinguish our capital expenditure loan and real estate term loan with BB And T. As of March 31, we had $84,500,000 in inventory, a decrease of $8,800,000 from Q4.
This inventory reduction is consistent with our long term plan as we continue to rationalize inventory levels. We made a total of $12,800,000 in capital investments in the quarter, including $7,200,000 in production equipment and machinery, and $5,300,000 on construction and building improvements. Looking ahead, we now expect capital expenditures which factors in a continuation of the construction of our new factory in China. We continue to monitor end market conditions and may adjust our spending plans as necessary. Moving now to our Q2 outlook.
We expect Q2 revenue to be between $40,000,000 $45,000,000 and non GAAP gross margin to be in the range of 25% to 27%. Non GAAP net loss is expected to be in the range of $6,900,000 to $8,600,000, and non GAAP loss per share between $0.35 per share share count of approximately 19,900,000 shares. With that, I will turn it back over to the operator
Thank you. Session. And our first question today comes from Simon Leopold with Raymond James. Please go ahead.
Great. Thank you. I want to ask one sort of nearer term and a longer term question. First, on the nearer term, could you give us an an update on what you're seeing competitively particularly in Silicon Photonics Technologies, and I I guess the context of this is coming out of the the optical show in March, we we not only heard from Intel who's been dabbling in this area for a long time, but Cisco had made an acquisition and Juniper's talked about, launching some products. So maybe, some update overall competitive environment, but but place some context around Silicon Photonics.
And then I've got a follow-up. Okay, Simon. I would say in this quarter, we haven't seen any sort of meaningful shift with respect to the competitive environment, especially as it pertains to Silicon Photonics. You noted a couple of companies who've made investments in Silicon Photonics. All of those companies have had had some activity in the past either as a company that they're currently with or as previous firms.
They're not in other words, they're not new entrants to the industry. And I haven't really seen any meaningful shift in terms of the way that those types of companies are approaching the market or the way that our technologies differentiate themselves. I think as we've noted in past conference calls and conferences, that, you know, we believe our technology competes very favorably with Silicon Photonics in terms of cost, in terms of flexibility, and in terms of our ability to make modifications and things to the products throughout their life cycle, which can also help us to maintain and attract cost throughout the life cycle of the product. So, but as far as it goes, I haven't seen too much, shift really in the competitive environment there. And your follow on question?
Yes. I wanted to talk a little bit more about, how you see the 5 g market developing. I think I appreciate the fact that that the harden optics, makes this a great opportunity for for your technology. But we hear suggestions that this will be a very competitive market with a lot of of varied entrants, maybe from emerging markets like China, And so I'm I'm sort of struggling to figure out the dynamic of how how big is this opportunity and how does it compare to other markets you've played in? Thank you.
So I think it's a little early to parse out the competitive environment. I think you're right, Simon. It's going to be a competitive There's no doubt about that. I would note that, you know, as you've seen in our data center market, we've been able to compete favorably in highly competitive markets. So I think the fact that it's competitive is really a reflection of the fact that the market is sizable.
And it one where optics is going to play a very critical role. So, you know, we think that that it's an exciting market and the competitiveness in that market really just reflects that As far as how does this relate to margins and things? Think it's a little bit early to say, as we noted in our prepared remarks, we're pretty early in the 5G cycle. We think we have very attractive technologies, not only at the module level, but laser and photodiode level and optical sub assembly level. And we intend to to, to compete with, with all the players that we are aware of, including those that are in China and elsewhere, using our technologies.
And we think we can compete favorably there.
And our next question comes from Mark Teller with D. A. Davidson. Please go ahead.
Wanted to just talk about the main business, the data center demand. What are your customers telling you about the excess inventory is this a 1 quarter situation? Is this a whole year situation? What do you think the cycle is there? And then with respect to China, Is there an opportunity in the data center market in China to kind of offset some of the weakness in the U.
S?
