Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics business update call to discuss the agreement entered into today for the sale of its manufacturing facilities located in the People's Republic of China and certain assets related to its transceiver business and multichannel optical subassembly product for the internet data center telecom and FTTH markets. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that this call is being recorded. I will now turn the call over to Lindsay Savarese, investor relations for AOI . Ms. Savarese, you may begin.
Thank you. I'm Lindsay Savarese, investor relations for Applied Optoelectronics, and I'm pleased to welcome you to AOI's business update call. After the market closed today, AOI issued a press release announcing its agreement to sell its manufacturing facilities located in the People's Republic of China and certain assets related to its transceiver business and multichannel optical subassembly products for the Internet data center, telecom and FTTH markets. The release is also available on the company's website at ao-inc.com. This call is being recorded and webcast live. A link to the recording can be found on the investor relations section of the AOI website and will be archived for one year. Joining us on today's call is Dr. Thompson Lin, AOI's founder, chairman, and CEO, and Dr. Stefan Murry, AOI's chief financial officer and chief strategy officer. A question-and-answer session will follow with 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, levels of activity, performance or achievements of the company or its industry to differ materially from those expressed or implied in such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as believes, forecasts, anticipates, estimates, intends, predicts, expects, plans, may, should, could, would, will, potential, or thinks, or by the negative of those terms or other similar expressions that convey uncertainty of future events or outcomes. The company has based these forward-looking statements on its current expectations, assumptions, estimates and projections.
While the company believes these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond the company's control, including important factors such as risks related to the company's ability to complete the transaction described on this call on the proposed terms and schedule or at all. The risk that certain closing conditions may not be timely satisfied or waived. The failure or delay to receive the required regulatory or other government approvals relating to the transaction. The occurrence of any event, change or other circumstance that could give rise to the termination of the transaction. 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 innovation, as well as statements regarding the company's outlook.
Except as required by law, we assume no obligation to update forward-looking statements for any reason after the date of this call to conform these statements to actual results or to changes in the company's expectations. More information about other risks that may impact the company's business are set forth in the Risk Factors section of the company's reports on file with the SEC, including the company's annual report on Form 10-K for the year ended December 31st, 2021, and quarterly reports on Form 10-Q. Also, all financial results and other 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 prior earnings press releases that are available on our website. Now, I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics founder, chairman, and CEO. Thompson?
Thank you, Lindsay, and thank you for joining our call today for an important business development at AOI. In a press release published after market close today, AOI announced that it had entered into a definite agreement with Yuhan Optoelectronic Technology (Shanghai) Co., Ltd. for sale of its manufacturing facility located in the People's Republic of China and certain assets related to its transceiver business and multichannel optical subassembly products for the internet data center, telecom, and FTTH markets for a purchase price of $150 million. Subject to certain working capital and other closing adjustments, including a holdback amount, we anticipate that the transaction will be complete in 2023, and is subject to customary closing conditions and regulatory approval.
We are excited about this transaction as it will enable us to make strategic investment in higher margin and higher growth opportunities, particularly in our fast-growing CATV broadband business in some of our newer laser-related products. Additionally, prior to the closing of this transaction, we anticipate investing between 4% and 10% of the proceeds from the transaction in exchange for 10% equity interest in Yuhan Optoelectronic Technology. Our management team and board of director have been actively engaged in reviewing our strategy in order to accelerate our path to profitability and drive shareholder value. We believe today's announcement is a great outcome for our shareholder as well as for our partner and customers. Before I turn the call over to Stefan, I want to thank our team in China for their hard work and contributions over the years.
I'm confident that this team will continue to thrive, and we are facilitating a smooth transition for our employees, customers, and partners. We are proud of the transceiver business that we have built, and we look forward to its growth under Yuhan Optoelectronic Technology ownership. In addition to the sales, we look forward to a new collaboration with Yuhan Optoelectronic Technology through a contract manufacturing agreement for production of certain AOI CATV product, and look forward to continuing to supply lasers for the production of Yuhan's data center transceivers. With that, I would turn the call over to Stefan to review the details of the transaction. Stefan.
