Good afternoon. I will be your conference operator. And at this time, I would like to welcome everyone to Applied Optoelectronics First Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the call over to Monica Gould, Investor Relations for AOI. Ms. Gould, you may begin.

Thank you. I'm Monica Gould, Investor Relations for Applied Optoelectronics, and I'm pleased to welcome you to AOI's First Quarter 2020 Financial Results Conference Call. After the market closed today, AOI issued a press release announcing its first quarter 2020 financial results and provided its outlook for the second quarter of 2020. 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 1 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. Thompson will give an overview of AOI's Q1 results, and Stefan will provide financial details and the outlook for the second quarter of 2020. 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. In some cases, you can identify forward-looking statements by terminology such as believes, anticipates, estimates, intends, predicts, expects, plans, may, should, could, would, will or thinks and by other similar expressions that convey uncertainty of future events or outcomes. Forward-looking statements also include statements regarding management's beliefs and expectations related to the expansion of the reach of our products into new markets and customer responses to our innovations as well as statements regarding the company's outlook for the second quarter of 2020. Except as required by law, we assume no obligation to update…

Thank you, Monica, and thank you, everyone, for joining us today. First, I would like to thank the entire AOI team who has come together to support each other and our customers through these crises. Our thoughts go out to all those individuals around the world who are suffering from this virus and the first responders who are protecting our communities, we thank you. We have taken numerous actions to ensure the safety and well-being of our employees while continuing to support our customers' needs. Our offices around the world are generally back to normal operations, and we are adopting recommendations and safeguards in our factory to maintain optimal working conditions. These measures include regular testing of the employees where available, mandatory use of face mask and other personal protective equipment, increased remote working and limitation on meeting and employee gathering. I am pleased to report that no AOI employees is so far testing positive for the virus. However, we will continue to further enforce with new requirements for the safety of our employees and the larger society of which we are a part. Turning to the quarter. AOI delivered Q1 revenue of $40.5 million, which was below our expected guidance range due primarily to shipping delays out of China and Taiwan due to the COVID-19 pandemic. As a result, we have certain shipments from China and Taiwan and approximately $2.3 million delay was associated with these shipments pushed into Q2. AOI delivered non-GAAP gross margin of 19.5% and a non-GAAP net loss of $0.44 per share, which was below our expected guidance range, due to increased expense during the quarter associated with the coronavirus. As we discussed, on our Q4 earnings call, in order to reduce the impact of the shutdown in China on our customers, we took measures…

Thank you, Thompson. I'd first like to address the COVID-19 crisis and how AOI has proactively responded and adapted to the current environment. Given our presence in China, we had early indications of the possible impact of the virus globally and took action to protect our workforce earlier than many companies in the U.S. We have adopted recommendations from the CDC and safeguards in our factories and offices to maintain safe working conditions for our employees and keep our manufacturing capabilities on track. While we had significant disruptions in operations in our China factory during Q1, we believe we are largely back to normal operating capacity. The coronavirus has led to a significant rise in the number of employees working from home, which we believe has resulted in increased demand from our data center customers as they work to meet the heightened network capacity needs. Our team has been working tirelessly to support our customers through this crisis. Looking ahead to Q2, we are expecting nearly 45% sequential revenue growth at the midpoint of our guidance range and an improvement in our gross margins to the low to mid-20% range. Turning to our quarterly performance. Total revenue for the first quarter was $40.5 million, which was below our guidance range. Our Q1 financial performance was impacted by the shutdown of our China factory during the coronavirus crisis there, unanticipated shipping delays out of China and Taiwan due to the COVID-19 pandemic and higher costs as a result of shifting manufacturing to higher-cost locations in the U.S. and Taiwan. Additionally, certain cost reductions we had planned for Q1 were pushed out due to a pandemic-related work slowdown in China. We had approximately $2.3 million in revenue associated with delayed shipments from China and Taiwan pushed into Q2. Shipping times have improved…

[Operator Instructions] Our first question today will come from Simon Leopold of Raymond James.

So first, I wanted to see if we could talk a little bit about the big picture data center trends. Obviously, we've all sort of heard all the headlines about traffic growth, and I understand you're not necessarily going to be able to guide for the full year. But just maybe if you could update us on your thinking about how to trend this particular vertical longer term and beyond just the second quarter, maybe some of the puts and takes you're seeing.

Sure, Simon. Well, as we noted in our prepared remarks, I think, given all the uncertainties at this time surrounding the virus and the progression and what have you, it's really difficult to put a precise -- any kind of precise guide on that. I do think, in general, we're hearing from our customers that their networks are under pressure from the remote work and what have you. And that they need, in many cases, to address capacity constraints on their networks. And I would expect that, that will result in some incremental improvement to the business. But again, we guide 1 quarter out and especially in times of uncertainty like this, it's really difficult to give you a whole lot more than that. I would say directionally, it's somewhat better than I might have expected.

