Applied Optoelectronics

Conference Operator: Good afternoon. I will be your conference operator, and at this time, I would like to welcome everyone to Applied Optoelectronics second quarter 2026 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. If you require operator assistance at any point, please press star then zero. Also, please note that this call is being recorded. I would now like to turn the conference over to Lindsay Savarese, investor relations for AOI. Ms. Savarese, you may begin.

Lindsay Savarese, Investor Relations, Applied Optoelectronics (AOI): Thank you. I’m Lindsay Savarese, investor relations for Applied Optoelectronics. I’m pleased to welcome you to AOI second quarter 2026 financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter 2026 financial results and provided its outlook for the third quarter of 2026. 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. Thompson will give an overview of AOI’s Q2 results, and Stefan will provide financial details and the outlook for the third quarter of 2026.

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, forecasts, anticipates, estimates, suggests, 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. Forward-looking statements also include statements regarding management’s beliefs and expectations related to the expansion of the reach of its products into new markets and customer responses to its innovations, as well as statements regarding the company’s outlook for the third quarter of 2026 and for the full year of 2026. Except as required by law, AOI assumes no obligation to update these 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 Factors section of AOI’s reports on file with the SEC, including the company’s annual report on Forms 10-K and quarterly reports on Form 10-Q. 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 the company’s earnings press release that is available on ao-inc.com. Before moving to the financial results, I’d like to note that AOI management is attending Rosenblatt’s Sixth Annual Technology Summit virtually on August 18th.

This discussion will be webcast live and a link to the webcast will be available on the investor relations section of ao-inc.com. I’d like to note that the date of AOI’s third quarter 2026 earnings call currently scheduled for November 5th, 2026. I would like to turn the call over to Dr. Thompson Lin, AOI’s Founder, Chairman, and CEO. Thompson?

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Thank you, Lindsay, and thank you for joining our call today. We are pleased to deliver solid second quarter results that were in line with or better than our expectations, driven by robust demand in both our data center and CATV business. We generated our fifth consecutive quarter of record revenue, and we achieved an important milestone as we return to non-GAAP profitability in the quarter. Demand to support next generation AI infrastructure remains so robust that our near-term revenue is bounded almost entirely by production capacity and key component availability. We continue to anticipate steady sequential revenue growth this year and continue non-GAAP profitability. During the second quarter, we delivered revenue of $191.9 million and non-GAAP gross margin of 29.8%, in line with our expected guidance range and our non-GAAP income per share of $0.06 came in above our expectations.

During the quarter, we saw continued robust customer engagement around our 800G and 1.6 terabit products. We saw a strong volume ramp of our 800G product in Q2, which more than doubled sequentially. Forecast demand continue to outpace our production capacity through mid-2027. We are working hard to add additional capacity to meet this demand. We continue to believe our 2026 revenue will be around $1.1 billion this year. I will turn the call over to Stefan to review the detail of our Q2 performance and outlook for Q3. Stefan.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Thank you, Thompson. As Thompson mentioned, we are pleased to deliver solid second quarter results that were in line with or better than our expectations. We generated our fifth consecutive quarter of record revenue. We achieved an important milestone as we returned to non-GAAP profitability in the quarter. Our performance continues to be anchored by robust demand across both our data center and CATV businesses, validating the power of our dual growth strategy and diversified revenue streams. Demand to support next generation AI infrastructure remains so robust that our near-term revenue is bounded almost entirely by our production capacity and key component availability. Because of this, we continue to anticipate steady sequential revenue growth and continued non-GAAP profitability this year as more capacity comes online. In Q2, we delivered revenue of $191.9 million, which was in line with our guidance range of $180 million-$198 million.

We recorded non-GAAP gross margin of 29.8%, which was in line with our guidance range of 29%-30%. Our non-GAAP income per share of $0.06 was above our guidance range of a loss of $0.03 to earnings of $0.03. Notably, we continued to make progress on our key priorities in the second quarter, which included, 1, scaling our next generation data center products, including both our 400G and 800G solutions, by expanding our production capacity in a disciplined manner. 2, diversifying our revenue base. 3, strengthening operational execution to improve our margins and position us for long-term profitability. Today, that execution is directly translating into tangible business momentum. During Q2, we continued to see robust customer engagement around our 800G and 1.6 terabit products, particularly as AI-driven data center investments accelerate.

