Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics' Second Quarter 2023 Earnings Conference Call. 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. All participants, again, have been placed on need to prevent any background noise. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event 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. I am pleased to welcome you to AOI's second quarter 2023 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2023 financial results and provided its outlook for the third quarter of 2023. 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 Murray, 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 the outlook for the third quarter of 2023. 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, 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, forecast, anticipates, estimates, intends, predicts, expects, plans, may, should, could, would, will, potential or things 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…

Thank you, Lindsay, and thank you for joining our call today. Our second quarter revenue was in line with our expectations, while our non-GAAP gross margin and non-GAAP loss per share were better than our expectations. We are pleased by the continued progress we have made on improving our gross margin and are encouraged by increased demand we saw for our 100G and 400G products in our data center business during Q2. Normally revenue for our 10G product increased 30%, sequentially, while revenue for our foreign product doubled sequentially and accounted for 11% of our total data center revenue in Q2. During the second quarter, we did revenue of $41.6 million, in line with our guidance range of $40.5 million to $47.5 million, ‘we’ve delivered non-GAAP gross margin of 24.8%, above our guidance range of 20.5% to 23.5% mainly driven by a favorable product mix and not targeted cost reductions. Our non-GAAP loss per share was $0.21, above our balanced range of a loss of $0.23 to $0.31. Total revenue in our CATV segment was $9.3 million, down 61% year-over-year and down 66%, sequentially. As a reminder, our Q2 results were negatively impacted by some inventory build up with certain CATV customers. which led to softer than expected CATV revenue in Q2. We do believe that this inventory digestion in transfer and based on what we have seen today, we expect our CATV revenue to increase slightly sequentially also be down year-over-year off a record strong Q3 of last year. Total revenue for our datacenter total of $27.6 million increased 28% year-over-year and increased 35% sequentially large due to increased demand for our 100G and 400G products as we continue to see the run-up of our 400G products. On our last two calls, we discussed an agreement we have signed with Microsoft, who has been a long-term key customer of ours, for a development program to make next-generation lasers for each datacenter both for 400G and beyond. During the second quarter, we signed additional agreement with Microsoft to provide design and assembly services for active optical cables. We view this country awards as validation of the strength and quality of our core laser predication ability. In total, we believe that, this award for AOI of over $300 million over three years. 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. As Thompson mentioned, our second quarter revenue was in line with our expectations, while our non-GAAP gross margin and non-GAAP loss per share were above our expectations. We're pleased by the continued progress we have made to improve our gross margin and expect this trend to continue. Further, we are encouraged by the increased demand we saw for our 100G and 400G products in our datacenter business during Q2. We Lastly, we are excited about our newly formed broadband access group, the strength of talent we have recently added to this team and believe that we are well positioned to execute on our new strategy to sell our CATV products directly to MSO customers. Before turning to discuss our results and outlook, I want to provide an update on the transaction that we announced last September with Yuhan Optoelectronic Technology. As we have previously discussed, we entered into an agreement with Yuhan, for the sale of our manufacturing facilities located in the People's Republic of China and certain assets related to our transceiver business and multi-channel optical subassembly products for the datacenter, telecom, and FTTH markets for a purchase price of $150 million. As a reminder, this transaction is subject to customary closing conditions and regulatory approvals, including CFIUS and ODI. We continue to make progress in preparing the information that will be needed in order to file for the various regulatory approvals that are required in order to finalize the divestiture. Although these filings are not yet complete, we do expect to submit our application to CFIUS within the next 45 days. While the timing of the regulatory approval process is uncertain, based on our current schedule, we expect the closing timeframe will be early 2024. Turning to the quarter, our total revenue for the second…

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Simon Leopold with Raymond James. Please go ahead.

Thanks for taking my question. You've given us a lot of good modeling information here, and I'd like to just clarify something I think is implied in that you suggested that the CATV business would be up a little bit sequentially. Telecom would be flat to slightly up. And so kind of backing out that into your total revenue forecast suggests your data center business is up sequentially by something on the order of 70%. And you didn't mention that explicitly, but you kind of guided us this way. Can you just clarify what your expectation is there?

Sure, Simon. You're pretty good at math. The uptick there is mainly from the data center business, as you surmised.

Great. Thank you. And you talked about the Microsoft project timing being the end of this year. So it's not coming from the new Microsoft awards, could you give us some color on what's driving this big jump?

Well, I mean, we've continued to see very strong results in our existing 100G and 400G products and that's where this uptick is coming from. We've talked about over the last, gosh, probably at least a year that we felt like our 400G was starting to ramp and was in that ramping phase, and that's indeed what we're seeing right now. 400G is continuing to ramp. While at the same time, we're seeing very strong results from 100G as well. So -- both of those things are kind of firing on all cylinders. As you noted, the revenue increase that we're seeing is primarily not coming from the new Microsoft contracts. It's mostly coming from existing products.

And don't forget, I think the because of AI, the customer [indiscernible] grow and AOI at the same time is [indiscernible] strong market share.

