Applied Optoelectronics' (AAOI) CEO Thompson Lin on Q4 2016 Results - Earnings Call Transcript

Start Time: 16:30

End Time: 17:09

Applied Optoelectronics, Inc. (NASDAQ:AAOI)

Q4 2016 Earnings Conference Call

February 23, 2017, 16:30 PM ET

Executives

Thompson Lin - Founder, Chairman and CEO

Stefan Murry - CFO and Chief Strategy Officer

Maria Riley - IR

Analysts

Simon Leopold - Raymond James

Troy Jensen - Piper Jaffray

Paul Silverstein - Cowen & Company

Brian Alger - ROTH Capital

Richard Shannon - Craig-Hallum

Operator

Good afternoon. I will be your conference operator. At this time, I would like to welcome everyone to Applied Optoelectronics Fourth Quarter and Year 2016 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. [Operator Instructions]. Please note that this call is being recorded.

I will now turn the call over to Maria Riley, Investor Relations for AOI. Ms. Riley, you may begin.

Maria Riley

Thank you. I'm Maria Riley, Applied Optoelectronics Investor Relations, and I'm pleased to welcome you to AOI's fourth quarter and year 2016 financial results conference call.

After the market closed today, AOI issued a press release announcing its fourth quarter and year 2016 financial results and provided its outlook for the first quarter of 2017. The release is also available on the company's Web site at ao-inc.com. This call is being recorded and webcast live. A link to that recording can be found on the Investor Relations page of the AOI Web site 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 Q4 results and Stefan will provide financial details and the outlook for the first quarter. A question-and-answer session will follow our prepared remarks.

Before we begin, I would like to remind you to review AOI's Safe Harbor statement. On today's call, management will make forward-looking statements. These forward-looking statements involve risks and uncertainties as well as assumptions and current expectations, which could cause the company's actual results to differ materially from those anticipated in such forward-looking statements. You can identify forward-looking statements by terminologies such as may, will, should, expect, plan, anticipate, believe, or estimate, and by other similar expressions. Except as required by law, we assume no obligation to update forward-looking statements for any reason after the date of this earnings call, to conform these statements to actual results or to changes in the company's expectations. More information about other risks that may impact the company's business are set forth in the Risks 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 Web site.

Before moving to the financial results, I’d like to announce that AOI management will attend the Raymond James Institutional Investors Conference on March 6 in Orlando and we hope to have the opportunity to see many of you there. Additionally, we will be hosting an Investor Session at OFC on March 22 in Los Angeles. This Session will be webcast live and link to the webcast will be available on the Investor Relations section of the AOI Web site.

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

Thompson Lin

Thank you, Maria. Thank you for joining us today. Q4 was a record quarter for AOI and we are pleased with our results and strong finish to the year. Revenue grew an impressive 60% over Q4 of last year to reach $84.9 million.

Our revenue growth in the quarter was driven by continued strong demand for our market-leading datacenter products which resulted in 76% datacenter revenue growth over last year and record revenue for the seventh consecutive quarter.

In CATV, revenue grew 22% over the prior year to $13.4 million. We achieved non-GAAP gross margin of 38% which represents the highest in our history as a public company. Our record gross margin was driven by our cost-leadership and continued improvement in our manufacturing efficiencies.

We have delivered a record non-GAAP operating margin of 20%, which is about the high end of our long-term target model. This leads to record non-GAAP earnings of $15.5 million or $0.84 per diluted share.

I would like to note that this was our second quarter in a row where we doubled our EPS quarter-over-quarter [indiscernible] and our strong focus on working capital management, I’m pleased to announce that we generated approximately $15.6 million in free cash flow for the quarter.

Our performance in the quarter further demonstrates our growing market share in advanced optics and our commitment to improved executions. I’m especially pleased with our team’s ability to deliver [indiscernible] and manufacturing efficiencies with our [indiscernible] goals and increasing scale.