In line with our expectations, we saw a strong volume ramp of our 800G products in the second quarter. 800G revenue of $12.8 million, or 11.9% of our total data center revenue, increased more than tenfold year-over-year and more than doubled sequentially in Q2. Looking ahead, we expect revenue from our 800G products to grow by nearly 5 times sequentially in the third quarter and expect continued strong growth, gated by our production capacity and component supply in the fourth quarter. During the quarter, in line with our expectations, we saw continued strength in our 400G business. 400G revenue of $48.4 million, or 45% of our total data center revenue, increased more than fourfold year-over-year and 27.4% sequentially in the second quarter.

As a reminder, in Q1, we announced that we received our first volume order for our 1.6 terabit transceivers from another one of our long-term major hyperscale customers. We also announced that we had received 2 new volume orders from this customer for our 800G single mode transceivers. We began delivering these 800G orders in Q2. We expect full qualification of our first 1.6 terabit product by this customer within the next couple of weeks, followed by shipments of 1.6 terabit beginning later this quarter. We continue to expect that shipments of these orders will return this customer as a 10% plus customer for us in Q3. Looking ahead, forecast demand for 800G and 1.6 terabit modules are projected to continue to exceed our production capacity through mid-2027. We are working to add additional capacity and secure necessary key components to meet this demand.

During Q2, we continued to make solid progress on our production capacity ramp, particularly for our 800G and 1.6 terabit products. Once complete, we continue to believe that we will have the largest AI-focused data center transceiver production capacity in the U.S. As a reminder, our U.S. manufacturing footprint is anchored in Sugar Land, just outside Houston. Through a combination of real estate acquisition and leases, we have expanded our Texas manufacturing footprint significantly to over 1.6 million sq ft in the greater Houston area, and which are in various stages of development. During the quarter, we made further progress building out our 210,000 sq ft facility, which is just a few hundred yards away from our headquarters.

We continue to expect to begin initial production in this facility late in the third quarter. As a reminder, this facility will be entirely dedicated to the manufacturing of 800G and 1.6 terabit transceivers. While this will not directly increase our indium phosphide wafer capacity, we plan to move the existing transceiver production from our current headquarters facility to this new building, which will allow expansion of our indium phosphide capacity. The facilities in Pearland and Houston will be built out to expand our production capacity for 800G and 1.6 terabit transceivers. We began construction on these facilities in Pearland recently, and we’re proud to have received strong local support to meet our manufacturing needs. We are excited to expand our presence in an area with such a strong workforce, excellent infrastructure, and room to scale our operations, and continue to expect these facilities to come online in early 2027.

Currently, our total manufacturing capacity is approaching 200,000 units per month, up from nearly 100,000 units per month of 800G and 1.6 terabit capacity at the end of Q1. Looking ahead, we continue to expect by the end of this year that we will be capable of producing over 650,000 pieces of 800G and 1.6 terabit products per month. By the end of next year, 2027, we continue to expect to grow our production capacity to be able to produce over 930,000 pieces of 800G and 1.6 terabit products per month, with over half of that output coming from Texas. These investments reflect measured scaling of our footprint while aligning with strong and growing customer demand and qualification progress across both 800G and 1.6 terabit products.

It’s important to note, as a reminder, our 800G and 1.6 terabit products can be manufactured on the same production line with the same process. While our 1.6 terabit products will require a different final testing, our 800G automated manufacturing lines have been developed with an architecture that will allow us to support future high-speed products as customer demand materializes and evolves over time. Our automated manufacturing lines are engineered to scale efficiently from 800G to 1.6T with minimal incremental investment. This structural flexibility provides a powerful dual advantage. It accelerates our time to market for AI customers while expanding our long-term margin potential. Looking ahead, we continue to believe that our 800G products will drive our near-term data center ramp, followed by our 1.6 terabit products, which are on track to begin to contribute to our overall revenue later this year with the bigger ramp beginning in 2027.

At OFC, we also discussed our plans to increase our manufacturing capacity for our external light source or ELSFP. That’s for co-packaged optics or CPO. This utilizes the ultra-narrow linewidth, high-power laser that we announced late last year. We have very limited production of these modules now, but we anticipate ramping production later this year and into 2027, ultimately culminating in about 400,000 pieces per month in 2028. We believe our in-house laser capabilities continue to be a strategic advantage for the company. As we have mentioned before, we’ve been manufacturing lasers internally for many years. This has allowed us to avoid some of the shortages that have affected others in the industry. As we continue to expand our footprint in Texas, our in-house laser manufacturing positions us well to support both near-term customer needs and longer-term growth.