Thank you, Thompson. As Thompson mentioned, in a press release published after market close today, we announced that AOI has entered into a definitive agreement with Yuhan Optoelectronic Technology (Shanghai) Co., Ltd. for the sale of its manufacturing facilities located in the People's Republic of China, and certain assets related to its transceiver business and multichannel optical subassembly products for the internet data center, telecom, and FTTH markets, for a purchase price of $150 million, subject to certain working capital and other closing adjustments, including a holdback amount. We anticipate that the transaction will be completed in 2023, and is subject to customary closing conditions and regulatory approvals, including CFIUS in the U.S. and ODI in China.
After careful consideration, we concluded that it's in the best interest of the company and our shareholders to exit the data center transceiver market, which has recently been a lower margin business for us, and focus our resources on our data center laser business, our CATV broadband business, and the manufacturing of lasers and laser components for other markets such as FTTH and sensing. We believe that these remaining businesses will generate free cash flow and can achieve EBITDA breakeven once the transaction closes. As a result, we believe that operating expenses will be reduced by nearly 40% after the completion of this transaction. Our focus as we plan for AOI's future is to continue to look for additional OpEx savings while maintaining a strong commitment to R&D, which is the lifeblood of our company.
We will discuss these plans in more detail in subsequent earnings conference calls, including on our Q3 earnings call, which is currently scheduled for November third. The significant proceeds we expect to receive from this transaction would enable us to make strategic investments in higher margin and higher growth opportunities and give us the financial flexibility to accelerate our growth, particularly in our data center laser business, our fast-growing CATV broadband business, and some of our newer laser-related products. Additionally, prior to the closing of this transaction, we anticipate investing an amount equal to between 4% and 10% of the proceeds from the transaction in exchange for a 10% equity interest in Yuhan Optoelectronic Technology. In addition to the sale, we are looking forward to a new collaboration with Yuhan Optoelectronic Technology through a contract manufacturing agreement.
We expect to continue to use the manufacturing facilities in China on a contract basis to produce certain CATV products. I believe that this transaction should best be understood as a strengthened commitment to the data center business, which will be accomplished by enabling us to focus greater resources on the design and manufacturing of data center lasers. The sale agreement includes transfer of our 40G, 100G, 200G, and 400G transceivers for inter data centers. However, we will maintain all of our data center laser manufacturing capability, which is entirely housed in our fab facility in Sugar Land, Texas. This fab will not be affected by this transaction. Included in the sale are our manufacturing facilities in China, which have approximately 1,200 full-time employees. We currently anticipate that these employees will become employees of Yuhan after the completion of the sale.
Revenue for our data center segment was approximately $92 million for the trailing twelve months ended June 30th, 2022. Since we have historically utilized our lasers in the production of our transceiver products, we have not broken out revenue within our data center segment for our laser business. On completion of the sale, our data center revenue will be comprised of revenue from the sales of our data center lasers and laser components for data centers. We look forward to continuing to supply data center lasers for the production of Yuhan's data center transceivers. We understand that Yuhan Optoelectronic Technology (Shanghai) Co., Ltd. expects to utilize AOI's lasers in the production of their data center transceiver products.
We believe that this transaction opens up new opportunities for customer expansion within our data center laser business, as our production capacity for lasers will no longer be dedicated solely for internally used devices. This completes my financial overview of the transaction. With that, I'll turn it back over to the operator for the Q&A session. Operator?
Thank you very much. Our first question comes from Simon Leopold with Raymond James. Please go ahead.
Great. Thanks for taking the question. First off, it's my recollection, and maybe it's dated. Is the problem that the vast majority of your cable TV infrastructure was manufactured outside of China or in the China facility, and that your Taiwan and Sugar Land facilities were more associated with transceivers and lasers? Maybe I'm just out of date, but is that incorrect, or have you shifted cable manufacturing out of China already? Or will you be heavily reliant on Yuhan as a contract manufacturer? Thank you.
