祥茂光電 (AAOI) 2016 Q1 法說會逐字稿

Good day, and welcome to the Applied Optoelectronics first quarter 2016 Financial Results Conference Call. All participants will be in a listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note that this event is being recorded.

I would now like to turn the conference over to Maria Riley. Please go ahead.

Thank you. I am Maria Riley, Applied Optoelectronics Investor Relations. And I am pleased to welcome you AOI's First Quarter 2016 Financial Results Conference Call. After the market close today, AOI issued a press release announcing its first quarter 2016 financial results. The release is also available on the Company's website at ao-inc.com.

This call is being recorded in webcast live. A link to that recording can be found on the relation page at the AOI website and will be archived for 90 days.

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. Thompson will give an overview of AOI's Q1 results, and Stefan will provide financial details and the outlook for the second quarter. 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 such forward-looking statements. You can identify forward-looking statements by terminologies such as may, expect, plan or believe, and by 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 factor 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. The reconciliation between our GAAP and non-GAAP financial 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 on to the financial results, I'd like to remind you that AOI management will host its Inaugural and Investor Day in their new building in Sugar Land, Texas on June 9. We hope to have the opportunity to see many of you there.

Now I would like to turn the call over to Dr. Thompson Lin, Applied Optoelectronics' President, Founder and CEO.

Thank you, Maria. Thank you for joining us today. Looking at our first quarter of the year of 2016, AOI delivered revenue of $50.4 million. We projected 67% growth year-over-year, and with our guidance of $50 million to $54 million. Our goals were driven by continued demand for our market [leading] datacenter products offset by lower than anticipated (inaudible) revenue.

We reported a fourth quarter non-GAAP loss of $0.04 per share. In our original guidance range of earnings between at $0.21 and $00.20 per share. Our gross margins were primarily impacted by lower than expected EBIT on certain internal loss, (inaudible) the lower than expected [EBIT] have largely been resolved and we expect gross margin of this product to gradually improve as we progress to our second quarter.

Additionally, gross margin was lower than anticipated because one of the G transceiver orders were lower than forecasted. Our bottom-line [products] were also impacted by higher than expected R&D costs as we work to simplify and build more automation into a compress line engine manufacturing process for both 40G and all other G products to obtain greater efficiency on these products.

In addition, we invested in development of a new 100G transceiver design to allow further cost reduction on this product as [bargain] later in the year, because without saying that, we are disappointed with our bottom-line result. We recognize it is critical to consistently deliver our earning objectives, due to a complexity of our manufacturing process and our [money for prints] in the US and Asia. Currently, internal communications is critical to our ability to accurately forecast results.

To this end, we have taken action to improve our internal and information systems, and we have brought out additional operation measurement staff in Asia to support this effort. I would rather know that despite our operational change we saw in the fourth quarter, there was no impact to our customers, and we will be accommodate them for the first quarter.

We believe we have a very strong tradition in the datacenter optics market with leading and growing market shares within our customer-base. We remain committed to building on our strong foundation as a leader in advanced optical technology and expanding our footprint within the market. We believe the upgrade to 100G in a datacenter should be one of the largest upgrade cycles to update to-date.

Research (inaudible) estimates that 100G single or more transceivers units will grow at 55% compounded annual growth rate from 2016 through 2019. We believe AOI's well positioned to capitalize on this growing long-term trend. A few of those trends include, first, we are vertical integrated and one of the few companies with ability to delivery 25G edge emitting laser in high volume. This means we have opportunities to participate in the 100G upgrade cycle in three different areas of the supply chain by setting lasers in all of the transceiver modules.

We're adding capacity for our new factory in Houston, that is scheduled to come online in Q3. It will enable us to expand our avenue to market 100G. Second, what we have expected the 100G market to be comparative given the size of opportunity. We are committed to remain the core leader. We feel we can continue to be the core leader in 100G while at the same time, we now cover gross margins back to the label to get it above market. As we mentioned to you before, our 100G gross margins is about corporate average, and while competition is increasing, we believe we can maintain the strong margin even as the market matures.

We will leverage our vertical integration, (inaudible) our manufacturing process, and regain leverage in advanced optics to draw product innovation, shorten manufacturing time, and draw efficiencies. This is an area where AOI exists and where we continue to develop. As an example, we have manufacturing engineers that improve the cycle time for one of the lines in production of approximately 60% faster than the area of which we improve 40G production.

And so, we report to the market that we believe we have the core position to announce the growth of 100G transceiver designs with our two largest datacenter customers. We went beyond the internal datacenter market; we are also participating in the 100G datacenter internal market by supplying laser to a new and growing innovator in the space. While this is a much smaller market than our core datacenter market, we are excited that our lasers are helping customers changing the landscapes of this market.