So maybe one of the things that we imagine is occurring in the crisis is that new technology maybe gets pushed out in time. I'm wondering if that's the case for 400-gig technology for intra data center. And if you view that as a good thing by extending the life of your 40- and 100-gig products or a bad thing in that it keeps you from enjoying benefits of a new product cycle.

Well, it's a little hard to say exactly how that's going to play out, too. I do think that we have -- a number of our customers have engineers or qualification labs that are not operating or operating at less efficiency than they would have normally. In other words, engineers are working from home, and they may not be able to have access to their test equipment and what have you. So I think at least in the short term, we expect some of those qualifications to be pushed out. Although I would emphasize again that we actually had an all-time high of design wins in the first quarter despite the virus. But nevertheless, for some of the 400G stuff, in particular, we are seeing customers that are saying, look, we're going to have to delay a little bit the final qualification efforts that were previously ongoing. Whether that results in a delay in the ramp-up or the deployments, it's not clear at this point. I think that they're -- if anything, they're more motivated now to try to get these newer technologies in. I think they will add capacity and they'll certainly improve operating expenses and things like that for the customers in many cases. So I think they're -- they want to get these technologies in. Their employees are limited in their ability to do what they need to do to be able to start these technologies. And it's really going to depend on how fast recovery happens as to whether they'll be able to -- when things do normalize, whether they'll be able to get the qualifications done and get all that lined up in time to ramp up on schedule or whether it might be delayed a little bit.

And maybe just quickly, gross margin, can you bridge the -- would you have met your guidance if it wasn't -- on gross margin if it wasn't for the shipping issues you mentioned?

So it wasn't only related to the shipping issues. As we mentioned in our prepared remarks, the -- a lot of the cost reduction efforts that we intended to do during the quarter were not able to be completed during the quarter because of the shutdown in China. So we had an additional 3-week shutdown, almost 3-week shutdown there. And so we weren't able to finish a lot of the cost reduction work that we intended to do. So that will roll out over the next couple of quarters. So it wasn't only related to the shipping. It was also related to the delay in completing the cost reduction efforts.

And just one last one, if I might. I did notice you filed an 8-K in April, taking roughly $6 million of the PPP money. Just want to see if you can give us some context. Was this essentially being opportunistic? Or is there some reason we should think there's need for taking out additional debt? And do you expect you have to repay this? Or should we consider this a grant? How to think about that in the context of the business?

Yes. So the PPP loan is something that's really very much influx at this point. I think I'm going to avoid commenting specifically on that at this point just because the guidance and things like that seems to change on an almost daily basis. So in early April, when we applied for the loan, there was certainly a great deal of uncertainty around our operations and really the global economy. Since then, we continue to evaluate the guidance as it comes out, and we'll continue to monitor that as we go forward.

[Operator Instructions] Our next question will come from Samik Chatterjee of JPMorgan.

This is Bharat, on for Samik. So the first question I had was the data center segment. I mean, can you highlight what are the spending trends there by especially the 3 large customers that you have? I noticed that you still have 2 10% customers there and whether a customer has been spending at the reduced level. So any incremental visibility you have there. Are you still expecting a second half pickup from that customer? That would be the first question.

So we don't comment on individual customer trends. As I mentioned, I think there's a lot of positive trends in the data center right now. We discussed the fact that this was the first quarter of year-over-year revenue growth in 100-gig since the end of 2018, which was very early in the 100-gig cycle. We also discussed that the increase in business that we're seeing in 100-gig is actually very broad-based. It's not only just from a couple of customers but from a number of different customers and the design win activity that we had this quarter also continues to bear that out. So again, it's not just about 1 or 2 customers, it's about a much more broad increase in business in the data center, in general, and in 100-gig, in particular. And as we talked about with Simon, some of the dynamics around finishing qualifications on 400G and when that starts to ramp is a little difficult to say at this point.

Got it. And then just one more question on the design wins. I mean, 2019, I think you highlighted 30-plus design wins, and you also said that 1Q this year was very strong in terms of design wins. So just any wins in particular that you could highlight? I mean, any segments that you see could have a potential uptick in the second half, be it telecom, be it cable, where you are seeing momentum building? Anything in particular that you could highlight there?