In reviewing our results for the year, AOI delivered 37% revenue growth and improved our gross profit by 44%, which led to a non-GAAP earnings growth of 45%. We completed the expansion of our new state-of-art fab in Sugar Land and with this facility with operational, we have been able to increase capacity and scale to meet growing demand.

In one other [indiscernible] is extending the gap between AOI and the competition. [Indiscernible] we increased our 25G chip production by nearly 150% between January and December and expanding our customer footprint by earning a new large scale customer.

We met or exceeded our objectives for the year and we are very pleased with what we accomplished. As we look ahead to 2017, we are more excited than ever about growth prospects. We’re even more committed to operational excellence and positioning AOI for continued success.

With that, I will turn the call over to Stefan to review the details of our Q4 performance and outlook for Q1. Stefan?

Stefan Murry

Thank you, Thompson. Total revenue for the fourth quarter grew 60% year-over-year to reach a record $84.9 million, driven by continued strong demand for our market-leading datacenter products. Datacenter revenue in the fourth quarter increased 76% year-over-year to $68.1 million.

Our growth this quarter was driven by record demand for both our 40G and 100G products. In this quarter, 74% of our datacenter revenue was derived from our 40G datacenter products and 20% was from our 100G products.

Our strong and sustained growth in the datacenter reflects the continued evolution of computer networks into highly interconnected cloud based and always available resources upon which consumers and businesses are becoming increasingly reliant.

Additionally, we believe the economic forces that influence the demand for our business in the datacenter are fundamentally different from other businesses, like telecommunications, which are characterized by alternating waves of investment interspersed with periods of relatively low expenditures on network infrastructure.

As a result, we believe we have many new opportunities ahead of us to drive further growth as datacenter operators transition to 100G and continue to expand their datacenters and upgrade their infrastructure to handle higher bandwidth needs.

Our ability to internally manufacture lasers and light engines combined with our ability to quickly transition production between 40G and 100G products provides us with cost-leadership advantages, a faster time to market, and the ability to quickly scale and adjust our throughput to meet growing demand.

And lastly, the added capacity from our new fab in Sugar Land enables us to expand our avenues to market for 100G. For example, as we demonstrated with 40G, we were able to expand our share and ramp quickly to the demand of our hyper-scale operators.

Based on our analysis, we believe we are now the leading supplier of 40G optics for hyper-scale datacenter operators and expect to maintain our leadership position as we continue the transition to 100G.

Turning to our CATV market. Revenue from cable TV products increased 22% year-over-year to reach $13.4 million compared with $11 million in Q4 of last year. Demand for our CATV products was in line with expectations and we continue to anticipate improved demand in this business, as cable MSOs evolve and transition to a more fiber deep network architecture with DOCSIS3.1.

Our telecom segment delivered revenue of $2.9 million, up 3% year-over-year with consistent results coming from ongoing deployments of advanced mobile telecom networks around the world.

In the fourth quarter, we had two datacenter customers that contributed more than 10% of revenue. Our largest datacenter customer contributed 63% and our newest datacenter customer contributed 11%.

For the full year, we had two datacenter customers contribute 55% and 18% of total revenue, respectively. Given our tremendous top line datacenter growth in the year, we did not have a cable TV customer contribute more than 10% of revenue in the year. However, revenue for our two top CATV customers combined grew 2% for the year.

For the full year, revenue grew 37% over last year to reach $260.7 million. By end market, 77% of our revenue was from datacenter products, 17% from cable TV products with the remaining 6% from FTTH, telecom and other.

Moving down the income statement, as Thompson mentioned, we delivered a record non-GAAP gross margin of 38%, which is ahead of our guidance and current target model and reflects an increase of 490 basis points when compared with the 33.1% reported in Q3 of 2016, and an increase of 850 basis points from the 29.5% reported in Q4 of last year.

The increase in our Q4 non-GAAP gross margin was driven by increased scale and the investments we made to simplify and automate our light engine and transceiver manufacturing processes for both 40G and 100G products. For the full year, our gross margin was 33.4%, up from 31.9% in 2015.

