Good afternoon, everyone, and welcome to Applied Optoelectronics Second Quarter 2016 Conference Call. [Operator Instructions] Please also note that today's event is being recorded. At this time, I would like to turn the conference call over to Ms. Maria Riley, Investor Relations for Applied Optoelectronics. Ma'am, you may begin.

Thank you. I'm Maria Riley, Applied Optoelectronics Investor Relations, and I'm pleased to welcome you to AOI's Second Quarter 2016 Financial Results Conference Call. After the market closed today, AOI issued a press release announcing its second quarter 2016 financial results. 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 page of 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 Q2 results and Stefan will provide financial details and an outlook for the third 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 terminology, such as may, expect, plan or believe and 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 expectation. More information about other risks and uncertainties 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. A reconciliation between our GAAP and our 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 remind you that AOI management will attend the Jefferies Semiconductor, Hardware & Communications Infrastructure Summit on August 30 in Chicago, and the ROTH Capital Partners Datacenter and Technology Corporate Access Day on September 7 in San Francisco. 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. Thompson?

Thank you, Maria. Thank you for joining us today. AOI deliver second quarter top and bottom line results well above our guidance. We accomplished a great deal in the quarter, and we are pleased with our progress. We grew revenue 11% over last year to reach $55.3 million, which was well above our guidance of $49.5 million to $52 million. We grew datacenter revenues 39% over last year and achieved record datacenter revenue for the fifth consecutive quarter. We resolved the operational challenges that we experienced last quarter at our NinGo, China factory with the support of our dedicated operation team, and this contributed to 310 basis point sequential improvement in our gross margin. We delivered improved profitability with non-GAAP earnings per share of $0.16, well above our original guidance range. We saw improvement in CATV demand as cable operator began to run out their deployment of DOCSIS 3.1 technology in their network footprint. And lastly, we completed the expansion and move to our new state-of-art fab facility in Sugar Land. We also hosted an Analyst Day in June, where we had opportunity to showcase our new facility. After a challenging start to the year, AOI delivered a strong second quarter. Our progress in the quarter reflects our commitment to operational excellence, and I'm especially proud of our team's hard work and dedication. While we still have work to do over the coming quarters, I'm confident that we are on the right pace to build on our momentum in the datacenter and CATV markets and achieve our long-term financial objectives. With that, I will turn the call over to Stefan to review the details of our Q2 performance and outlook for Q3. Stefan?

Thank you, Thompson. Total revenue for the second quarter grew 11% year-over-year to reach $55.3 million, well above our original guidance of $49.5 million to $52 million. Our strong results in the quarter were driven by continued demand for our market-leading datacenter products and an increase in demand for our CATV products. Datacenter revenue in the second quarter grew to $41.3 million, an all-time high, which represents 39% year-over-year growth. Continued demand for our market-leading 40G products primarily contributed to our strong growth in the quarter. This quarter, 86% of our datacenter revenue was derived from our 40G datacenter products. Demand for our 100G products was in line with expectations, and we continue to expect 100G shipments to increase in Q3. Leading hyper scale datacenter providers continue to see a growing need to upgrade and expand their infrastructure to address the demand for higher bandwidth and faster data speeds. Our ability to internally produce 10G and 25G lasers and 40G and 100G light engines, combined with our ability to quickly shift capacity between 40G and 100G products, provides AOI the flexibility to quickly scale to growing demand and adjust to customer needs as they evolve. We believe this is a key differentiator for AOI, giving us time to market and cost leadership advantages over the competition. We believe we have the leading market share within our current datacenter customers. Additionally, we continue to be active in qualifications with another hyper scale datacenter customer and are making good progress on this initiative, which is in line with our expectations. We look forward to sharing more information when a decision has been made. Turning to our cable TV market, revenue from our CATV products in the second quarter was $9.5 million compared with a record $16.4 million in Q2 of last year.…

[Operator Instructions] And our first question comes from Troy Jensen from Piper Jaffray. Please go ahead with your question.

Thank you and then congrats on nice results.

Thank you.