In cable TV, the first quarter continues to be very soft. However, it seems from the demand that it begins to improve as we have activity in the quarter, and we continue to believe that we are well positioned to capture a significant portion of the DOCSIS 3.1 infrastructure spend, and not reach a (inaudible). Overall, we remain focused on building our strong foundation in the datacenter and cable TV market to draw growth in the two of AOI's financial objectives.

With that, I will turn the call over the Stefan to review the details about Q1 performance. I will now bring you over to Stefan.

Thank you Thompson. Total revenue for the first quarter grew 67% year-over-year to reach $50.4 million, within the original guidance of $50 million to $54 million. We continue to see strong demand for our datacenter products.

Datacenter revenue in the first quarter grew to $39 million, representing growth of 139% year-over-year and ahead of our record performance last quarter. Our Datacenter growth this quarter was primarily driven by continued 40G sales to our two largest datacenter customers. We also expanded the number of 100G shipments by 30% compared with the fourth quarter.

However, as Thompson mentioned, we are starting to see customers push our forecast for 100G transceivers. This is due to the delay in market availability of advanced 100G chip sets required for switched and routers. Current forecast from our customers indicate that we should expect to see strong growth for our 100G transceivers once the enhanced chip sets are more broadly available in the back-half of the year. Despite this near-term delay, longer-term customer forecasts for 100G products have remained consistent. We continue to be in active qualification with existing and new hyper-scale datacenter customers for other 100G products, and we continue to expect decisions to be made sometime in the first half of the year.

We are particularly encouraged by results coming from one of our hyper-scale engagements and we look forward to sharing more information about this opportunity in the future.

Turning to our CATV market. Revenue from CATV products in the first quarter was $7.7 million, down 36% year-over-year when compared with $12 million in Q1 of last year. While we had expected a sequential seasonal decline in CATV, revenue for these products was lower than expected due to the same dynamics we saw in Q4, which included lower international sales especially in Latin America and consolidation among our CATV customers in the US. As Thompson mentioned, this was our lowest CATV revenue in many years, but fundamental demand began to improve as we exited the quarter.

While we believe Q1 to be the bottom for CATV, please recall that in Q2 of 2015, we had very strong demand from Latin America, and thus, we are facing a stiff comparable quarter last year, and we expect to see a year-over-year decline in CATV revenue compared to the same quarter last year. We continue to believe DOCSIS 3.1 will be a significant growth catalyst for our CATV business and widespread deployment is expected to begin in mid-2016. Ahead of this demand at the end of Q1, we began to see a resumption in normal order flow from one of our CATV customers who had previously slowed markedly. As the CATV market leader, we believe AOI remains very well positioned to capture a significant portion of the DOCSIS 3.1 infrastructure spend directed towards node and head-end replacements.

Revenue for our FTTH segment came in at approximately $400,021. Revenue in this segment is expected to continue to fluctuate quarter in the $0.1 million to $2 million range in the near-term.

Our telecom segment delivered revenue of $3.1 million, up 80% year-over-year driven by recent design winds with several of our telecom customers. For the quarter, 77% of our revenue was from datacenter products, 15% from CATV products, with the remaining 8% from FTTH, telecom, and other. In the first quarter, we had two 10% or greater customers in the datacenter business that contributed 52% and 25% of total revenue.

Moving down to income statements; Q1 total gross margins was 28.3%, a decrease of 120 basis points when compared with the 29.5% reported in Q4 of 2015 and a decrease of 490 basis points from the 33.2% reported in Q1 of last year. Our consolidated Q1 gross margin was primarily impacted by lower than expected yields as we ramped new capacity and trained new staff for certain longer reach 40G and 100G light engines.

During the quarter, we experienced a higher than expected turnover in production line workers in our Ningbo, China factory. While in the first quarter, we always expect to see a seasonally higher level of turnover in China because of the Lunar New Year, the turnover this first quarter was double what we normally see. As a result, we experienced lower than expected yields and longer manufacturing times as we brought in and trained new production line workers. I would like to reiterate that despite these operational challenges, there was no impact to our customers, and we fulfilled customer requirements for the quarters.

The activities we undertook to simplify and automate more of the manufacturing process for light engines, along with design activity for our cost reduced 100G transceivers, caused our R&D expense to increase in the quarter by approximately $2.2 million. We expect these investments to yield improved yields and lower manufacturing costs. We also believe these investments will help enable us to maintain our cost leadership in 100G products even with anticipated volume-driven price reductions in the future.