R&D expense was $7 million or 8.3% of revenue compared with $8.2 million or 11.7% of revenue in the prior quarter. Sales and marketing expense was $1.6 million or 2% of revenue, up from $1.5 million or 2% of revenue in the prior quarter.

G&A expense was $6.6 million or 7.7% of revenue, up from $5.5 million or 7.8% of revenue in the prior quarter. The sequential increase in G&A was due to year-end audit fees and higher performance-based employee compensation as we exceeded our plan for the year. This brings total operating expenses to $15.3 million or 18% of revenue, slightly up compared with $15.2 million or 21.6% of revenue in the prior quarter.

Non-GAAP operating income in Q4 increased to $17 million, up 111% when compared with $8.1 million in the prior quarter and up 366% from $3.6 million in Q4 of last year. Our non-GAAP operating margin in the quarter was 20%, up 850 basis points from the prior quarter and up 1,310 basis points from Q4 of last year.

Non-GAAP net income after tax for the fourth quarter increased to $15.5 million, up 123% when compared with $7 million in the prior quarter and up 294% from $3.9 million in Q4 of last year.

We reported non-GAAP net income of $0.84 per diluted share, up from $0.38 in the prior quarter and $0.22 in Q4 of last year. GAAP net income for Q4 was $14.2 million or $0.77 per diluted share compared with GAAP net income of $17.7 million or $0.97 per diluted share in the prior quarter. The Q4 weighted average fully diluted share count was approximately 18.5 million shares.

Turning now to the balance sheet. We ended Q4 with $52 million in total cash, cash equivalents, short-term investments and restricted cash compared with $60.2 million at the end of the previous quarter. Accounts receivable increased to $49.8 million compared with $44.2 million last quarter and accounts payable increased approximately $4 million over Q3.

As of December 31, we had $51.8 million in inventory, a decrease of $3.1 million from Q3. We raised approximately $27.2 million of net proceeds in our at the market offerings which allowed us to pay down $48.5 million of our debt, giving us greater flexibility with our capital structure and a positive net debt ratio.

We made a total of $10.4 million in capital investments in the quarter, including $6.2 million in production, equipment and machinery and $3.6 million on construction and building improvements. For the year, this brings our total capital investments to approximately $49.4 million. And it is evident from our growth and scale that we are already seeing the benefits of our investments.

We will continue to invest in capacity as we see near-term revenue opportunities evolve. With our record results and our strong focus on working capital management, I’m pleased to announce that we generated approximately $15.6 million in free cash flow for the quarter.

Before we move to the Q1 outlook, I’d like to take the opportunity to update our target model. As you know, we are exiting the year with record gross margins and operating margins at the high end of our target range. Taking this into consideration and as we factor in expected future cost and price reductions, we are increasing our target for gross margin to 37% to 40% from our prior range of 33% to 35%.

As a reminder, when we ramp new products, we tend to see gross margins fluctuate from quarter-to-quarter and we believe we should perform within this new target range. Our target net income before tax is expected to be in a range of 18% to 22%. We believe this new target model to be sustainable.

Moving now to Q1. We expect Q1 revenue to be between $87 million and $91 million, representing 73% to 80% year-over-year growth. As we mentioned last quarter, we have fewer production days in Q1 as a result of the Chinese New Year holiday. However, strong customer demand for datacenter and solid execution by the AOI team will drive higher sequential datacenter revenue.

We also expect to experience less than normal seasonality in cable TV. We expect Q1 non-GAAP gross margin to be in the range of 38% to 40%. Non-GAAP net income is expected to be in a range of $15.5 million to $17.2 million and non-GAAP EPS between $0.80 per share and $0.88 per share using a weighted average fully diluted share count of approximately 19.5 million shares. Our first quarter non-GAAP net income guidance assumes an expected annual effective tax rate of 18.4%.