So, as as far as what customers are saying, I I don't think that there's a common cadence across all customers. As you can imagine, inventory levels are not uniform across, you know, all all different customers. And so we're hearing different things from different customers. Some, some customers are saying this is going to be a relatively short term thing and others frankly just aren't giving us a lot of really good visibility into, when the situation improves. As far as the data center market in China, as we noted in our prepared remarks, we have had a number of design wins with data center operator China.
And we have some active qualifications ongoing for for future. What we hope will be future design wins in there, in that, that area. There is some potential that those customers could offset some of the weakness that we're seeing in the U S. That hasn't proven to be the case so far, but I think that, it's one of the reasons why, I think there is hope and optimism surrounding, you know, the next few quarters, but we ought to get through this period of weakness and the U. S.
Data center market first.
And then on the cable side, the remote PHY, you had a pretty nice growth there on the cable TV side. Is that some sign that the there's some thawing in the in the cable market? Is the is that demand finally coming through?
I think that there's some signs that the thawing is occurring. I think it's too early to say we're we're back into a robust growth period yet, but I think that, you know, we do expect cable TV, to, to, to continue to improve. That market is notoriously sort of lumpy and difficult to predict. However, and so, you know, I think overall, we think that there's some good tailwinds in cable TV driven by Remote PHY. But again, you know, in any given quarter, the results can be kind of up and down as we've seen over the past several years, really.
Okay, great. Thanks.
And our next question comes from Richard Shannon with Craig Hallum. Please go ahead.
Stefan and Thompson, thanks for taking my questions as well. Probably just a couple for me. Stefan, I know you're loathe to to typically to talk more than 1 quarter out, but one to, see if you have any thoughts relative to some other companies who have data set and exposure and their thoughts about the second half of the year. Are you seeing any sign of visibility or stabilization that might lead you to think your data center revenues can improve, in the third quarter versus the second?
I think there's a lot of reasons for optimism. We, you know, we noted that, we have some some very important new technologies that we've talked about 400g, etcetera. There's some customers that are talking aggressively about deploying that. I won't put a precise timeframe on it, which is really part of the problem with visibility. While I do believe that, that, you know, there's a number of very exciting things that are going to happen in the data center market.
It's very difficult to predict the timing. And especially with respect to inventory because that's one of the more opaque things that our customers are relatively less inclined to talk about with us. They're very interested in talking with us, as you can imagine, about new technologies and their their deployment plans for those new technologies. They're a little bit less interested talking to us about the specifics of their inventory situation. So that's a little bit hard to get a concrete read on.
I think it's you know, it would be it would be a very questionable thing to say that data center companies are not going to eventually continue to invest in their infrastructure. They got out a little bit ahead of themselves, I think, in terms of, of, buying inventory, and that's what we're digesting right now. But it seems to me that really only a matter of time till growth resumes. It's just hard to put a precise timeframe on that.
Okay. Well, that's fair enough. Based on what we've been hearing otherwise, My second and last question, Stefan, is, obviously, you guys are are are trying to grow and to to get to back to breakeven here. Wondering if you could help us kinda schedule, you know, how you get there in terms of of revenues, gross margins, OpEx, and also maybe that revenue contribution, do you expect, obviously, I would assume data center would be a big part of that where they expect, you know, new products like 2400 gig or 5 g or, you know, outside of your, your main cloud customer base that you have today. Can you just help us to understand how you expect to get there?
Well, I think what we've seen so far, I think we've you know, operating expenses have been relatively stable over the last few quarters. If you take out some of the extraordinary items that we have. So if you kind of run that forward, get an idea where we need to be in terms of gross margin and, and revenue to cover those operating expenses And so we obviously need to see revenues increased to some extent. And we also believe that we can continue to some gross margin uptick and that that will also contribute to profitability. But as far as putting us precise numbers on that, we don't have sort of an updated model that we've that we put out there yet.
Okay. That's fair enough. I think that's all the questions for me. Thank you.
And our next question comes from Liz Pate with Cowen and Company. Please go ahead.
My first question is you've talked about a number of new design wins, this past quarter and in the prior quarter. Are those translating into any meaningful revenue at this point for you?