We believe that in the future, CPO will continue to drive increased demand for high-power lasers. We plan to continue to expand our laser manufacturing capacity in Texas in order to accommodate these future growth drivers. Notably, our expansion planning has been underway for several years. We have already secured orders for long lead equipment and are partnering closely with vendors on delivery. Crucially, our reliance on proprietary in-house developed machinery heavily insulates us from the broader equipment supply bottlenecks in the industry. There are exceptions to this, of course, but overall, we feel that our in-house developed technologies give us an edge in ensuring reliable supply of production equipment. During the quarter, direct tariffs had a $1.9 million impact on our income statement. With the overturn of the IEEPA tariffs, we have received a refund of approximately $5.7 million.

We are still evaluating the potential impact of the new tariffs recently announced in the U.S. At the present time, we don’t expect any material change from tariffs as a result of this announcement. Turning to our second quarter results. Our total revenue was a record $191.9 million, which increased 86% year-over-year and increased 27% sequentially off a strong Q1. Was in line with our guidance range of $180 million to $198 million. During the second quarter, 56% of revenue was from data center products, 42% was from CATV products, and the remaining 2% was from FTTH, telecom, and other. In our data center business, Q2 revenue of $107.7 million increased 140.4% year-over-year and 32.3% sequentially.

Sales of our 100G products increased 31.3% year-over-year, while sales for our 400G products increased more than fourfold year-over-year. Sales of our 800G products increased more than tenfold year-over-year. In the second quarter, 38.3% of data center revenue was from 100G products, 45% was from 200G and 400G transceiver products, 11.9% was from 800G transceiver products. 4.4% was from 10G and 40G transceiver products. We currently expect to see a decline in 100G business in Q3 due to one of our customers’ inability to source sufficient 100G switches to meet their initial forecast. We believe that this shortage of switches is related to memory shortage and expect that 100G weakness will persist until the memory supply recovers.

Even with this temporary weakness in 100G, we continue to believe that by mid-2027, 100G and 400G revenue will be approximately $90 million, 800G revenue will be approximately $217 million, and 1.6 terabit revenue will be approximately $164 million monthly. In total, this is about $471 million per month of data center transceiver revenue. In our CATV business, we saw record CATV revenue of $80.6 million, which was up 43.8% year-over-year and 20.6% sequentially, and was slightly above our expectations of $75 million and $80 million. Similar to the last couple of quarters, we shipped a significant quantity of 1.8 gigahertz amplifiers to our largest CATV customer in Q2. We also continued to see momentum with the newer set of MSO customers that we have talked about on our prior few earnings calls.

We continue to see a broad-based appeal of our amplifiers and QuantumLink software across our potential customer base. During the quarter, we announced that Mediacom selected AOI as the primary vendor to accelerate its DOCSIS 4.0 network upgrades, driving multi-operator commercial adoption of AOI’s next generation 1.8 gigahertz Quantum Bandwidth smart amplifiers and software solutions. We’re excited to partner with Mediacom to deliver more reliable service while lowering operational costs. Looking ahead to Q3, we expect our CATV revenue will be between $100 million and $110 million. Looking further ahead, we continue to expect to generate over $325 million annually in CATV. While the vast majority of our CATV revenue expectations for this year are related to our amplifiers, we do anticipate that we will generate some revenue from our software solutions this year.

For the second quarter, our top 10 customers represented 99% of revenue, compared to 98% of revenue in Q2 of last year. We had three greater than 10% customers, one in the CATV market, which contributed 42% of total revenue, and two in the data center market, which contributed 26% and 24% of total revenue respectively. In Q2, we generated non-GAAP gross margin of 29.8%, which was in line with our guidance range of 29%-30%, and compared to 29.2% in Q1 2026, and 30.4% in Q2 2025. As we discussed on our last quarterly earnings call, while we do expect continued gradual improvement in gross margins, we continue to expect that the revenue mix in data center in the short term will be a slight headwind.

We remain committed to our long-term objective of returning non-GAAP gross margins to around 40% and believe that this goal is achievable as our mix shifts toward higher margin products and as we capture additional efficiencies across our operations. The revenue figures presented above are net of a contra-revenue amount due to the accounting for warrants provided to customers. As a reminder, this amounts to approximately 2.5% of revenue derived from certain customers to whom AOI has provided warrants in exchange for future revenue. In Q2, the amount of this contra-revenue was $1.2 million. Total non-GAAP operating expenses in the second quarter were $67.6 million, or 35% of revenue, which compared to $42.1 million, or 41% of revenue in Q2 of the prior year.

Our OpEx this quarter was higher than expected due mainly to higher shipping costs associated with the rapid ramp in CATV revenue in the quarter, combined with higher than expected R&D spending, as we have been asked by customers to qualify new 800G and 1.6T products in the quarter. We believe that R&D spending will continue to be elevated. However, we do not expect additional shipping costs to recur in Q3 or subsequent quarters. Looking ahead, we expect non-GAAP operating expenses to be in the range of $70 million-$80 million per quarter. Non-GAAP operating loss in the second quarter was $10.3 million, compared to an operating loss of $10.8 million in Q2 of the prior year.

