Good afternoon. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to Applied Optoelectronics First Quarter 2018 Earnings Conference Call. All lines have been placed questions. Please also note that today's event is being recorded.
And at this time, I'd like to turn the conference call over to Maria Riley, Investor Relations for AOI. Ms. Riley, You may begin.
Thank you. I'm Maria Riley, Applied Opto Electronics, Investor Relations, and I'm pleased to welcome you to AOI's first quarter 2018 financial results conference call. After the market closed today, AOI issued a press release announcing its first quarter 2018 results and provided its outlook for the second quarter of 2018. The release is off 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 Joining us on today's call is Doctor. Thompson Lynn, AOI's Founder, Chairman and CEO and Doctor. Stefan Murray, AOI Chief Financial Officer and Chief Strategy Officer. Thompson will give an overview of AOI's Q1 results and Stefan will provide financial details and 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. You can identify forward looking statements for terminologies such as may, will, should, expects, plans, anticipates, believes or estimates and by other similar expressions. 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.
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 Alan Technology Media And Telecom Conference in New York on May 30th. We hope to have the opportunity to see many of you there.
Additionally, I'd like to note the date of our second quarter 2018 earnings call is currently scheduled for Tuesday, August 7, 2018. Now, I would like to turn the call over to Doctor. Thompson Lynn, Applied Optoelectronics' Founder, Chairman and CEO. Thompson?
Thank you, Maria. Good afternoon, everyone, and thank you for joining us today. I'm reviewing our 4th quarter results revenue of $65,200,000 and gross margin 40 percent, which led to net income of $5,600,000 or $0.28 per diluted share. Our revenue came in slightly below our guidance as a delivery of certain orders slipped into Q2 due to higher than expected in poly turnover in our China factory as a result of the Chinese New Year. This order had been shipped in Q2.
On a more positive note, market trend were in line with our expectations. We couldn't believe the fourth quarter represents the burden of the decline in datacenter demand we have seen over the past few quarters. Denasan inventory condition has begun to normalize with our expectation being that interiver will return to more normal level later this year. We also currently expect 100g volumes to more than double in the second half of the year over the fourth half as we deliver on the committed orders we announced last quarter. We also made good progress in diversifying our customer base with 9 design wins, including 5 for our 100g products, and some of these design wins work with new customers.
In order to meet our customers' needs, AOI had continued to innovate both in new product development as well as in advanced automation and manufacturing process. Our recently announced 200g PEN4 pin photodi array is a great example. With this new technology, AI now controls production of both the laser and the photodiode rate, which was the most critical and expensive component required in the production of 200g and 400g transceiver. We believe our continued innovation, vertical integration, and our proprietary, manufacturing process together set AOI apart from our competitor as a cost and quality leader in this highly competitive industry. With that, I will turn the call over to Stefan to review the details of our Q1 performance and outlook for Q2.
Stefan?
Thank you, Thompson. Total revenue for the first quarter was $65,200,000 compared with $96,200,000 reported in Q1 last year. As Thompson mentioned, our revenue came in below our expectations due to slight delays in the completion of some orders as we in our Ningbo China factory, which experiences a shutdown during the lunar New Year. After the holiday, it is typical for some employees to fail to return to the factory on time or at all. This can affect our ability to produce sufficient products to meet our demand, which was the case this quarter.
A larger number of employees than usual the process of bringing these new employees to full productivity took longer than expected and some orders were delayed as a result. We worked closely with our customers Looking ahead, as Thompson mentioned, we believe that unit sales of our 100 G products will more than double in the second half of twenty eighteen compared with the first half. This estimate is based largely on the committed orders we announced last quarter. While there will be some price reduction as volume increases this year We believe that In Q1, our data center revenue came in at $50,600,000 compared with $79,600,000 in Q1 of last year. In the quarter, 41% of our data center revenue was derived from our 100 G transceiver products, compared with 35% last quarter and 53% was from our 40g products.