In total, R&D expense was $8.3 million or 16.4% of revenue, compared with $5.9 million or 11.1% of revenue in the prior quarter. Sales and marketing expense was $1.6 million, or 3.2% of revenue, in line with the $1.6 million or 3% of revenue in the prior quarter. G&A expense was $4.9 million, or %9.7 of total revenue; an increase slightly from $4.5 million or 8.5% of total revenue in Q4 of last year. The increase in G&A was mostly from annual compensation increases and additional headcount added in Q1. This brings total operating expenses in the first quarter to $14.8 million, or 29.3% of revenue, up approximately $2.8 million when compared with $12 million or 22.6% of revenue in the prior quarter, with the majority of the increase in R&D.

On a year-over-year basis, total operating expense as a percent of revenue decreased by 510 basis points compared with the first quarter of 2015. Non-GAAP operating loss in Q1 was $0.5 million compared with operating income of $3.6 million in the prior quarter and operating loss of $0.3 million in Q1 of last year. Non-GAAP net loss after tax for the first quarter was $0.6 million compared with net income of $3.9 million in the prior quarter, and $0.3 million in Q1 of last year. We reported a non-GAAP net loss of $0.04 per share compared with non-GAAP net income of $0.22 per diluted share in the prior quarter and $0.02 in Q1 of last year.

GAAP net loss for Q1 was $1.3 million, or $0.08 per share, compared with GAAP net income of $2.7 million, or $0.15 per share, in the prior quarter. The Q1 weighted average basic share count was approximately 16.9 million shares.

Turning now to the balance sheet. We ended Q1 with $58.5 million in total cash, cash equivalence, short-term investments, and restricted cash compared with $40.7 million at the end of the previous quarter. Accounts receivable decreased to $34.9 million compared with $38.8 million last quarter. Accounts payables decreased approximately $3.6 million over Q4. We made a total of $16.9 million in capital investments in the quarter, including $7.6 million in production equipment and machinery and $8 million on construction and building improvements, mostly for our new production facility in Sugar Land.

As of March 31, we had $60.3 million in inventory; a decrease of approximately of $6 million from Q4. The decrease in inventory is due to improved supply chain management procedures that were implemented over the last several quarters.

Moving to our outlook. We expect Q2 revenue to be between $49.5 million and $52 million, representing flat to 5% year-over-year growth. We expect Q2 non-GAAP gross margins to be in the range of 29.5% to 31%. Non-GAAP net income is expected to be in the range of $0.7 million to $1.5 million, and non-GAAP EPS between $0.04 per share and $0.08 per share, using a weighted average of fully diluted share count of approximately 17.9 million shares.

With that, I will turn it back over to the operator for the Q&A session. Operator?

(Operator Instructions) Simon Leopold from Raymond James.

This is Victor Chiu in for Simon Leopold. I guess I'll just ask about the gross margin issue and the outlook. I think most of us were surprised, I guess, to the extent that the issues continue to persist even into your second quarter guidance.

First, with the operational issues that you had - the same as the constrained production issues that you had last quarter with the longer-range 40G transceivers, and were there any additional issues that came up?

No, I mean, the gross margin issue that we saw this quarter, a lot of it had to do with higher than expected turnover in staff in our China factory, as we mentioned. The number of employees - seasonally in Q1 we always lose some employees in China due to the Lunar New Year, but this year the amount of turnover that we saw was double what we normally see in the first quarter. So we had a lot of new staff that we had to bring on and train during the quarter. That resulted in additional costs in terms of training costs, yield loss that we had to overcome as we were training these new employees, and hiring expenses, that sort of thing. So that was a big contributor to the shortfall in the quarter.

Well, what about the issues that you experienced last quarter, did that have any impact at all this quarter, and is that issue large rectified? And if not, how much longer are we looking at before you get to a normalized production rate?

Yes. So I think the yield issues that we experienced last quarter, those issues have been large resolved and the remaining issues that we had in this quarter were really kind of unique to the first quarter.

We did note that we had lower than expected 100G orders, even though that brings our corporate - the 100G margins are actually higher than our corporate margins, so that also was a contributor to the lower than expected gross margins in this quarter. And those issues are expected to be resolved over the next few quarters, as I mentioned.

Just speaking on 100G, can you give us a sense of how many units you've shipped this quarter and if there were any new customers? I'm just a little bit surprised that the demand is shifting out a little bit. So if you could just speak about that some?

Yes. Well, we tend to ship about 30% more units than we shipped last quarter. Last quarter we talked about shipping around 10,000 units, so 30% more than 10,000 or so was what we shipped this quarter.

As far as what we expect in the future, as we mentioned in the earlier remarks, in order for our customers to utilize the optimal devices that we manufacture, they plug those optics into switches and servers that they purchase from other customers. So the chips that are used in the switch, which we don't manufacture, we don't purchase, but it's another piece of the 100G ecosystem if you will. And that switch chip set - it's our understanding, we don't buy that chip set directly, but it's our understand based on what our customers are telling that the widespread availability of an enhanced version that has additional features of that chip set is going to be shipped by two quarters or so, roughly till the end of Q3. So for that reason, they need less of the optical modules that we manufacture than they had earlier thought they would need. But longer-term demand we expect to be as strong as we ever thought we would be.