Thanks, Troy.

Hey, so Stefan, when you look at your Q3 guidance, I'd be curious to know, cable versus datacenter. Are you expecting both to grow modestly sequentially? Or is one going to outpace the other?

Yes, I think we're expecting both cable and datacenter to grow in the quarter.

So modestly then for both and then, within the datacenter business, I mean, is it safe to assume that 40G is going to decline, and we're going to get a quicker ramp on 100G or do you think the 40G business stays at this level for a bit?

Well, I think, as 100Gig ramps, we will expect to see a decline in 40Gig. This quarter, as we indicated, 100Gig is really going to be ramping. So there's going to be a transition period, I guess, you could say, between the 40Gig growing, obviously, as it did this quarter and eventually declining. As far as the specifics of how that breaks out in this quarter or next quarter, it's a little difficult to say. But we would expect - we don't expect 40Gig to drop significantly, let's say, all at once. It will take a period of time for it to decline.

Yes, that's comforting. And then last question and I'll cede the floor. Can you just give me any update on QSFP-28 units you shipped, I know you've provided a data point maybe a quarter or two ago. Are there any new 100G design wins in the quarter?

So as far as the 100Gig shipments, in terms of units, we shipped somewhat less than what we shipped last quarter in terms of units, which was in line with what we had expected. And as far as 100Gig design wins, we didn't announce any design wins for 100Gig in this quarter.

All right, guys. Good luck in the second half.

Thanks.

Our next question comes from Simon Leopold from Raymond James. Please go ahead with your question.

Thank you for taking my question. This is Mauricio Canjura on behalf of Simon Leopold. A couple of questions, the first one, Stefan, can you give - please give us an update on your expectations of the availability of the 25G, 50G chipset? And based on that, when are you expected to meaningfully ramp 100G shipments?

Well, with regard to the chipsets, that's really a question that's probably better addressed to either one of the chipset manufacturers or one of the customers that's buying them. We did guide for a ramp in 100G starting in this quarter in Q3. And so clearly, our customers have, to some extent, at least resolved the 100G problems they had. As far as of the availability of the chipsets, I won't comment on that because it's not our chipset.

Okay. Also, if you could also give us some color on the overall pricing environment, and most notably, on 100G?

Sure. I think, as we indicated in our Analyst Day, AOI is prepared to maintain our cost leadership in the 100G products. So the pricing environment has been competitive. There's no doubt about it. But we think we're well positioned to maintain gross margins and revenue growth, even in light of the competitive pricing on 100G.

Okay and the final one if I may. You previously talked about - you were on trials on the 100G portfolio with the third web-scale customer. I was wondering if you could - I know you addressed that on your statements, but if you could give us more color on that.

No, I mean, pretty much what we said in the early remarks is what we have to say at this point on. The qualification is still ongoing. It's going well. It's within - we're where we expected to be at this point in terms of the plan. And as soon as we have a concrete decision to make or to announce, we'll do so.

Our next question comes from Richard Shannon from Craig-Hallum. Please go ahead with your question. Please go ahead with your question.

Hey, guys. Thank you for taking my questions and nice quarter and guide here. Let's see, a few questions from me, maybe on 100G here. Stefan, I wondered if you could maybe add a little bit more precision to your expectations here in third quarter. You mentioned it coming down in the second and coming back up in the third. Is this going to be a record level here in the third quarter or not up to the levels you saw in the first?

We haven't really indicated any numbers. We don't really give guidance on a kind of by-product basis like that. We do think that the customers, as I said on the previous - the answer to one of the previous questions, that the customers are moving beyond the problems that they had with the chipsets in the previous quarters. And so I think this should be the beginning of a sustained ramp. As to what exactly how much comes into this quarter or next quarter, we're not going to comment on the precise level.

Okay, fair enough. Question on gross margins, had a nice ramp up after the issues in the first quarter. Your guide for the third quarter at the midpoint just is slightly below what you had in the first. And you're talking about some growth in the 100G in datacenter, I guess, specifically. Seems to be contrary to one another because I think you've talked about 100G being a positive mix shift for you. Can you help us understand, at least at the midpoint why that would be down? Is this due to some sort of mix or depreciation? Or what would be the reasons for that, Stefan?

