Applied Optoelectronics' (AAOI) CEO Thompson Lin on Q1 2017 Results - Earnings Call Transcript

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Applied Optoelectronics, Inc. (NASDAQ:AAOI) Q1 2017 Earnings Conference Call May 4, 2017 4:30 PM ET

Executives

Maria Riley – Investor Relations

Thompson Lin – Founder, Chairman and Chief Executive Officer

Stefan Murry – Chief Financial Officer and Chief Strategy Officer

Analysts

Paul Silverstein – Cowen

Troy Jensen – Piper

Brian Alger – ROTH Capital Partners

Simon Leopold – Raymond James

Richard Shannon – Craig-Hallum

Tim Savageaux – Northland Capital Markets

Operator

Good day, everyone. I will be your conference operator today. At this time, I would like to welcome everyone to Applied Optoelectronics First Quarter 2017 Earnings Conference Call and Webcast. [Operator Instructions] 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 today’s event is being recorded.

At this time, I will turn the conference call over to Maria Riley, Investor Relations for AOI. Miss. Riley, you may begin your conference.

Maria Riley

Thank you. I’m Maria Riley, Applied Optoelectronics Investor Relations, and I’m pleased to welcome you to AOI’s first quarter 2017 financial results conference call.

After the market closed today, AOI issued a press release announcing its first quarter 2017 financial results and provided its outlook for the second quarter of 2017. 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 that recording can be found on the Investor Relations page 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 Q1 results and Stefan will provide financial details and the outlook for the second 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, expects, plan, anticipate, believe, or estimate, and by other similar expression.

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 non-GAAP measures as well as a discussion of why we present non-GAAP financial measures are included in our earnings press release that is available on our website.

Before moving to the financial results, I’d like to announce that AOI management will attend the Jefferies Technology Group Investor Conference on May 9 in Miami and the Stifel Technology, Internet and Media Conference on June 6 in San Francisco. We hope to have the opportunity to see many of you there.

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

Thompson Lin

Thank you, Maria. Thank you for joining us today. We started off the year strong with another record quarter for AOI. Revenue grew 91% over Q1 of last year to reach a record $96.2 million. Demand for our market-leading data center product continued to drive our exciting result this quarter. Data center revenue more than doubled over last year and we balance our eighth consecutive quarter of record revenue.

In CATV, revenue grew 69% over the prior year to $13.1 million, as the demand environment continue to improve. We achieved another record non-GAAP gross margin of 43.2%, driven by continued improvement in our manufacturing process and favorable product mix.

We also delivered a record non-GAAP operating margin of 27.1%, which reflects the strong operating leverage in our model. This lead to record non-GAAP net income of $21.8 million or 22.6% of revenue, which is above our target model and non-GAAP net income of $1.10 per diluted share using the weighted average diluted share count of $19.7 million.

The first quarter is a mark AOI’s 20th year of business and innovation. Over this 20 years in business we have met some incredible products and viewed a world class company that we believe has proven it can compete and win in a competitive market. Our commitment to technology innovation, manufacturing excellence, and extreme customer satisfaction as only becomes stronger since our funding. We believe beside AOI the quarter that set AOI apart. And our commitment to excellence in this area is a foundation to review upon for our next 20 years.

In summary, AOI delivered an outstanding first quarter, and we are very pleased with the team’s strong execution. Our goals in a quarter further demonstrates, our growing market share in advanced optics and reflects our continue commitments to operational excellence. We do remain focus on building on our momentum to drive growth and achieving our long-term financial objectives.

With that, I will turn the call over to Stefan to review the details of our Q1 performance and outlook for Q2. Stefan?

Stefan Murry

Thank you, Thompson. Total revenue for the first quarter grew 91% year-over-year to reach another record $96.2 million, this was primarily driven by continued demand for our market-leading data center products. Data center revenue in the first quarter grew 104% year-over-year to reach $79.6 million for 82.7% of our Q1 revenue.

Our growth this quarter was driven by record demand for our 100G products and continued demand for our 40G products. In this quarter, 62% of our data center revenue was derived from our 40G data center products and 30% was from our 100G products.

I’d like to take this moment to provide some additional color on our product mix in the data center and the trends we are seeing. As you may recall from our presentation at OFC, I mentioned that hyperscale data center operators generally use short-reach and long-reach transceivers within the data center. AOI mainly focuses on long-reach and long-reach light transceivers those having transmission distances of 150 meters to 2 kilometers.