Right. That's a great question, Simon. Thanks for asking. As we noted in our prepared remarks, you know, we do have an arrangement with Yuhan to continue to produce any of the cable TV products that we, you know, that we currently produce there. However, as we've noted in prior earnings calls also, we have been building capabilities to produce cable TV products in our Taiwan facility as well. You know, moving forward, we're gonna be evaluating the manufacturing operations for cable TV products in light of you know, those two different manufacturing locations.
I'm guessing that you're not prepared to provide essentially a pro forma variation of your financials. You're not able to tell us how much revenue we can sort of back out, given you're still doing lasers for the data center but not transceivers. It's a little bit, I think, tricky for us to rebuild the models given the information we have. Is there any other quantitative detail you can offer?
Right. We're still working through, you know, some of those numbers. As I noted in our prepared remarks, we'll, you know, share those on subsequent calls. We did note that, you know, the data center transceiver business overall was about a $92 million business trailing twelve months from the last quarterly report. Typically, the laser part of that would represent, you know, 10% to 15% of that spend. There can be a lot of nuance there based on product mix and what have you. We're gonna be, you know, providing more guidance as soon as we can. At this point, that's all we can share.
Yeah, that's helpful. Thank you. Then just one last one. Do you know how this transaction would alter your book value? Given that you're divesting yourself of some assets, but getting some cash, I imagine it's depreciated. Do you have an update on what the book value will be after this transaction?
I don't have that number at this point. Again, we'll be able to report more of that data as we get, you know, into the next earnings call.
Great. Thank you for taking the question.
The next question comes from Paul Silverstein with Cowen and Company. Please go ahead.
Thanks, guys. I appreciate that it's precious early, but picking up where Simon left off. Any sense for what the margin profile will look like shortly after the close of the transaction? In addition, any sense for what the cash flow breakeven revenue level would be post-transaction? I've got some follow-ups.
Right. Well, I noted on our prepared remarks that our, you know, that our models, our preliminary models, which again are, you know, subject to a lot of variation, not the least of which because it's a forecast for some indeterminate time next year when this closes. They do indicate that, you know, we should be EBITDA positive in cash, you know, generating free cash flow after the close of this transaction. As far as the, you know, the revenue level and such that we've assumed in that, you know, I'll have to refine those estimates and share them with you at a future date.
Yeah, I'm not trying to give you a hard time, but I'm curious, when you all prepared the press release and made the statement that you expect to be FCF and EBITDA positive, I assume you had some revenue level in mind. It wasn't as simple as post-transaction will be EBITDA positive revenue. I mean, the two seem to be related, no?
Yes. They are. There's also various different scenarios under which we looked at it, and we have to refine those scenarios before we can try to pin down, you know, revenue numbers for you.
All right. I guess your message is you're gonna focus. The priority will be getting to EBITDA positive and FCF as opposed to revenue, as opposed to driving revenue for revenue's sake. I mean, that clearly is gonna be the focus. At least I hope it's gonna be the focus.
Yeah.
Oh.
Sorry to interrupt there. You were finishing your question. Go ahead.
No, no.
Yeah. The focus on this transaction is to improve and speed up our path to profitability, as we noted in our prepared remarks. That's what we're focused on. You know, we're heavily focused on being able to make the investments that we wanna make in businesses that we think are gonna be more profitable than the assembly of data center transceivers. You know, the laser business, for example, for data centers and other applications, which we're gonna maintain in its entirety, you know, post-transaction, you know, that's an example of something where we think that we can drive, you know, additional revenue opportunities and expanded, you know, gross margin relative to the assembly operations and things that are being performed in China currently.
That's definitely our focus, is improving margin and improving profitability post-transaction.
Got it. A couple more, if I may. I assume by definition, given that you've struck the deal and announced it, you believe that CFIUS will not be a significant hurdle in precluding this deal from getting done. You're selling assets, significant assets to a Chinese entity, that would seem to be non-trivial. I don't know what your response is.
Right. We've looked at that and, you know, we've had experts in that area look at it. You know, you never can tell with CFIUS, it's a little bit of a black box, obviously. The feeling is that, you know, this has a pretty good chance of being able to make it through the review.