GAAP net loss for Q2 was $22.8 million, or a loss of $0.28 per basic share, compared with the GAAP net loss of $9.1 million, or a loss of $0.16 per basic share in Q2 of the prior year. On a non-GAAP basis, net income for Q2 was $5.5 million or $0.06 per diluted share, which was above our guidance range of a loss of $2.5 million to income of $2.8 million, or non-GAAP income per share in the range of a loss of $0.03 to earnings of $0.03. This was largely due to foreign tax benefits and modest government subsidy income, which we expect to continue in subsequent quarters. This compares to a non-GAAP net loss of $8.8 million or $0.16 per share in Q2 of the prior year.

The weighted average, fully diluted shares outstanding used for computing the earnings per share in Q2 were 88.1 million. Turning now to the balance sheet. We ended the second quarter with $508.8 million in total cash equivalents, short-term investments, and restricted cash. This compares with $449.4 million at the end of the first quarter of 2026. We ended the second quarter with total debt, excluding convertible debt, of $92.8 million, which compared to $77 million at the end of last quarter. As of June 30, we had $278.8 million in inventory, which compared to $206.2 million at the end of Q1. The increase in inventory is primarily due to increased inventory of raw materials for near-term production as we ramp capacity. As we disclosed in May, we initiated a new at-the-market offering. To date, we have raised $538.8 million net of commissions and fees under this new program.

We intend to use these proceeds to continue to make investments in the business, including new equipment and machinery for production and research and development use. We made a total of $565.5 million in capital investments in the second quarter, including $280 million in prepayments on equipment we have on order. These expenditures are mainly for manufacturing capacity expansion for our 400G, 800G, and 1.6 terabit transceiver products. We expect CapEx intensity in the second half of the year will be higher than in the first half as we prepare for increased 400G, 800G, and 1.6 terabit data center production. We expect to finance these investments through a combination of cash on hand, cash generated from operations, and some equity sales, along with additional debt.

Looking ahead, we believe we are uniquely positioned to capture two distinct growth engines, the rapid AI-driven demand acceleration in our data center business alongside a robust runway in our CATV business. Our current capital investments are designed to scale our advanced manufacturing footprint, structurally lower our long-term production costs, and enable our path towards sustained profitability. Moving now to our Q3 outlook. We expect Q3 revenue to be between $255 million and $290 million, representing 130% year-over-year growth at the midpoint. We expect non-GAAP gross margin to be in the range of 29%-30.5%. Non-GAAP net income is expected to be in the range of $10.1 million-$24 million and non-GAAP earnings per share between $0.11 per share and $0.26 per share using a weighted average diluted share count of approximately 92.8 million shares.

Looking more broadly at 2026, we believe our 2026 revenue will be around $1.1 billion. As we have discussed previously, this revenue level is limited by our production capacity and supply chain, not market demand, which we believe is much larger. With that, I will turn it back over to the operator for the Q&A session. Operator?

Conference Operator: Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you’re using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question today will come from George Nader with Wolfe Research. Please go ahead.

George Nader, Analyst, Wolfe Research: Hi, guys. Thanks very much. I wanted to ask about all the stuff that’s been in the news of late around Chinese transceivers and the potential for a U.S. ban on those transceivers being shipped into the U.S. Could you just talk about your perspective on that? What are you seeing, hearing? How might that affect AOI? Does that change anything in terms of your capacity planning? Does it change anything with your conversations with customers? Any insights would be great. Thanks.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): It’s a little early to say. That report that came out a couple of days ago was obviously somewhat speculative in terms of the fact that this ban or whatever it ultimately turns out to be isn’t in place yet, and the details aren’t really out there. I think AOI’s U.S. manufacturing presence has been a very important, probably the most important element of our appeal to our customers, and clearly that announcement heightens that appeal. As we said in our prepared remarks earlier, we believe that we are and expect to remain the largest manufacturer domestically of optical transceivers for AI. Certainly anything that would heighten interest in that is good for us, but it’s hard to point to any specific ramifications at this point since it’s still early.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): I think this is really not news at all. I think this kind of discussion for quite a while. That’s why, as I mentioned, we have been working very close with three customers for a long-term agreement, especially AOI making our own laser, and we are maybe the only one company commit to really invest heavily in U.S. for U.S. manufacture, not only laser, including the transceiver. With some early feedback, I would say customers more aggressive will give us much more share, especially for U.S. manufacture. Yeah. How serious or how big it is, we will know. Because as I said, right now our capacity complete book already from now until Q2 next year. The best we can do is maybe we can more aggressive adding more capacity maybe from Q3 next year, especially for the, I would say U.S. manufacture.