We continue to maintain focus on diversifying our customer base and in the quarter had 9 design wins, including 5 for our 100 G products. We believe our cost leadership, scalable production in house component supply and track record of innovation will allow us to be successful in these customer engagements. As Thompson mentioned, AOI continues to innovate and expand our product portfolio. We recently announced the development of a 200 G PAM4 pin photo diode array that can be leveraged to produce 200g and 400g transceivers based on 50g per Lambda technology. With the development of this new technology, AOI now manufactures the 2 most expensive components required to produce 200g and 400g transceivers in house.
Enabling us to maintain low cost During the first quarter, AOI successfully transitioned a majority of the optical multiplexers used in our CWDM, data center transceivers, to in house produced parts. By the end of Q3, we expect the majority of the de multiplexers to be sourced internally as well. Together, the multiplexer and demultiplexer pair represents the 2nd highest cost material in our CWDN modules, just behind the active optical components. By transitioning these to in house produced parts, we are realizing significant cost reduction on these high value components. This continues our strategy of vertical integration as we have now brought the lasers, the photo diodes and the mux in house.
With the Demux to follow in Q3. The cost advantage, time to market, and flexibility afforded us by bringing these components in house is a significant factor At OFC, we showcased our full suite of next generation technology, including our 20400 G transceiver products, and 100g, EML and DML lasers, and we are very encouraged by the customer response. We also discuss during our OFC investor session, our new 400g high density light engine assembly, which extends our 40g and 100g platform to 400 G. We expect to leverage this mature, high quality and low cost platform for years to come. Turning to our cable television market, $13,100,000 that we generated in Q1 of last year.
Looking ahead, we continue to anticipate growth in this market especially as demand for remote PHY picks up later this year. Our telecom products delivered revenue of $3,600,000, compared with $3,200,000 in Q1 of last year. For the quarter, 78% of our revenue was from data center products. 16% from CATV products, with the remaining 6% from FTTH, telecom and other. In the first quarter, we had 3 10 percent or greater customers in the data center business that contributed 36%, 26% and 14% of total revenue, respectively.
Moving beyond revenue, we generated a gross margin of 40%. Which represents a decrease of 100 basis points compared with a 41% reported last quarter. Our gross margin came in slightly below our expectations due to capacity underutilization during the Chinese New Year. And higher than anticipated costs for training new employees in NIMO. Total operating expenses in the quarter were $20,100,000, or 30.8 percent of revenue compared with $18,900,000 or 23.7 percent of revenue in the prior quarter.
The sequential increase was mostly due to higher R and D expense as we invested in new production technologies that will enable further cost reduction on our transceiver products as well as 200g, 400g and Remote PHY products. As a reminder, we expect R and D to remain at this level over the next few quarters, while we focus our efforts on $800,000 in Q4 of 2017. Our operating margin in the quarter was 9.2%, compared with the 17.3% reported in Q4 of 2017. During the quarter, we had a larger than expected foreign exchange loss associated with the settlement of intercompany accounts receivable balances. This negatively impacted our non GAAP income by approximately one $200,000 Non GAAP net income after tax for the first quarter was $5,600,000 or $0.28 per diluted share.
Compared with $21,800,000 GAAP net income for Q1 was $2,100,000 or $0.11 per diluted share compared with GAAP net income of $19,800,000 or $1 per diluted share in Q1 of last year. The Q1 weighted average fully diluted share count was approximately 20,000,000 shares. We recognized approximately $300,000 in tax benefit from employee options that were exercised during the quarter. Turning now to the balance sheet. We ended Q1 with $83,300,000 in total cash, cash equivalents, short term investments and restricted cash, compared with $84,000,000 at the end of the previous quarter.
As of March 31 we had $92,600,000 in inventory an increase of $16,900,000 from Q4. The increase in inventory is primarily attributed to higher work in process as we prepare for expected demand in including $7,500,000 in production equipment and machinery and $2,100,000 on construction and building improvements. We continue to expect our capital expenditures in 2018 to approach $109,000,000 with the construction of our new factory in China accounting for most of the We expect Q2 percent to 41%. Non GAAP net income is expected to be in the range of $7,800,000 to $10,400,000, and non GAAP EPS between $0.39 per share and $0.52 per share, using a weighted average fully diluted share count of approximately 20,000,000 shares. We expect our Q2 effective to be between 7%
And ladies and gentlemen, questions. Questions. And our first question comes from Simon Leopold from Raymond James. Please go ahead with your question.