Sure. Well, I mean, I can give a little bit of extra color perhaps on that. First of all, the design wins that we had, out of the 12 design wins, 5 of those were with new customers. So we had 5 new customers among that list of design wins in the quarter. One of those new customers was a data center customer that we hadn't previously sold to before and 2 of them are related to 5G deployments in China. So in addition to data center strength, we're also starting to see early signs of demand in China around 5G network builds. I think as things in China started to normalize after the coronavirus shutdown there, we started to see increased activity from customers trying to finish qualifications and get orders on the books related to 5G. So I think that's another notable area of strength among the new customer base.

Our next question is from Joe Flynn of Craig-Hallum.

Just a quick question on the guidance. I was wondering if you could either quantitatively or qualitatively give a sense of how much data center is the driver of that 45% Q-over-Q growth. And within data center, anything you could give us rather than a 100-gig -- the split between 100-gig and 40-gig would be appreciated.

Okay. So as far as how much of the growth is related to data center, I mean, we do expect cable TV to be stronger in the second half as we noted, but most of the growth between Q1 and Q2 is going to come from the data center, just by virtue of the fact that cable TV is a relatively much smaller amount of revenue. So I would expect it to come -- the growth to come mostly in terms of data center growth, if you're looking at the sequential growth rate. As far as the specifics around the 100G versus 40G products, it was -- I'm looking for the number here, it was about 60% from 100G products and 31% from 40G products. So at this point, 100-gig is clearly driving the bus, so to speak, in terms of data center revenue. 40-gig, we expect to continue to see 40-gig business and maybe business that's close to where we are today. But most of the growth, I think, is expected to come from 100-gig or even 400-gig perhaps towards the end of the year depending on...

We don't compare with the Q2 the growth in the 5G.

And from 5G as well, of course. Yes.

Okay. Great. And then just piggybacking off the design win question. I was wondering if you have any update just specifically on 400-gig and, I guess, a customer pipeline or along those lines, you're expecting, I guess, by the end of this year.

Yes. We did not have a 400-gig design win during the quarter. We did have one design win on 200-gig product, however.

Our next question today will come from Liz Pate of Cowen and Company.

Most of my questions have been answered, but I may have missed it. Can you remind me what the top 10 customers were as a percentage of the revenue in the quarter? And how that compared with last quarter and last year?

Sure. So this quarter, top 10 customers were 84.8% of revenue. In the same quarter in the prior year, it was 92.1%. And in the prior quarter, so that would be Q4 2019, it was 87.5%. So again, Q1 last year, 92%; last quarter, 87.5%; and this quarter, 84.8%.

So showing some good diversification going on. And I think you said of the 12 new customers, 5 were new to you, 2 were related to 5G deployments in China. And I missed what you said before that.

Yes. Just to make sure we're on the same page. We had 12 design wins in the quarter, 5 of those were new customers. So that's a total of 5 new customers, 1 design win each. And 1 was the data center customer and 2 were related to 5G business in China.

[Operator Instructions] Our next question is from Dave Kang of B. Riley FBR.

This is actually Danny, on for Dave. I was wondering if you guys could comment on the crowdedness of the 400G market and any color you can give on that.

I'm not sure what you mean by the crowdedness of the 400G market. Can you elaborate on that?

Just like, I guess, if the time line of the 400G launch is pushed out, what I mean with that is, would there be increased competition from competitors?

Well, I can't really speculate on that. First of all, as I mentioned in my remarks with Simon, it's not clear that the 400G deployment is going to be pushed out. I think customers are very interested in getting those deployments underway as quickly as they can in many cases. If that were not to happen for whatever reason, I really can't speculate on whether there'll be more competitors or not. I do think that the technology of 400-gig is significantly trickier in terms of design and manufacturing than earlier generations of products. And that generally has an effect of making the competitive landscape smaller rather than bigger. But how that would play out with the pushout specifically is difficult to speculate.

Got it. That's helpful. And I guess, I was wondering if you guys could comment on the pricing environment in the 400G and 100G markets.

So 400G pricing is really not...

Oh, sorry, did I say -- I meant 40G, not 400. Sorry about that.

Oh, 40G and 100G is relatively pretty stable pricing in terms of different products. We have seen some average price declines over the last couple of quarters due to some product mix issues in 100-gig. I mean more PSM and less CWDM as we've talked about in earlier calls. But as far as price on individual products, it's been fairly stable.

Ladies and gentlemen, this will conclude our question-and-answer session. And at this time, I'd like to turn the conference back over to Dr. Thompson Lin for any closing remarks.

Again, thank you for joining us today. As always, thank you to our investors, customers and employees for your continued to support. And we look forward to virtually see many of you at our upcoming investment conference.

And ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation, and you may now disconnect your lines.