George Nader, Analyst, Wolfe Research: Got it. Okay. Just as a follow-up, I was just curious about the ramp in 800G. It looks like the growth in the business right now is coming from 100, 200, and 400, just based on your comments about the mix of transceivers in the quarter. It seems like at this point, the 800G has got to be the driver on the growth in data center. I’m kind of wondering exactly where you guys are. Is all that tooling fully installed and ready? Are those laser data comm chips built and sitting on the shelf? Do you need to get qualifications on any of this? Any more you can tell us on the ramp and the readiness would be great. Thanks.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): No, as we said in our prepared remarks, look, our ability to deliver revenue in general, and specifically when it comes to 800G products, is limited by our production capacity right now. If we could produce more, we could ship more right now. To answer your question directly, no, not all the manufacturing capacity that we have or expect to have is online at this point. In fact, we’re going to continue to add more and more capacity really, most likely through next year, but certainly into next year. We’ve only begun. As we mentioned in our prepared remarks, we have 1.6 million sq ft of manufacturing space here in Houston. A year ago at this time, we had about 65,000 sq ft. Clearly all of that manufacturing space has not been built out, doesn’t have equipment in it yet.

There’s tremendous room for expansion, and we plan to expand. However, over the next couple of quarters, the first increment of that manufacturing does start to come online, which will increase our manufacturing capacity from roughly 200,000 pieces a month, as we mentioned earlier, to about 650,000 pieces a month by the end of the year. That’s all 800G and 1.6T. Most of that is going to be 800G, given the demand that we’re seeing. That’s all incremental new capacity that doesn’t exist today, and then growing from there. No, there’s significant room for expansion, and we’re only getting started on the 800G ramp now.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): By the way, I want to emphasize one thing. Right now, the Q3, you can see compared to Q2, average, we’re talking about 40% growth. Something like that. 35%-45% growth. The growth is mainly from 800G. At the same time, in the screen, we already mentioned, because of memory issue for the switch, actually, 100G will decrease by $20 million-$25 million. Otherwise, our Q3 revenue, the growth should be more than 50%, as I mentioned. This is short in effect. We believe the 100G demand will come back to normal within a few months, either by end of this year or next year. All right? Don’t forget, we mentioned by June, July, the overall transceiver revenue will increase from today’s number to $471 million per month. That’s huge growth.

All growth, actually, from 800G and 1.6T, 100G will go down. All this is because the additional capacity we are building, not only in Asia. Most of the increased capacity will be in U.S. Even so, let me say that, like I keep emphasizing, that is not good enough for the customer demand. The customer demand is 20%-40% higher. All right? Actually, we are getting this kind of demand from several big customers almost every week, every month, to speed up our delivery schedule. We are doing everything we can. The other is working very close with our key supplier. Because as you know, I think the DSP, TIA, good news, they are making our laser. Otherwise, laser is the biggest bottleneck right now for the transceiver business. This is not the only one.

That’s why we are working with several key suppliers to increase the volume in the next few quarters to maintain our demand.

George Nader, Analyst, Wolfe Research: Great. Thank you very much.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Yep.

Conference Operator: Our next question will come from Simon Leopold with Raymond James. Please go ahead.

Simon Leopold, Analyst, Raymond James: Thanks for taking the question. I appreciate you’ve given us a lot of guidance commentary, and some quick arithmetic suggests that in the fourth quarter, you’re anticipating the combination of 800G and 1.6T revenue in the neighborhood of $330 million. I want to make sure that I’m thinking about this correctly first, and then I’ve got a follow-up.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Yeah, that’s about right, directionally. Mm-hmm.

Simon Leopold, Analyst, Raymond James: Great. I recall in the spring that you were talking about the 1.6T ramp and having a commitment for $200 million through an order. I’m trying to get a better sense of how to think about the timing of that particular project in that it sounds like it may start in the fourth quarter of this year, but maybe the majority of it is a 2027 event. How should we think about that $200 million order you had talked about for 1.6T in the past?

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Actually, we’ll start deliveries on that probably very late in the third quarter and then ramp into the fourth quarter. I think the bulk of it should get delivered in the fourth quarter, and then there may be a tail into the first quarter. The important part about that is that’s just the first, the beginning of what we expect to be significant orders from this customer for 1.6T for the foreseeable future. I wouldn’t get too wrapped up on that particular order. That’s just the very beginning of it.