Great. Thanks for taking the question. A couple of things I wanted to check on. One was from a longer term perspective, I think you've given guidance for gross margin in a range of 41% to 45%. You're guiding a little bit below that for for the June quarter.
And I know this is one of the questions we get a lot given the Facebook commitment worry about gross margin. Could you talk about the longer term gross margin trend
Yes, Simon. I think, we still believe that we can, we can, in the longer term, maintain that 41 plus percent gross margin. Part of what's affecting us right now is we have some inventory that we had to buy towards the end of the year and into the first quarter that was at a little bit higher cost than what we expect that inventory to be at in the longer term. So that's pulling down the gross margin a little bit in this quarter and in Q3. Too.
The other thing as we mentioned in the call is we have a number of components that we're going to be bringing in house. For example, we talked about the multiplexer and demultiplexer pair. Well as the photodiOD. And those components will also help us to reduce costs. So we do think we can get back up to that 41% range, but we have a little bit of work to do to get there.
Okay. And could you quantify how much or can you quantify how much revenue has slid from the March quarter into June. I'm just wondering why given the timing issues with what happened in March, why the June outlook wasn't a little bit better?
Well, as we noted in the remarks, it's just a couple of days worth of production. So basically, you could take our sort of average daily production in and tacking on 2 or 3 days to that. And that's that was the size of the slip. It was not that much. We had significant orders in the quarter, But we just couldn't ship all of them due to the personnel issues that we talked about in around Chinese New Year.
Okay. And one last one. Arista on its earnings call last week and yesterday at its Analyst Meeting indicated that it viewed the 100 gig optical transceiver market as having adequate supply now. And it wasn't clear what exactly they were alluding to. Given your 100 gig shipments, it doesn't seem as if you've opened up the flood gates.
I'm just wondering what you're seeing in terms of the marketplace of new capacity competitive landscape? Thank you.
Mean, we continue to adjust our capacity as needed to make sure that we can meet the current demand and the demand that we expect to see in the future. Think we mentioned earlier that the we expect the second half to be a pretty strong second half of the year. So we're certainly preparing to meet that demand. I don't know if that answered your entire question there, Simon, but
Well, any commentary on competitive landscape because listening to the supply chains, for example, Fabrinet, it's not clear to us where a significant volume of new supply could be coming from. And so I'm not seeing it. I'm just wondering what you're seeing in terms of supply from your competitors.
Mean, I think there's pretty good evidence that a couple of our competitors have, either exited the market or are changing their focus in terms of the way that they attack the market. So from that perspective, I think the biggest change that we've seen is those competitors most of whom weren't really big, producers in the first place, but they're basically changing their strategy or getting out altogether. Whereas AOI has been the cost leader in this market. I think we continue to believe that we are the cost leader. And I think in the long term, that's what it takes for us to continue to win these customer engagements, as we mentioned in our remarks.
Great. Thanks for taking my questions.
Thanks. Our next question comes from Mark Kelleher from D. A. Davidson. Please go ahead with your question.
Great. Thanks for taking the questions. Just a follow-up on that last thought there. Let me ask it a different way. Are you seeing any change?
A couple have exited, but there are a couple that are still in the market very aggressively pricing. Have you seen any change in that pricing dynamic?
No, I don't think so. I mean, look, our prices are generally negotiated well in advance. So we think we have a pretty good handle on what the prices are going to be in the future and we haven't seen any, anything in the pricing dynamic that's meaningfully changed from what it was flows.
Okay. And on those personnel issues that you encountered on the Chinese New Year, is that something that caught you by surprise? Is that something unusual? Is that something we should anticipate each March quarter? How odd was that that you had that problem?
Well, I
think, anybody that produces product in China has issues surrounding the Chinese New Year. That is their typically factory shutdowns and there's personnel turnover around that time. That's definitely not unique to us and it's something that we experience every first quarter. What we have to do is take a sort of an estimate on, how many employees are going to come back and which employees, how many do we need to hire, and that sort of thing. And obviously, this year, we were off by a little more than we expected.