The 4% to 10% contemplated investment, is that a requirement? Why, what's driving that, and what determines whether it's 4% or 10%?
The amount of the investment is still, you know, still under negotiation and discussion. The thinking there is, you know, first of all, I mean, this company is gonna be a significant partner for us, as we mentioned, both in terms of the contract manufacturing business as well as, you know, a significant customer for us. We do feel like that there's opportunities for this company to grow and, you know, to the extent that we can maintain some investment in there, we'd like to be able to get some return on that investment as well.
All right. One last one from me. With respect to the manufacturing relationship, can you remind us what the historical relationship with Yuhan has been? Are there commitments going forward in terms of you using them as a contract manufacturer, is that a hard commitment? Are you obligated to use them, and are they obligated to manufacture on your behalf? What's the nature of that commitment going forward, and what's been the historical relationship?
We don't have any historical relationship with Yuhan other than, you know, as a part of this transaction. As far as the commitments in terms of manufacturing, you know, we don't have a hard commitment. There are some exclusivity provisions which are, you know, sort of detailed in some of the documents you can read in the Form 8-K, that hinge on, you know, us using them and them performing activities of contract manufacturing for us. But outside of that, there's no obligation for us to continue to use them. As I noted, you know, we've, you know, we've been growing our manufacturing operations, for example, in Taiwan. But we think, you know, the Ningbo factory for us has done a really good job over many years.
They're very, you know, skilled in the manufacturing operations that we have. You know, we don't see any reason why we would, you know, need or want to move manufacturing away from them anytime soon. We have the capability to do so, should we desire to.
I appreciate the response. I'll pass it on. Thank you.
Thanks, Paul.
Again, if you have a question, please press star, then one. The next question comes from Tim Savageaux of Northland Capital Markets. Please go ahead.
Hi, good afternoon. Can you hear me okay?
Yes, Tim.
Yes.
Okay, great. Well, first, congratulations on just a spectacular transaction. Very dynamic and I think very much in the right direction. In terms of, you know, several of your or a couple of your much larger peers, you know, and I think this has been the case historically too. If you're just making a laser or a device, you know, those gross margins can start with a five or even more. Is that what you expect in terms of a standalone laser supplier, something in that range, or do you have any guidance for us for what that margin profile would look like on the laser-only part of the business? I've got a follow-up on cable TV.
Yeah. I think, you know, I can't make a comment at this point on kind of where our specific forward expectations are in terms of gross margin. As I mentioned earlier, you know, when I was answering Simon's questions, you know, those are a little difficult to pin down, you know, precisely at this point. However, I think, you know, your observation about the industry in general, that margins can be, you know, in the 50% or higher range, is certainly consistent with our thinking on that. Now, clearly, you know, different types of lasers and different types of applications have somewhat different margin profiles, but that's certainly a reasonable observation regarding, you know, regarding the industry.
Right. Well, good. You know, given your metric, your 10% to 15%, I mean, this depends, kind of leads into my second question, which is, you know, where from your current business standpoint, I guess the assumption might be that, you know, data center transceiver margins are below the corporate average and cable TV above. That's sort of part of my question there. It looks like you're targeting something like 20% of the BOM or 20% of cost of goods sold, maybe a little less than that if you're assuming, you know, data comm transceiver gross margins of, you know, 10%, 20%. I don't know where they are, but that seems to make sense. Maybe just start on that question about, you know, cable TV is gonna be the biggest part of the revenue going forward.
Can you make any comments on where you expect those margins to be or where they are relative to your overall margins currently?
Well, I mean, you know, cable TV makes up about half of our business, and we don't, you know, we haven't historically broken out margins by segment there. It's, yeah. We have noted pretty consistently in prior calls that the cable TV segment, in particular, has a lot of product mix involved in it. I mean, it's not as much one monolithic product as some of the data center business is. So, you know, it's a little hard to pin that down, but I would say it's. The cable TV margins are not that far off from the corporate average. They're reasonably close to the corporate average. Now, the data center business is a little more nuanced than that because, you know, there's a lot of intercompany,
Right
technology that gets transferred around. It's so, you know, it's a little difficult to say how much of the margin is comprised of data center transceiver manufacturing operations versus the margin that derives from the laser itself.