Simon Leopold, Analyst, Raymond James: Great. I want to ask a different China-related question. Apart from the potential regulatory issues. We’ve been getting a lot of questions about the suggestion that there will be new manufacturing of lasers coming out of China. Just trying to get a sense of how you’re thinking about that potential, and if that were to occur, if new Chinese manufacturing came online to make lasers, what could that possibly mean to your business? Thank you.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Let me answer the question. Okay. I think the investor maybe underestimate how big is laser market. Let me say that. Right now for the CPO laser, used in the EOSAP, is a 300 milliwatt laser compared to 70 milliwatt laser used at the 800G transceiver and 100 milliwatt used for the 1.6 terabit transceiver. People don’t understand, not only the power is several times bigger, but the size. The size is about six times or even higher, or even more. E is lower. Overall, you’re talking about to meet the demand just for the, I would say, the phase I, the EOSAP is only the 1310 nm for wavelengths. I think the next generation of EOSAP will be using DWDM. That means because wavelength is so tight, I think the yield loss will be easily 40%-50% compared to 1310 wavelengths. Okay?

That means to meet the demand for the CPO market, the operator market needs to be 8 to 10 times bigger compared to today. That’s why not only AI, Lumentum, Coherent, Broadcom, everybody, we invest huge money to meet the demand in the next few years. Because for laser, from today, if I order the equipment, it will take minimum 21 months to 24 months to start manufacturing high volume. Okay? That’s how long it takes because it’s a semiconductor process, build a long lead time of the equipment, everything. I think it’s, yes, there’ll be some new supply in China. We are not surprised because that’s what market needs. Most of them, they are working maybe 70 milliwatt or very few can really do 100 milliwatt. For 300 milliwatt laser, especially DWDM spec, we don’t see that.

Not in the next two, three years, especially the demand is so big. Okay? Even combined AI, Lumentum, Coherent, Broadcom all together, it’s still very tough to meet the customer demand in the next few years. We are doing everything to speed up the process, to expand our capacity. I think that for me, I think no effect at all because the demand is much bigger than the worldwide capacity, even including all the company in Taiwan, China or other countries like Japan.

Simon Leopold, Analyst, Raymond James: Great. Thank you for taking the questions.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Thanks, Simon.

Conference Operator: Once again, if you would like to ask a question, please press star then one. Our next question will come from Ryan Koontz with Needham & Company. Please go ahead.

Ryan Koontz, Analyst, Needham & Company: Great. Thanks. Maybe just following up on the question about laser supply, and thinking about your own constraints there, indium phosphide. How are you guys feeling about substrates and other raw materials that you need to ramp? Is that a current bottleneck for your products? Which products are the most challenging for you to ramp at the moment?

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): No. As Thompson mentioned on our last earnings call, the situation hasn’t changed, we’ve secured supply out into next year. We’re not currently limited by substrate capacity. We’ve had a lot of discussions with substrate suppliers, going back into last year and continuing even till very recently. We feel pretty good about the substrate supply situation. I would say it’s incrementally better than it was last earnings call and prior to that. Things I think are getting somewhat better, but we’re feeling pretty good at least as far as we can see into the future for the substrate supply.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Yeah. I think especially right now, AI, we just move into a four-inch substrate volume manufacture. As I mentioned, we already had two supplier in Europe, two supplier in Japan, plus three supplier in China. Right now we are very aggressive to have some kind of partnership with two, three supplier. Even maybe the possible, I would say, potential joint venture. Okay? Because as you can see, how much laser capacity AI will increase in the next few year. Let me say that it’s much, much more than a factor of 10. Okay? Especially for the CPO laser market. I would say right now we have enough inventory, we have enough supply until end of next year, but what we are looking for is the volume we will need in, I would say 2028, 2029.

That’s why we are very careful and very aggressive to working with all the suppliers for the expansion.

Ryan Koontz, Analyst, Needham & Company: Great, really helpful. Then maybe following up on George’s question earlier about 1.6T. How are you feeling about your broad market traction with that product? Obviously, we’re expecting a pretty big uptick in demand with Tomahawk 6 at the end of the year. How are you feeling about your traction with other customers besides the one order you have in hand now?