Well, certainly, mix is always an element for us among the different products that we have. But I think, as we talked about at the Analyst Day, we have a gen 2 100G product, which is significantly lower cost, which will be coming online for us towards the end of the quarter. And so the 100G margin profile will improve as that gen 2 product comes on board. But that won't be until later on in the quarter. So you won't see as much of the margin effect in this quarter as you will next quarter.

Okay, great. I apologize. I missed this comment as I was looking at something else. But I think you mentioned something about CapEx. Can you repeat that please, Stefan?

Yes, I mean, well, all we said about the CapEx. We just repeated the CapEx numbers that we had in the quarter, which were - stand by a second here.

Did you mention anything about third quarter trends? I thought I missed something there, so that's why I'm - that's the point of my question. Did you mention anything about the third quarter or second half?

No. What we said about was that we spent $17.6 million total in the quarter, $6.2 million was on production equipment and machinery and $9.7 million on construction and building improvement. And then what we said is that, as the construction projects that we have ongoing are drawing to a close, that we would expect that portion of it, that is the $9.7 million that we spent in Q2 on construction and building improvements, we would expect that to start to go away.

Got it, okay. That's what I think I missed there. Okay, great. Then my last question on cable TV, started to see some improvement, finally, which is great to see. Obviously, DOCSIS 3.1 trends seem to be pretty positive. Wondering if you can kind of give us kind of your big-picture thought here and numerically, as we look relative to your recent past here. You had a record quarter, I think, about five quarters ago at - where did I put the number, roughly $16.5 million a year ago. Is that a number that you see as achievable as DOCSIS 3.1 begins to build over the next few quarters at all? Is that remotely a possibility?

I mean, I think, it's achievable. I won't say specifically, over the next couple of quarters. But certainly - I mean, it's not something where we've never expect to see that number again. I think, what we've said about the cable market is that this is the beginning of what we expect to be a long upgrade cycle. Cable, as you probably are aware, is relatively slower moving, I would say, in terms of adopting new technologies compared to, say, datacenter customers, for example. So we wouldn't expect the ramp to be as sharp. But I certainly think this has got the potential to be a sizable upgrade cycle and certainly one that we should be able to achieve that $16-plus million figure at some point in the future.

Our next question comes from Brian Alger from ROTH Capital Partners. Please go ahead with your question.

Thank you. And good afternoon, guys and I'll echo the congratulations, nice quarter. You mentioned that you expect growth from both the datacenter as well as the CATV. I'm wondering if the remaining segments, the fiber-to-the-home and the telecom are expected to be flat in the quarter or perhaps even not growing. How should we think about the rest of the business?

Well, I think, if you kind of look at our FTTH results over the last few quarters, it's been kind of hovering up and down around that $400,000 to $500,000 a quarter figure. So we - I wouldn't expect there's no catalyst - that we would expect that to change dramatically in the next few quarters. Telecom has been growing as a segment for us pretty steadily. But again, that's kind of a - this is a hodgepodge of different products that we sell for different applications and several different customers there. It's not an area of emphasis for us. So while we continue to look for opportunities to get business in that segment as well as any other one that we can find, it's not an area of emphasis for us. So I wouldn't expect that to be it, again, a big source of growth for us. They're also - I mean, all those segments together are relatively small for us. So even if we did see some growth, even if it was healthy on a percentage basis, on a dollar basis, it would be small enough that whatever growth we see in cable TV and datacenter would likely dwarf that amount of business.

All right and I guess, where I'm going with this is that, at the midpoint, the guidance for the quarter, in the September quarter's roughly about 5% growth. There's others talking about faster growth within certainly the datacenter markets. And it's - one would think that the cable adoption of 3.1 is just getting started. Trying to understand why the growth wouldn't be stronger than seasonal here in the September quarter. Is this just a matter of conservatism? Or is it lack of visibility? Or how should we think about it?