Great. And then just pivoting now to the cable business. Just others who are in that market have talked about some of the transitional effects. And you've been pretty clear in talking about excess inventory as a factor. And I wanted to maybe see if you could talk a little bit about the transitions of technology and how that might be playing into it specifically the deployment of DOCSIS 4.0 and the -- basically, the debate between full duplex and extended spectrum. Is that a factor that's sort of amplifies or creates a greater pause in this market is that we're sort of burning off old technology ahead of new technology. Could you help me understand that?

I don't think that's a big factor right now. I think that the bigger factor just has to do with the distribution channel, and I think I mentioned on the previous earnings call, with the interest rate environment, many of the distributors are taking a hard look at how much inventory that they carry. So I think it has more to do with sort of financial effects and just the raw amount of inventory that's out there as opposed to looking ahead and saying, well, we might not need these products because DOCSIS 4.0 is coming on board. There's going to be a long tail, I would anticipate with the existing sort of 1.2 gigahertz DOCSIS 3.1 type of products. So I'm not hearing from distributors that they're concerned about the inventory level that they have due to concerns they won't be able to sell it efficiently. It's more about why I just don't know what the right level of inventory is at this point given the financial situation and interest rates and what have you.

Great. Thanks for taking the questions.

[Operator Instructions] The next question comes from Tim Savageaux with Northland Capital Markets. Please go ahead.

Hi. Good afternoon. And congratulations on the outlook, in particular. I wanted to follow up with some questions there. I see there's a good bit of deferred revenue that has been added to your balance sheet here, both short-term and a little long term. And I was wondering if part of that revenue increase might be some of the NRE or project development payments coming out of Microsoft in addition to product revenue. And if that's the case, I wonder if you could try and quantify that. And I imagine that would have a real positive impact on gross margins as well or is this just all module revenue driving this increase?

You're talking about in the guidance. How much NRE revenue or

That's right.

So there is some of that in there for nondisclosure reason, I can't give you the exact toll in there, but there is some of that in there. But really, the bulk of the increase in margin is coming from increased margins on the products that we're selling, as we mentioned in our prepared remarks. It's not primarily being driven by NRE revenue. And that's a relatively small amount that's included in guidance.

Okay. Great. And so would you say the same thing about product revenue being the bulk of the increase, the sequential increase in data center. And within that, -- do you expect to see these dynamics continue around 400 gig and 100 gig in terms of outsized -- where do you expect, I guess, over the next few quarters, your 400-gig revenue to go or, say, I guess you'd classify 200 gig plus as a percent of total data center revenue?

Yes, I expect the 400 gig. And you're correct in saying it's 200 gig plus, but for us, that's almost entirely 400 gig. We don't have a lot of 200-gig business -- we expect that to continue to grow, both in absolute dollars and as a percent of data center revenue. That being said, I mean, I think 100 gig is continuing to track very well as well. So I think both of those things are looking good. as I mentioned when Simon asked earlier. You had another question there, Tim, I'm sorry, I forgot. Yes. I think basically, we're just asking -- I think the first part of the question, if I remember, was just basically asking is this really truly product revenue is driving the increase in revenue as well as gross margin? And the answer is, yes, it's product revenue that's driving it. I mean we're selling a lot more 100 gig and 400 gig in data center space. cable TV, as we mentioned, is down a little bit, but we do anticipate that to pick up a little bit sequentially in the guidance and that's what's really driving the growth.

Great. And I could ask you a question about kind of what's happening at your Microsoft, your biggest data center customer. So on the one hand, you look to be developing this active optical cable product or what I assume to be a very high-speed application, 800 gig, I suppose, maybe 400 as well associated with an AI build-out. And yet you're also prior to that seeing some pretty strong increases in volumes and maybe pricing as well, given the gross margin movement on the current module product. I wonder if you can kind of relate those 2 things. I mean, we've seen Microsoft with a pretty dramatic uptick in spending here this quarter that's expected to continue really for the next several quarters. So from your perspective, I'd be interested on kind of what's happening sort of short-term versus medium-term there with regard to data center connectivity demand.

Well, without going into too many details that would be difficult to disclose publicly due to our relationship there. I think your observation that Microsoft has been investing heavily. It's a very apt explanation. The fact that the AI is really driving their network needs right now is extremely important to them and keeping up with the demand there is very, very critical to their operations. And so they're definitely adding a lot of optical modules, a lot of interconnect modules now and their expectation based on the contracts that we've supplied in terms of active optical cables certainly would indicate to us that they expect to continue to see strong demand mainly driven by AI applications, although certainly, the sort of general purpose compute is also a part of that. And it would seem to imply that that's expected to be a pretty strong demand for Microsoft for several years, at least, as we noted in our prepared remarks, I mean if you kind of look at some of the forecasts that we've received from them and the contractual -- the minimum contractual levels of manufacturing that they've asked us to prepare, that would imply revenue of $300 million plus over the next few years just in those products. not counting existing other types of business that they might have. So it's a pretty sizable opportunity for us.

Great. Thanks very much.

Thank you.

At this time, I will turn the call over to Dr. Thompson Lin for closing remarks.

Okay, thank you for joining us today. As always, we want to extend a thank you to our investors, customers and employees. We will continue to support. We look forward to seeing many of you at our upcoming investment conference and update you our next earnings call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.