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): No, I think we have pretty broad-based interest among customers. I think as Thompson mentioned, and we’ve talked about pretty extensively, we’re still in the process of adding capacity. Until we have sufficient capacity to service multiple customers, we have to be careful about taking too many orders. We’re trying to balance the capacity additions against the customer demand. As Thompson mentioned, the customer demand is a lot bigger than what we can provide, especially in the short term. As we get further out, then our capacity expands and we have a little more breathing room, if you will, with respect to new customer orders. We’re trying to be careful, and we definitely don’t want to overpromise what we can actually deliver. We’re being appropriately circumspect about that.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Let me say, we already said, as of today, I think AOI will be the fourth supplier qualified by one big hyperscale data center customer for 1.6 terabit transceiver. Right now, I think that we will finish most of the qualification only in the last stage. I think it should be finished within maybe, I would say, two, three weeks. We can start to deliver, I would say, by end of this quarter. As you know, right now we have more than $200 million orders in hand. I would say right now our target is to finish all the orders by sometime in Q2. How much we can deliver in Q4 is, I would say, Yes, I think good news, we have orders. At the same time, we are working very closely with all the DSP and TIA suppliers.

Even so, we still believe we can deliver more than, I would say, $70 million of revenue in Q4 for 1.6 terabit transceiver. For sure, customer want everything, okay? Right now, we are doing everything to speed up. I think one of the big concerns in Q4 for 1.6 terabit transceiver is the material supply. I think all my physical capacity should be ready, I would say within two, three weeks. The overall demand is very big. Right now, I think overall, based on the customer feedback, the volume we’re talking about is more than 500,000 transceivers per month by end of next year. Then you talk about how much money per month, I would say $300 million-$350 million.

Ryan Koontz, Analyst, Needham & Company: Yeah.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): As I said, we are working very closely with customers based on their schedule. We don’t want to overpromise, and we want to be careful, especially I think quality is very important, especially most expansion in U.S. take times. I just say the demand is so big, especially right now, not only the overall industry demand is so big because of AI. The other for sure is U.S. manufacturer. That’s a very important factor for the customer. Okay?

Ryan Koontz, Analyst, Needham & Company: Right. Yep. Thanks so much.

Conference Operator: Our next question will come from Michael Genovese with Rosenblatt. Please go ahead.

Michael Genovese, Analyst, Rosenblatt: Great. Thanks so much. Guys, the guide for the full year is on track and the milestones for next year seem to be on track. There has been a pushout this year into 4Q. Could you just give us a little bit more color on the challenges of ramping up capacity that were different than what you expected three months ago, and that clearly are going to keep getting better as we go forward. What are some of these specific challenges where 800G, for instance, wasn’t quite as big as you thought it would be in 2Q?

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Right now, let me say that, okay? As I mentioned, because of memory issues, okay, the Q3, I think we lose about $20 million-$25 million of revenue for 100G single mode transceiver. In Q4, I think based on our capacity, we should be able to deliver, I would say, more than $500 million revenue. Okay? You can see how big our growth will be. It’s like 60% of growth from Q3 to Q4. Right now, the big challenge, as I say, is the DSP and TIA. Okay? For 800G or 1.6T transceiver. That’s why we are working very closely with the supplier. Especially 1.6T, I think the whole supply chain is very tight. Good news is I think the supplier put AI as the fourth priority, and it’s a long-term partnership.

We almost have very close discussion with all the key suppliers almost every week or twice a week.

Michael Genovese, Analyst, Rosenblatt: Okay, perfect. That’s very helpful.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): AOI is much better than other competitors. The other competitors, their number one issue is not the DSP, it’s this, and we don’t have this problem, okay? AOI making our own laser. That’s why the customer come to AOI, especially with our aggressive expansion plans in the next few years. Not only transceiver including CPO, including ELSFP. Right now, we already have about five customers. They all come with some kind of very aggressive demand for the next three, four years. That’s why our CapEx is so big, because as I said, if I promise any customer the laser like in Q3, Q4 2028, I need to start to spend the money, buy the equipment, buy the building, build the equipment. That’s the reason our CapEx is increased so fast.

Michael Genovese, Analyst, Rosenblatt: Okay, great. That was great color. Thank you so much. I guess, my next question would be, given that 1.6 will be a lot more in the mix in the fourth quarter, do we still expect to exit the year in the mid-30s of gross margin?

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): The gross margin for sure will still be better, because we need to pay some expertise fee for some key supplier, I would say, 32%-33%. The most important is how much is the 1.6T, because that’s highest gross margin product. The more we deliver for 1.6T, the high gross margin it would be. For sure by Q3, Q4 next year, when we deliver the CPO laser or EOSAP module to different customer, the gross margin will be even higher, because gross margin for laser is about 55%-65%. For EOSAP, the gross margin should be more than 50%, that’s more like Q3, Q4 next year. In the short term, the gross margin improvement, for sure the most important factor is the percentage of 1.6 terabit transceiver, because gross margin is very good.