And there are two types of technologies used for long-reach transmission, parallel and single-mode PSM and CWDM. Hyperscale data center operators will generally use a combination of PSM and CWDM transceivers within the data center and when evaluating which of these two technologies to deploy they consider the cost of the transceiver as well as the cost of the fiber cable. PSM uses eight fibers total, four for transmit and four for receive, which makes this type of fiber cable significantly more expensive compared to the two fiber cable used in CWDM solutions.

However, the laser or lasers used for PSM are relatively inexpensive compared to CWDM lasers, because of the cost of the PSM transceiver is lower than CWDM. PSM is more suitable for relatively short distances inside the data center. However for longer distances, the additional cost of the eight fiber cable exceeds the cost of the more expensive CWDM transceiver. Therefore a CWDM solution is more economical for longer distance interconnections.

The use case for these two technologies will vary based on the size of the data center and the fiber stand needed for a particular interconnection. At OFC, we highlighted that hyperscale data center operators are shifting to larger data centers as well as a more sophisticated and intricate leaf and spine architecture that requires more interconnections within the data center. And we see CWDM contributing to a greater portion of our business, as a point of reference that we do not expect to provide on a go-forward basis.

In Q1 revenue from CWDM transceivers accounted for 54% of our data center revenue, while PSM products generated 35% of data center revenue these totals include both 40G and 100G products.

Notably, the ratio of CWDM sales to overall data center revenue nearly doubled from Q1 of 2016. We believe this trend toward increasing data center size will continue to drive the need for more CWDM products. It is also worthwhile to note that for AOI CWDM products generally have higher gross margins than PSM due to our advanced design and manufacturing capabilities for these products.

In line with the trends that we see in the market AOI continues to innovate and expand our product portfolio. During the quarter we announced a CWDM 10 kilometer 100G data center interconnect product that can also be leveraged within the data center. We also released several next-generation 200G CWDM products for intra-data center applications. We believe that we are first to market in developing a 200G solution and the only company to showcase a solution with these capabilities at OFC. These products leverage AOI’s unique in-house laser design and manufacturing processes that can be optimized to produce 400G solutions. And solutions with even higher data rates to address the industry’s evolving needs for higher speed and more advanced optics.

During the quarter we had design wins with three new data center customers. Although the scope of these customers data centers are much smaller than our leading data center customers, we nevertheless think these design wins demonstrate our ability to meet the needs of a diverse customer base. Based on current orders and forecasts from our customers, we believe that 2017 data center revenue should grow by more than 85% compared with 2016 and would include contributions from three hyperscale data center customers each of whom will represent more than 10% of our annual revenue.

Turning to our cable television market, revenue from CATV products increased 69% year-over-year to reach $13.1 million compared with $7.7 million in Q1 of last year. On a sequential basis CATV revenue was down 2% reflecting better than normal Q1 seasonality due to an improving demand environment as cable MSOs transition to a more fiber deep network architecture with DOCSIS 3.1.

AOI remains at the forefront in developing and manufacturing advanced optical technology. And I’m pleased to announce that during the quarter we introduced a new high performance 10G electro absorption modulated laser that is designed for the next-generation fiber to the home telecom and CATV networks. We leveraged our unique combination of technology and manufacturing processes in the design of these high-performance EML that operate with high data rates, and are suitable for long transmission distances in demanding outdoor conditions. We believe these lasers are enabling technology for widespread deployment of fiber deep CATV or fiber to the home architectures.

Our telecom products delivered revenue of $3.2 million up 3% year-over-year with consistent demand coming from ongoing deployments of advanced mobile telecom networks around the world. For the quarter 83% of our revenue was from data center products, 14% from CATV products with the remaining 3% from FTTH telecom and other. In the first quarter we had two 10% or greater customers in the data center business that contributed 56% and 19% of total revenue respectively.

Moving down the income statement, as Thompson mentioned, we delivered another record non-GAAP gross margin of 43.2%, which is ahead of our guidance and target model and reflects an increase of 520 basis points when compared with the 38% reported in Q4 of 2016. The increase in our Q1 non-GAAP gross margin was driven by continued improvement in our manufacturing processes and favorable product mix.

R&D expense was $7.2 million or 7.4% of revenue up from $7.1 million or 8.3% of revenue in the prior quarter. Sales and marketing expense was $1.8 million or 1.9% of revenue up from $1.7 million or 2% of revenue in the prior quarter. G&A expense was $6.5 million or 6.8% of revenue compared with $6.6 million or 7.7% of revenue in the prior quarter. This brings total operating expenses to $15.5 million or 16.1% of revenue compared with $15.3 million or 18% of revenue in the prior quarter.