Well, I think they're certainly translating into revenue. What your level of meaningful, I guess, you'd have to sort of define that a little bit. But We've seen some of these design wins that are contributing in the 1,000,000 of dollar range. Obviously low single digit millions given the overall revenue picture, but certainly some of the recent design wins are contributing. And for us, a design win occurs when we've not only completed the technical qualification of the product and also the pricing and other negotiations that go as part of the qualification process, but also when we've actually received orders.
So sort of by definition for us, all of our design wins, are contributing revenue or will contribute revenue very shortly after the design win. You know, how much of that is sort of meaningful, I guess, again, that sort of depends on your definition, but, you know, we all of those design wins are contributing revenue, essentially.
Right. And in terms of the the the customer profile, are are there tier ones in there, amongst the new customers?
I think there's some recognizable names in there. Yes.
Okay. I guess my last question is on the pricing trends that are that you're seeing, incremental price erosion over the past 90 days, anything to point to the ordinary and and kind of what you expected.
Patients. No, no, no changes to to what we've said. Previously, we said last year, we saw price reduction in our core 100 gigabit per second product line of about 20% and we've said that we expect to see about that same number this year and that's still our current expectation.
And our next question comes from Dave King with B. Riley FBR. Please go ahead.
Great. Thanks. This is Lee Kroll filling in for Dave. Thanks for taking my questions. 2 if I may, first, in the past, you guys have kind of talked about verticalization efforts, in an effort to kind of, aid gross margin.
Obviously, with margins where they are today, curious if you kind of had some updated thoughts on the strategies, that will kind of help trend gross margins higher as it relates to verticalization.
We noted in our prepared remarks, for example, that we've developed, a new line of, photodiodes. As you know, the the the 2 principle active optical components that define the performance of an optical transceiver or, frankly, any optical link really are the, the laser and the photodiode. And for many years, we've manufactured the lasers. Only more recently that we've begun to manufacture the photo diodes, the corresponding receiving element within the optical transceiver. And, so that's an example of where that vertical integration strategy, is continuing to, I mean, we're continuing to work forward on that strategy.
As far as how we see the gross margin trending up, vertical integration certainly plays a part there. But in addition to that, I think seeing capacity utilization return back to normal levels. And, and getting through some of the additional testing that we put in place in previous quarters. All those things will also contribute to the margin. So it's not just one thing that we need to do.
We've got several, several knobs that we will turn to continue to see improvement in gross margin.
Got it. And then I guess, with the, the Chinese facility, could you maybe just remind us when you expect it to be complete? Whether that's fully encapsulated in the CapEx number you guys guided to. And then just as it relates to the Chinese market, will that position you more competitively or with better visibility, building increased operations there?
So the building we expect to complete in Q1 of next year, and that is included in the CapEx guide that we gave. It accounts for roughly 50% of the CapEx that we anticipate this year. That CapEx that we've guided for this year will not complete the building. As I mentioned, it won't be done Q1 of next year. So there will be some additional CapEx next year, but it's relatively small compared to the level that we're spending this year.
As far as what that facility does for us, yes, I think it positions us well for the Chinese market. As we mentioned, there are some sizable markets in China. For example, the 5G market, I think, is going to be 1st active probably in China, or at least certainly one of the largest markets for 5G is going to be in China. And, you know, having a Chinese, an expanded presence in China will will no doubt help us in in that area. And also, you know, the data center operators in China are becoming more larger scale and more, advanced in their infrastructure similar to what we've seen with some of our domestic US based and European based, operators.
And so, you know, having a capability and expanded capability in China to be able to produce more of those advanced products in country for them will also be important to that business as well. So we think both the telecom and Data Center Business can benefit from that expanded presence in China.
Got it. Thank you for taking my questions.
And this will conclude our question and answer session. I would like to turn the conference back over to Thompson Lynn for any closing remarks.
Okay. And thank you for joining us today. As always, we send our investors, customers, and employees for your continued support, and we look forward to seeing you at our upcoming conference.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.