That’s why I say it will start to improve when we start to ramp in the revenue of 1.6 terabit transceiver in Q3, especially Q1 next year. As I said, right now, even customer want everything in Q4, but right now what we can commit, maybe, I would say $70 million-$80 million in Q4. Not because of capacity, because, I would say, material constraint. Q1 next year should be much better. Okay.

Michael Genovese, Analyst, Rosenblatt: Okay.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): If it double, I will not be surprised, okay, for Q1 revenue. Not for overall revenue, for 1.6 terabit transceiver revenue, Q1 next year will be double Q4 or more than double.

Michael Genovese, Analyst, Rosenblatt: Yeah.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): That’s our target right now.

Michael Genovese, Analyst, Rosenblatt: Okay. Final question from me to just follow up on what you said about CPO. I don’t think that all the investors know exactly that you’re in the CPO market or necessarily have high expectations for you guys in CPO. Any kind of additional update in terms of the number of customers that you’re talking to and status that you’re at with that program, I think would be helpful. That’s it for me. Thank you.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Come on, AOI is a laser company since day one, okay? Maybe AOI compared to other supplier in U.S., AOI is a pure laser supplier since day one, since 1997. Laser is our major technology, the core technology. We have been working very close with at least five customer. If you’re talking about really high volume manufacturer, I would say more like the late Q3 next year. Because as you can see right now, we are adding a lot more MOCVD, epi, stepper, everything in Houston. We even have second fab, and the size of current fab will increase at least, I would say, the overall capacity will increase by almost 300% by Q3 next year. That’s not enough. That’s why we are building a clean room of the second fab in Houston area. The size will be about four times of the current facility.

Just give you some rough idea how aggressive is our expansion plan. Let me say, even so, still not good enough for the customer demand in the next few years. We are still working very hard to expand our laser, including the manufacture of ESAP module based on customer demand. Yeah.

Dr. Stefan Murry, Chief Financial Officer and Chief Strategy Officer, Applied Optoelectronics (AOI): Mike, if I can just interject there. When we’ve talked to several of the major CPO customers, they love our laser. We just can’t make enough of them to be involved in their current first-generation deployments because there’s just not enough capacity. We have to prioritize our ability to make lasers for our own transceivers first, and then as we expand the fab, like Thompson mentioned, then we’ll have more capacity for the ESAP, for the CPO type laser. It has nothing to do with customer engagement. It has nothing to do with performance of the laser or not having the design. All those things are very good. In fact, I would argue our high-power narrow alignment laser is the best in the industry, the best in the world right now.

We just can’t make enough of it and still manufacture enough lasers for our transceivers, which has to be the priority. Again, same story as we had on the transceiver side of things, it is all about our ability to add capacity, and Thompson just outlined our plans on that.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): I think the investor maybe can understand. AI has been working on high-power laser, I would say six, seven years ago for LIDAR. The bandwidth demand is even much higher than CPO laser. That’s why it’s not tough for AI to get into CPO laser market. Right now, I would say for certain pin, CPO laser and ESP, several customer have qualified AI. The focus, as I said, is a DWDM. Right now, that’s what customer really want to focus because they’ll be very challenged For DWDM CPO laser and the CPO module, we call it EOSAP. I would believe only few companies in the U.S. can do that because it’s very high spec, a lot of change. Maybe some companies can do that, but I don’t believe their year performance will be as good as AOI, Lumentum, Coherent. Okay.

I think that’s very important. I said, additional is your capacity.

Michael Genovese, Analyst, Rosenblatt: Let me sneak in one more quick question. I’m sorry to interrupt, how far away do you think the Chinese are from having 350 milliwatt lasers, do you think they’ll ever have them? How many years away do you think they might be from having CPO lasers out of China?

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): If you’re talking about reasonable year and no quality issue or performance issue, I would say easily at least two, three years or even longer.

Michael Genovese, Analyst, Rosenblatt: I should let somebody else ask a question. Thanks so much. That was great. It’s Thompson and Stefan. Thank you.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): All right. Thank you.

Conference Operator: This will conclude our question and answer session. I’d like to turn the call back over to Dr. Thompson Lin for any closing remarks.

Dr. Thompson Lin, Founder, Chairman, and CEO, Applied Optoelectronics (AOI): Again, thank you for joining us today. As always, we want to extend a thank you to our investors, customers, and employees for your continued support. It is an exciting time for our industry and for AOI. We continue to believe in the fundamental driver of long-term demand for our business. Remember us, and we are in a unique position to drive value from this opportunity. We look forward to seeing many of you at upcoming investor conference. Thank you.

Conference Operator: The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines at this time.