Right. Understood. I guess last question for me, just let me know if this is the right way to think about it, but let's, you know, let's make it easy and say you've got $100 million of data center revenue last twelve months, and if those margins are, you know. I'm hearing you on the intercompany stuff, but module margins, you know, may be in the teens.
I mean, is it possible that, you know, obviously you're foregoing a lot of revenue, but given our, you know, our previous discussion about gross margin levels, is it possible that you won't be foregoing any gross profit dollars, which is to say, even at this lower revenue level, margins are high enough where it's you know can be kind of a wash with regard to where you come out on a gross profit absolute dollar standpoint?
Well, I think, you know, as I said earlier, you know, it's a little early for us to give a lot of details in terms of our, you know, our outlook for that. Is it possible? Maybe. I think it would be a stretch.
Yeah.
Our real expectation here also, which I noted in our prepared remarks, is that, you know, I think we can grow the data center laser business. If you think about it, right now, you know, we're sort of limited. We use the vast majority, pretty much all of our laser production for internal use. Now that we will not be producing transceivers in the future, once the transaction closes, you know, we'll have the opportunity to, result of this transaction.
The other important part of this transaction is that, you know, there are certain customers in China who we've noted on previous earnings calls that, you know, for political reasons or preference reasons, they saw what happened with Huawei when the U.S. government essentially shut down certain U.S. very skittish, I would say, about having key technology elements coming from U.S. companies for that reason. They know that, you know, it's just one phone call away from the Department of Commerce before they could potentially have that revenue shut off. I think, or rather that source of supply shut off.
I think that the opportunity for Yuhan post-transaction to grow the data center business by expanding sales to some of the large Chinese data center operators is another avenue by which I think we can actually increase revenue. Our expectation is not that, you know, data center laser revenue is gonna sort of remain consistent after this. I think we're expecting growth. And obviously, the gross margin will expand from current levels in the data center because it's, as you noted, you know, laser gross margins are significantly higher.
you know, we think this is a really positive transaction, and it enhances our ability to get the profitability, not just by increasing our, you know, gross profit margin, but also, you know, increasing our revenue opportunities, and those expand even further, you know, down the line.
Because as a key of this transaction, Yuhan with AOI China, I think they will have a lot of opportunity in the China market. Not only data center, including fiber to the home and maybe telecom, okay? For sure, we're still their major laser supplier. They will have AOI laser revenue and gross margin. I think that is a win-win position. That's whole purpose is I think the value is much more than the $150 million we can see. That's whole purpose. We can really, you know, expand out the overall market in transceiver and laser without limitation. Yeah.
Yeah. I've got it. Just last one for me.
We should also, in addition to your trailing data center revenue, you've got $25 million or so, $25 million of telecom, you know, fiber to the home, other revenue. You'll be selling lasers into that. Should we be thinking about that the same way from a content standpoint?
Actually, right now, quite a lot of the revenue is not transceiver, the laser already. Some of them actually quite a lot of the revenue are the laser business, not transceiver business. That's why right now, I think we are not really participants too much in China market for fiber to the home and telecom because of, you know, as a U.S. supplier, there are some limitations over there. That's our current. The number you see actually quite a lot of them are laser already. In the future, after the transaction, Yuhan can do transceiver, and for sure, I think they will use majority of AOI laser. There'll be additional revenue on top of what we can see.
Okay. That's interesting. That's currently mostly laser revenue. You're gonna keep that.
Yes, correct.
By and large. Okay.
Great. Thanks.
This concludes our question and answer session. I would like to turn the conference back over to Dr. Thompson Lin for any closing remarks.
Again, thank you for joining us on the call, especially on such short notice. As always, we want to extend a thank you to our investors, customers, and employees for your continued support. We look forward to updating you on our progress next quarter.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.