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

Question-and-Answer Session

Operator

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

Simon Leopold

Great. Thank you for taking my questions. Quite the results here. So one of the things I think a lot of us are going to wonder about is given the much better outlook for the March quarter versus sort of seasonal expectation, how should we extrapolate from this for the full year? So even if you’re not prepared to provide full year '17 guidance, if you can help us understand some sense of the cadence you would anticipate through the year given the strong start in the first quarter.

Stefan Murry

Okay, Simon, first of all I think it’s worth noting that the seasonality that we normally see in Q1 has been related to the kids TV segment primarily in the past. As we noted in the call a minute ago, the seasonality in cable we don’t expect to see as much as we typically do, which partially explains why there isn’t this overall seasonality. With respect to kind of longer term, as you know we don’t really give guidance on a forward basis. I do think as the year progresses, you’ll note that the comparables in the latter half of the year become a little harder. So in terms of percentage growth year-over-year, I wouldn’t expect it to be as high as it was this quarter in the back half of the year. But I think market conditions are very good right now and we’re not the only ones that are out there talking about the datacenter being very strong, in particular, and cable TV as well. So I think all the elements there are aligning up for a solid year.

Simon Leopold

Great. And then just maybe following up on the 100G, it sounds like you had a very strong improvement q-on-q and so it sounds like it’s doing well. Can you give us maybe a little bit more granularity on your competitive positioning where the sort of supply and demand is within the industry? Because my impression is that you’re ramping production maybe faster than some of your competitors. And maybe a little bit of color around specific products like the LR4 form factors. It sounds like that’s a challenging one for some of the manufacturers. How are you doing on that particular version?

Stefan Murry

Well, we don’t really give sort of results product-by-product. What I can say is I think AOI has for a long time talked about the benefits of vertical integration and the fact that we manufacture our own key components. And I think when you are in a situation where supply of some of those components may be constrained or the overall industry capacity is not what is needed to meet the demand, if the companies that have the ability to ramp up quickly by virtue of being integrated in their production like we are that we’ll do better I think than others. And honestly I think that that’s sort of the situation that we’re in right now and I think we’ve been able to start to prove out the value of that vertical integration strategy.

Simon Leopold

And you’ve talked about vertical integration in the past, just to make sure I’m understanding you correctly, I assume you’re alluding to the 25-gig lasers that you’re making as sort of that key differentiator?

Stefan Murry

Yes, it’s the lasers but also the light engines. I think we can’t emphasize enough that the light engines, the manufacturing of – the subassembly that includes the lasers and the rest of the optical components having our own in-house capability to do that and having a significant manufacturing infrastructure for that by virtue of the similarity between 100G and 40G modules really gives us an advantage in terms of being able to ramp that up quickly.

Simon Leopold

And one last one, if I might, on the 10% customer disclosure. If I understood you correctly, one of the 10% customers in the fourth quarter was new as a 10% customer. Is that correct?

Stefan Murry

That is correct.

Simon Leopold

Great. Thank you very much for taking the questions.

Stefan Murry

No problem. Thank you, Simon.

Operator

Our next question comes from Troy Jensen of Piper Jaffray. Please go ahead.

Troy Jensen

Hi. Congrats on just a great quarter, gentlemen.

Stefan Murry

Thank you, Troy.

Troy Jensen

How about quick – I’d love to know, I’m sure the answer is a small number but what percentage of the new capacity that you guys have kind of brought on is currently being used? Just trying to figure out how much runway you guys have left.

Stefan Murry

Basically we’re using the capacity that we have as we put it online. I think there’s two ways of looking at it. There’s capacity in terms of current sort of equipment and manpower and we’re constantly adding to that capacity. And so that’s kind of a moving target. I think the bigger picture is that we spent – as you know, we spent heavily last year on new building infrastructure, particularly here in Sugar Land but also in our overseas operations as well. And that gives us an ability to have the physical infrastructure to put new equipment in to be able to continue that ramp. And so on both those counts, I think we’ve been able to keep up with our customers’ demand and actually I think we’ve been able to gain some incremental advantage over competitors who maybe didn’t have that sort of latent capacity available to help customers when they saw a surge in demand.