Well, I think, the reality is that it's very hard to pinpoint growth in business quarter-by-quarter, right? I mean, we tend to look at business over a longer-term time frame. And I think, if you'll take a bigger picture, there's been quite a lot of good growth, both in the datacenter and most recently, in the cable TV business. So as far as how much of that we're going to attribute to the third quarter and the fourth quarter, it's just a matter of making a judgment on which quarter a lot of that revenue is likely to fall into. I'll also point out, as I have in the past, that some of our major - both cable TV and datacenter customers have vendor managed or VMI or vendor-owned inventory programs. And that also makes it a little bit difficult for us to predict precisely how much revenue is going to fall in any particular quarter. And so we have to be appropriately conservative with respect to those VMI and VOI programs, because we don't have control over that - the timing of that inventory.

Of course, it makes sense. And you mentioned the split between 40G and 100G. As you look at the datacenter customers and the orders that we have for the September quarter, would you expect a significant shift in that split in the September quarter towards 100G? Or are we still looking at a similar split between 40G and 100G?

Well as I said, I think, 100G is going to ramp in this quarter. I would not expect 40G to grow at the rate that it has been over the last couple of quarters just because as 100G comes on again, at some point, 40G is going to peak, and start to decline. So I think, it's likely that we'll see a lower percentage of 100G - correction, a lower percentage of 40G in the quarter and a higher percentage of 100G in the third quarter

And just to be clear, I think, I'm hearing that you still expect 40G to grow, just not at the same rate that 100G would grow. Is that - am I hearing that correctly?

I didn't mean to say that. I was just saying it won't grow - 40G won't likely grow faster than 100G is all I'm saying. It could shrink or it could stay the same, but it won't grow as fast as 100G.

Okay. I appreciate the clarification. Nice job, guys.

Thank you.

[Operator Instructions] Our next question comes from Fahad Najam from Cowen and Company. Please go ahead with your question. Please go ahead with your question.

You may have addressed this earlier, so I apologize if I'm asking this again. But can you help us understand regarding this third hyper scale customer that you noted? Where exactly you are in the qualification process with this customer?

We are in the final stages of the qualification. But I mean, it's not done yet, so.

Got it and then talking about your R&D OpEx. Did I hear you correctly, that you expect your R&D dollars to come down sequentially? Just wanted to understand a little bit better what's driving the reduction in OpEx. Do you have plenty of capacity in place for this 100G ramp? Do you think you won't need to be expanding your lines for the rest of the year?

I think, I heard sort of two questions embedded in there. The first one was regarding OpEx, right, and specifically, R&D. And yes, we said that we would expect our R&D to decline modestly sequentially from this quarter on a dollar basis. The second question seems to be more focused on CapEx, because you're asking about adding lines. And we didn't give specific guidance on equipment and machinery CapEx in terms of whether it's going up or down or what have you. But I did say that overall, CapEx should decline because we spent a lot of CapEx in this quarter on building projects, specifically, here at Sugar Land, and that part is ending. So we won't spend anywhere near as much on the buildings this quarter. As a result, the overall CapEx should decline.

Got it. One last question, and that's on the NOLs that you guys have been carrying over. By my estimate, you should be exhausting your NOL credit somewhere between now and the third quarter. Can you help us understand your tax implications for the rest of the year?

No, we still have significant net operating losses available in the U.S. In Taiwan, we do - we're coming up against the end, if you will, of those NOLs. But that's - in the U.S., we still got significant NOLs available.

So, no meaningful change in your non-GAAP tax rate for the foreseeable future?

Yes, that's right. It'll tick up a little bit this quarter probably because, again, the NOLs in Taiwan have been largely utilized, but nothing in the U.S.

Got it, thank you so much.

And ladies and gentlemen, we have reached the end of today's question-and-answer session. I'd like to turn the conference call back over to Thompson Lin for any closing remarks.

Okay. Thank you for joining us today. As always, we thank our investors, customers and employees for your continued support.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your telephone lines.