(Operator Instructions) Troy Jensen of Piper Jaffray.

Just to follow up on the question about the Silicon; it's a Tomahawk chip set you're referencing, correct?

Well, we don't want to comment on specific issues with other companies. It would be a chip set that would do the same functions as the Tomahawk chip set. Right, it's the main chip in the switch.

When I look at your guidance here for the June quarter, up slightly sequentially in year-over-year. Can you just talk about the datacenter piece of it? Do you expect that to grow sequentially? You did comment that cable was going to bow out to be the low last year, I mean, it's a big spread between $77 million and $16 million you did a year ago. Can you just help us out with the directionally growth rates for the cable TV in your Q2 guidance?

Of course, we don't really give guidance by segment as you know. So I won't comment on that directly. I think as we said in the earlier remarks, we did see a resurgence in cable TV orders toward the end of the quarter. And we think we said sort of the bottom in terms of cable TV revenue, so I would expect that to be up sequentially but we have a pretty stiff comparable quarter last year in Q2 and cable because of orders coming out of Latin America that clearly are going to be constrained due to the ongoing currency situation down there. So that's why we don't think cable is going to be as robust in Q2 of last year.

As far as the datacenter side of the business, we've continued to see strong growth in 40G products. This was I think our fourth or fifth quarter in a row of increased datacenter revenue. So we've been doing a really good job in executing in the datacenter side of the business. Nothing that's going on in the 100G is related to any shortcomings in AOI's products or anything like that. It's just an issue with switch chip sets, and so, we think that's going to be pushed out until Q3.

Do you think datacenter will grow sequentially? I guess that's was what I was trying to get to.

You know, there are scenarios where it could and there's scenarios where it won't and we haven't given guidance on that.

Was your book to build greater than one in the quarter?

Yes.

Last question for me; can you just talk about the 100G designed wins and the broader G customers?

We have five designed wins in 100G and they're with our two largest datacenter customers.

(Operator Instructions) Krishna Shankar from ROTH Capital.

Yes, Stefan, is some of this being gross margins guidance for Q2 impacted by the higher costs of goods in Q1 and are you selling, in affect, higher cost products in Q2, which is, again, continuing to impact gross margins?

Yes, there's some of that effect. I mean, clearly we didn't exit the quarter with zero inventory. And so, there is some of that higher margin product that will bleed through into the quarter. So that is one of the factors.

Your folks feel now that the production yield issues, the new operators sort of being trained; you are at a point where yields are starting to stabilize and you're still able to meet demand for your two largest customers? Do you have any additional 40G customers that you have the capacity to serve with your production now?

We do have, obviously, other 40G customers other than the top two, but they're relatively small and we've been able to meet all of their demands in the quarter, all the demand that we thought we were able to meet. Which isn't to say we didn't have any backlog at the end of quarter; we did exit the quarter with backlog, but the point is, what the customers needed during the quarter, we were able to deliver both at 40G and 100G.

And then the production yield issues, you have stabilized now and you're running at sort of normalized production yield levels now?

Yes; the productions yields improved a lot during the quarter. I think that there's still some room for improvement. We mentioned in our earlier remarks about the investments that we made on the R&D side to further improve the manufacturing process to make the cycle time shorter, improve yields and that sort of thing. And so, we would expect that those efforts will pay off in further manufacturing improvements in the future, but the yield has certainly improved substantially during the quarter.

Then my final question is on the competitor environment both for 40G and 100G, can you comment on that for both of the 40G and 100G market?

Yes, we haven't seen any real shifts in the competitive environment for either of those products. They've continued to be the same competitors that we've seen before, they continue to be there.

And I guess, as you've said, you've been able to retain your customers and continue to have the dominant share of their 40G and now for the 100G also you haven't lost any customers during this Q1 production issue?

Exactly. All of the issues that we've had, while they certainly have negatively impacted our financials, the customers got the products that they've needed with exceptional quality, very good on time deliver. We didn't have any issues at all related to anything that the customers would experience. So I think they remain just as happy as they always have been with AOI.

And ladies and gentlemen at this time, that does conclude today's question-and-answer session. I'd like to turn the conference call back over to Thompson Lin for any closing remarks.

Thank you for joining us today. As always, we thank our investors, customers and employees for your continued support and we look forward to seeing you at our Investors' Day in June.

Ladies and gentlemen, the conference is now concluded. Thank you for attending today's presentation. You may now disconnect your telephone lines.