Troy Jensen

All right, fair. And so Stefan on the 40G business, it looks like it grew nicely for you guys. Obviously your guidance implies probably good growth rate still or maybe stability, but just your thoughts on any concerns about the 40G business starting to decline? What do you think could happen and will 100G more than offset that?

Stefan Murry

I think not every customer moves in lockstep on this, right. So if some customers are approaching or at sort of the peak of 40G, others maybe are still growing or at least stable. The main message there is that as they transition away from 40G, they’re transitioning to 100G. And so we don’t see the decline of 40G, which is inevitable whether it’s here now or will be in the next few quarters depending on the customer. That decline really we don’t expect to be problematic because we can transition our manufacturing from 40G to 100G and it just gives us additional capacity on the 100G product. So I will say also that we don’t really expect a sharp decline in 40G. I think others have maybe speculated that that decline was going to be swift. I think there’s a lot of reasons why customers can’t transition completely away from 40G in a short timeframe. So we expect it will be a gradual decline and that 100G will more than make up for that.

Troy Jensen

All right, fair. Just one more technical question for you, it’s kind of multipart. So love to know when we will see a TAM4 [ph] announcement from AOI? And then can you just talk about the roadmap for 50G lasers and your thoughts of single [indiscernible]?

Stefan Murry

So I won’t comment on when we’re going to announce something – when we have something noteworthy. We’ll certainly let everybody know. As far as the 50G laser topic, I think we continue to believe in that technology. I think we’re working very hard. We’ve got some good preliminary results. But there’s still a lot of work to be done in that area but I think it’s very promising.

Troy Jensen

Okay. Just one last question. Can you just talk about what the ASP erosion was on the – or just how about in general on the datacenter products this quarter?

Stefan Murry

Yes, we don’t really break out the price decline or pricing level. What I could say is it’s within our expectations and clearly our gross margin this quarter and with the guidance that we have and the increase to our long-term model indicates that we’re very comfortable with the pricing environment that we see.

Troy Jensen

Perfect. All right, guys, keep up the good work.

Stefan Murry

Thank you.

Operator

Our next question comes from Paul Silverstein of Cowen. Please go ahead.

Paul Silverstein

Thanks, guys. This far, I can return on the 10% customers on the 100G. First off, Stefan, I just want to confirm. Can you refresh my memory? So this quarter, 100G was 20%, last quarter was 15% of datacenter revenues. Is that correct?

Stefan Murry

I don’t have that number in front of me. It sounds about right but I’ll have to double check and get back to you.

Paul Silverstein

If that is the case, it sounds like it’s not quite, but it almost doubled quarter-over-quarter and I want to – I guess to Troy’s question from a different perspective. 100G still is not – it doesn’t look like that’s been the key driver in the datacenter growth. And given what’s going on at Facebook, Microsoft and Amazon, I trust there’s a lot of runway ahead of you where timing’s always a question. But going back to the visibility question on 100G ramp, how much visibility do you have into the plans of your customers? And can you share – I know you don’t want to betray individual customer confidences, but can you give us any insight on what that time horizon roadmap looks like in terms of 100G deployment plan? And then I’ve got a follow-up question.

Stefan Murry

Okay. So there’s a couple of questions in there I guess. The first one is, do we have good visibility into our customers? And I think the answer is yes. I think we continue to see ourselves and I believe our customers see us as a key partner, as they rollout these new technologies. And so as a key and value partner for them, I think they’re giving us the best visibility that they possibly can into their future needs. So I think we have good very visibility there across all of our major customers, including the new ones. The other question that you had was related to sort of I guess kind of what Troy was asking about too in terms of the 100G ramp up. What I could say is we’re tracking as expected on the 100G. I think there’s always hiccups in the plan from time to time but overall the customers are basically purchasing what they let us to expect that they would purchase. And we feel comfortable with their plans for the future in terms of our capacity and our ability to meet their needs.