But I think it's worth mentioning that we've made so much progress over the last couple of years in terms of adding automation and things. If you go back a few years, we had a much larger problem in the first quarter again, related to Chinese New Year. This year, while there was some slip, it was relatively minor compared to what we've seen in years past. And the way that we're doing that is by improving the automation so that we can retrain and rehire more workers and get them up to full productivity faster. It's also worth noting that this year, the Chinese New Year was a little later in year than it sometimes is.
And that also makes it a little bit harder for us to get the employees in the door and sort of get them up to full speed and still be able by the end of the quarter.
Our next question comes from James Kinstner from Loop Capital. Please go ahead with your question.
Yes, thank you. So I really appreciate the comments about the 2nd half and sort of return to a normal level and much more growth doubling of 100 gig. But maybe you'd help us, just the overall revenue level for the year at this point, is it clear to you have the visibility that you could actually grow your top line year over year versus 2017?
Yes. So we don't really give guidance that far out. It's still relatively early in the year. As we mentioned, I think we've seen we're looking at a pretty good second half. A lot of that is based on orders that we have committed, which is unusual for us to have that many committed orders this early in the year.
But there's still a lot of work to do before we can confidently project what we're going to be for the whole year.
Okay. That's helpful. I guess on inventory, again, appreciate the comments on that. I mean, you previously thought that you'd hope to give it a normal level in the first half and some things have changed obviously. But any thoughts on the trajectory of inventory and what that might a couple of quarters from now either from a day standpoint or just an absolute kind of rough level of inventory?
Well, I think the inventory will come down a dollar basis. As I mentioned, we had some inventory, both in our vendor managed inventory warehouse as well as some inventory and work in process. And inventory in transit, meaning stuff that we had shipped prior to the end of the quarter, but wasn't received at the customer by the end of the quarter. So those things were the biggest source of the inventory increase over last quarter. And clearly those things will burn down over the next quarter or 2.
Okay, thanks. Just kind of last one here on just on cable. So I guess it looks like maybe there was a bit of it. Inventory correction at your customer or minor one, I mean, they mean, one of your biggest customers reported and talked about strength in access and you obviously didn't see that in Q1, recognizing Q1 is usually kind of seasonally weak for access. That was unusual.
But is your guidance contemplating that business would grow sequentially? I got the sense when you said that later this year is September, December, you expect to grow year over year kind of coming from that as well? Thanks.
The commentary that we had for later this year relative to cable was specifically about the Remote PHY product that will start ramping later this year. We do expect sequential growth in cable. And it's worth mentioning too that part of the reason why our cable results were a little bit lower than they would have otherwise been is that we did divert some of the personnel in China that were working on cable TV products and put them on producing some of the data center products, again, to try to make sure that we had minimal slippage on our data center delivery. So there were some cable TV orders also that we couldn't deliver in the quarter due to the manpower issues that we discussed earlier.
Okay. And I'm sorry, I lied one last one. Can you give any kind of qualitative sense for the mix of PSM4 versus CDM4 sequentially? I know you don't specifically disclose. I'm just curious about the overall mix.
Yes, I mean, we continue to see a trend towards more CWDM and less PSM. I think that's been a pretty consistent theme of ours for a number of quarters. I think there's others in the industry that have said similar things. So this isn't unique to AOI. But as far as the exact percentages, as you know, we don't disclose that.
Thank you very much. Welcome.
Our next question comes from Fahad Najang from Cowen and Company. Please go ahead with your question.
Glad you could squeeze me in. Previous question or asked all the questions I had. But just one question on in terms of if we delve into 100 gig CWDM4 versus PSM4. Can you just help us in terms of understanding is CWDM for a bigger portion of the mix?
Well, again, we don't really break out that. Well, we have said is that over time, we expect CWDM to continue to grow and the PSM will gradually decline.
Okay. Appreciate that. Then circling back to a comment that, Thompson, you had made earlier, where you said that you expected 1Q 2018 to be the bottom in terms of the demand from data centers. Can you help us understand in terms of the second half outlook are you expecting growth from all your major cloud customers? And in particular with this one customer that's been, what, 14% of your revenue they seem to have been declining down.
Do you expect that, particular cloud titan customer to start to ramp in the second half?