Paul Silverstein

Stefan, again not to betray customer confidences but what would that [indiscernible] that you’re currently looking at, what’s your expectation for 100G as a percentage of your total datacenter revenue in the first quarter?

Stefan Murry

It’s going to grow somewhat in the first quarter from what it was in Q4, but we don’t break that number out specifically.

Paul Silverstein

All right. One last quick question, if I may. With respect to the other 10% customer that you had, any insight you can share with us wherever that may be in terms of what happened with the significant reduction on a sequential basis? Is that just the main with quarterly volatility [ph] deployment plans or is something else going on?

Stefan Murry

Yes, I think it’s basically the quarter-to-quarter variation. What I can say is we’re very involved with this customer. We know them quite well. We had a lot of planned discussions and knowledge of their plan. We’re very comfortable that we haven’t lost share or anything like that there. But it’s just a fluctuation in their demand.

Paul Silverstein

All right. So to be clear, it’s your knowledge; you’re not aware of them having brought in another supplier displacing your setting at an appreciable extent?

Stefan Murry

That’s correct.

Paul Silverstein

All right, I’ll pass it on. Thank you.

Stefan Murry

Thank you.

Operator

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

Brian Alger

Hi, guys. Good afternoon. Impressive results all around.

Stefan Murry

Thank you.

Brian Alger

Especially on the operating and expense side, I’m surprised to see that the R&D level actually declined sequentially. Is that steady-state sort of dollar level that we should expect going forward, or is that something that we’ll see project by project fluctuating going forward?

Stefan Murry

Yes, I think it’s something that we – obviously with the growth rates that we’re having and the newer technologies that we’re bringing out, it would be not reasonable to expect dollar declines in R&D. What we would expect is for it to decline as a percent of revenue, because I think the R&D spend is not going to be growing certainly as fast as our revenue has been growing. So I wouldn’t say this is necessarily the new normal, but I think that it really has a lot to do with the roll off of some of the pilot run expenses and things like that for some of the 100G products. But we’ll continue to spend on R&D as we see the opportunities in the future to capitalize on it.

Brian Alger

I guess asking in a different way, is there anything out on the horizon development wise that would drive it from a percentage sales basis back into that double digit level that it obviously has previously been, or is it reasonable to think that as the business grows you’ll be able to fund it at these kind of high-single digit levels?

Stefan Murry

Yes, I think the latter. I think it probably won’t get – go back up as a percent of revenue.

Brian Alger

Okay, great. And there’s been some talk back and forth, plus and minus on the CATV side of things. You’re describing a less than a seasonal outlook for the first quarter here. I’m curious if that’s due to just the way the customers are shaking out or if that’s due to early adoption or early deployments for DOCSIS3.1?

Stefan Murry

It’s latter really or you could say it’s both in the sense that the DOCSIS3.1 is what’s driving the customers to adopt or to place larger orders. There really are upgrade projects going on. You’ve seen some of the MSOs talk about their – in fairly concrete terms talk about their upgrade plans and in some cases their actual ongoing upgrade activities. That’s really what’s fundamentally driving the business in cable TV and the growth there.

Brian Alger

Great, looks for me. Thank you.

Stefan Murry

Thank you, Brian.

Operator

[Operator Instructions]. Our next question comes from Richard Shannon of Craig-Hallum. Please go ahead.

Richard Shannon

Thank you. Thompson and Stefan, I’ll echo my congratulations on the great results and guys, keep up the great work.

Stefan Murry

Thank you.

Richard Shannon

Maybe a first question in the datacenter side, we’ve had a couple different ways already asked about delving into that one, maybe I’ll ask it more on the topic of distance breakpoints to serving there. I know you haven’t talked about this much in detail in the past, but curious how that mix has changed, the 500 meter versus 2 kilometer higher? And then how do you expect to see that happen or to transition as you get more 100G business, and I specifically note your press release from yesterday about a new 10 kilometer product in 100G, curious how that should transition throughout this year?