Yes, Fahad, this is Stefan. As you know, I mean, we have non disclosure agreements with our customers. We really can't talk about customer specific issues like that. What matters to I think is that in aggregate, we're seeing a strong booking ledger for the second half. And as we mentioned, a lot of that is coming on the basis of contracts that we have in place.
So we're fairly confident in those numbers. What the other customers are doing obviously remains to be seen. There's still some work to do to get them, to get their numbers anyway, but it's certainly not something that
we're going to break out in the call. One thing I want to add on is You can notice, we have many design win every quarter, and we are still many new customer on the qualification We believe weak shoe had 0 mode, a good sized customer in this year. We can bring in And we believe our market share in today as we increase compared to last year.
All right. So just so I'm I understood, Safani, your response and Tom's in your response. In terms of the second half outlook, the you're expecting a broad based improvement from all your cloud customers?
We're expecting a broad based improvement, yes. Okay. Add up all of cloud based customers together, we're expecting an improvement. Yes.
Got it. Got it. Appreciate that. And then one more, if I may. In terms of the new design wins, the 10 new design wins, sorry, the 9 new design wins, Can you tell us a little bit more about these design wins?
Is it with a Tier 1 NEM suppliers? Are the additional cloud suppliers? Is there any more qualitative insights on those in design wins?
It's a mix, Fahad. There's some that are data center operators cloud type data center operators and there's others that are OEMs. It's a good mix, which I think is important to us. I mean, one of the things that we're working very hard to do is to continue to diversify our customer base. So that means different types of products, different types of customers, different types of end markets.
And so making inroads into having design wins, in some cloud type customers, but other types of customers as well is important to us. And I think we're making good progress.
Next question comes from Richard Shannon from Craig Hallum Capital Group. Please go ahead with your question.
Thanks, Thomas. Thomas and Stefan for taking my question. Maybe just one kind of a 2 parter here. You talked about some 9 design wins in the quarter 5 for 100 gig. I wonder if you could tell us whether there are any of them are CWM4 full spec And if so are any of those wins helping you with your positive outlook for the second half of the year?
We do have some design wins for CWDM. And I actually don't remember off the top of my head if they were full spec or or light?
No. Most of them are full spec.
Full spec, I think is correct. As far as whether it's contributing to our positive outlook for the year, yeah, absolutely. I mean, I think it's worth noting that there are some of these design wins that could be really material to revenue either in the second half or beyond. And there are some that are certainly smaller. I don't wanna so that all these 9 wins are huge ones, but there's certainly some that can be material.
Okay. That's helpful. One last question for me. I got to jump off to another earnings call. If you can discuss the opportunities you're seeing with the large China cloud operators.
It's a customer base that hasn't existed with you at least in volume today, but like it could be an opportunity, wonder if you could discuss what you're seeing there?
Yes, we think we're making pretty good inroads into the China operators. I mean, by and large, those those China cloud operators are smaller in scale than certainly many of the cloud titans that are sort of our traditional customer base. So we're making good inroads. I think we've had a number of design wins and some design win activity that's still ongoing. But is looking very good.
But again, compared to our large cloud titans, most of those Chinese companies are somewhat smaller in scale.
And our next question is a follow-up from James Kinstler from Loop Capital. Please go ahead with your follow-up.
Yes, thank you. So, on 40 gig, Can you just give us an updated perspective on kind of how fast that rolls off? Is it just should we kind of taking revenue out of that 40 gig bucket as you put into the 100 gig or is there maybe kind of a longer tail on it? Just any kind of in texture on how we should model 40 gig would be helpful. Thank you.
Well, I can't go too much into more detail than what we've already said. We think it will decline. What's going on is, is that, it's a little bit customer specific. That is we have some customers that are already transitioned virtually 100% to 100 gig We have other customers that are continuing to use 40 gig. I think it's probably fair to say that if you look back, say, a year ago or so, that 40 gig is probably hanging in there a little stronger than it than we would have thought at that time.
But again, it's kind of customer specific. It's not across the board, 40 gig is important to some customers and less important to others.
And ladies and gentlemen, at this time, this will conclude today's question and answer session. I'd like to turn the conference call back over to Doctor. 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.
Ladies and gentlemen the conference has now concluded. We do thank you for joining today's presentation. You may now disconnect your lines.