Stefan Murry

Well, we don’t really break out the reaches and things like that certainly not on a forward-looking basis, so I’ll kind of defer on that question. I think as a general rule, customers upgrade their networks at different lengths, at different times sometimes, so it can vary. The ratio of shorter reach to longer reach products can vary a little bit from time to time. I do think the new 100G announcement that we made yesterday is significant. The module that we announced will allow us to offer a product at significantly lower cost and some competitive technologies using different kinds of lasers, for example. And again that’s an example of how our vertical integration and our ability to do new things with our own laser fab. It gives us advantages there. And I would expect – obviously that 10 kilometer 100G product is one that we haven’t had before. So in that sense you would certainly expect that it will contribute some revenue and therefore increase a little bit the proportion of sales that’s in a longer distance regime. But what that percentage is and what do we expect it to be on an ongoing basis, I can’t comment.

Richard Shannon

Okay. So you are expecting a 10 kilometer contribution in the current quarter then?

Stefan Murry

I wouldn’t associate the current quarter, it could be. But I think longer term we would certainly expect it to contribute. Otherwise, we wouldn’t have announced it.

Richard Shannon

Of course. Okay. I wonder if you guys could give us your sense of how big the datacenter market can be. I don’t know if you care to quantify it any way or maybe just give a sense as you’ve gone through the past year and into the early part of this year, how the forecast looks from your current customers and obviously the guys you were talking to but maybe haven’t generated business from. How is that market looking and how is that outlook transition here?

Stefan Murry

Well, I think we didn’t directly talk about obviously and we don’t really give guidance more than one quarter out. But clearly with us raising our long-term target model in terms of gross margin and things, that would be difficult to do if we talked that the revenue was going to meaningfully decline over a long period of time. So I think we’re pretty comfortable with what we’re seeing in the market. I think others have also announced pretty positive things about the datacenter market. The bottom line is I think that market as we noted in the earnings call is fundamentally different from some other parts of the optical market, like telecommunications where you see the large infrastructure spend and it’s kind of on a very bursty basis. It comes and then it goes. The datacenter business is different. It’s characterized by an ongoing upgrade process that’s sort of continuously going on. And that has implications I think on our ability to predict revenue out in the future and indeed on kind of fundamental building blocks of the market. If you can predict your revenue better, if you have this ongoing cycle, you can invest more in R&D and you have better ability to predict what R&D is needed, because you know what future generations of technologies are likely to be important. And that’s very good for our business in terms of being able to target our R&D investments and it’s also good for us by virtue of our ability to continue to automate and extract cost out of that process, it helps us improve our gross margin.

Richard Shannon

Okay, helpful. Thank you for that. One last question for me. Any way you can help us think about what kind of a free cash flow generation you might have in the quarter? I’m assuming with your revenue guidance higher than the fourth quarter results and you’re starting to leverage a little bit on CapEx, so we could see it higher than what you did in fourth quarter. But any way you can help us figure that out, it would be great Stefan. Thank you.

Stefan Murry

Okay. Free cash flow obviously is basically for us related to our CapEx and what we do in the quarter. We’ve always said that we will target CapEx very strategically as to what we see in terms of near-term revenue opportunities. So I would say look to our CapEx guidance to kind of determine where our future thinking is in terms of revenue as you probably already have. That’s the most meaningful way to really gauge what we think the future is going to hold is by investing or how much investment we’re putting in CapEx at this point.

Richard Shannon

Okay, fair enough. That’s all the questions from me guys. Thank you.

Stefan Murry

Thank you.

Operator

At this time, we have no further questions. And I will turn the call over to Dr. Thompson Lin for closing remarks.

Thompson Lin

Okay. Thank you for joining us today. As always, we thank our investors, customers and employees for your continued support. And we look forward to seeing you at one of our conference in March.

Operator

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

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