Non-GAAP operating income in Q1 increased to $26 million up 53% when compared with operating income of $17 million in the prior quarter and up from an operating loss of $0.5 million in Q1 of last year. Our non-GAAP operating margin in the quarter increased to 27.1% up 710 basis points from the prior quarter. Non-GAAP net income after tax for the first quarter increased to $21.8 million up 41% when compared with net income of $15.5 million in the prior quarter, and up from a net loss of $0.6 million in Q1 of last year.

We reported non-GAAP net income of $1.10 per diluted share up from $0.84 in the prior quarter and a loss of $0.04 per basic share in Q1 of last year. GAAP net income for Q1 was $19.8 million or $1 per diluted share compared with GAAP net income of $14.2 million or $0.77 per diluted share in the prior quarter. The Q1 weighted average fully diluted share count was approximately 19.7 million shares.

Turning now to the balance sheet, we ended Q1 with $60.6 million in total cash, cash equivalents, short-term investments and restricted cash compared with $52 million at the end of the previous quarter. As of March 31, we had $57.5 million in inventory an increase of $5.7 million from Q4. Accounts receivable increased to $66.8 million compared with $49.8 million last quarter. And accounts payable increased approximately $11.9 million over Q4.

During the quarter we also pay down our debt by $13.7 million. This includes $12.2 million paid on our credit facilities with East West Bank. $1.2 million to pay off certain equipment leases in Taiwan and $0.3 million to China Construction Bank bringing our balance on our line of credit with CCB to zero. As we outlined in our 8-K filed with the SEC on April 4, 2017 since we paid off and subsequently terminated this credit facility with CCB the bank release all claims to the collateral, we had offered to secure the debt.

Moving to capital investments, we made a total of $7.6 million in capital investments in the quarter including $5.6 million in production equipment and machinery and $1.1 million on construction and building improvements. Our free cash flow in the quarter was approximately $2.8 million.

Moving now to our Q2 outlook, we expect Q2 revenue to be between $106 million and $112 million, representing 92% to 103% year-over-year growth. We expect Q2 non-GAAP gross margin to be in the range of 41% to 42.5%. Non-GAAP net income is expected to be in the range of $22.2 million to $24.3 million, and non-GAAP EPS between $1.09 per share and $1.19 using a weighted average fully diluted share count of approximately 20.4 million shares. We expect our income tax rate for the quarter to be approximately 20.5%.

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

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time will begin the question-and-answer session. [Operator Instructions] And our first question today comes from Paul Silverstein from Cowen. Please go ahead with your question.

Paul Silverstein

Thanks guys. Stefan I appreciate your commentary on the competitive differences in terms of cost points on PSM versus CWDM. Can I ask you given the concern on the Street about competition? Can I ask you to revisit the issue and share with us what you and Thompson are seeing in terms of other folks, other competitors and competition in general in particular at you’re three big Web 2.0 – 2.0 customers? Why should the street not be concerned given that there’s certainly appears to be concern that you’re going to be displaced to one extend or another especially in the 100-gig arena.

Stefan Murry

Hi, Paul, well that’s a good question to start off with. So I think, first of all as we said along the most important factor for our success with these customers has been our ability to scale rapidly to meet their needs and to have a very low cost structure that allows us to get high gross margin while still meeting their pricing expectations. We believe relative to any other technology out there that we maintain a significant differential in terms of cost that is that we’re the lowest cost technology out there by a fairly wide margin.

And this is particularly true when it comes to the CWDM products as we mentioned in the prepared remarks the CWDM products make up the majority as a percentage of the overall revenue it’s more than doubled since last year. And that’s because these data centers are getting larger and as a consequence of the larger size of the data centers there’s more emphasis from these customers on the CWDM products, which for us are more highly differentiated and carry a higher gross margin.

So, all the trends that we’re seeing, I think are very positive for our technology and even on the relatively smaller PSM products we still maintain that we have a significant edge in terms of cost mainly due to our vertical integration and the amount of attention that we’ve paid to the manufacturing process and the automation that we put in place and the other factors that we’ve talked about a number of times that have really differentiated our manufacturing process.

Paul Silverstein

And Stefan can you I know you give it, before for my apologies, but can you remind me what that percentage increase it was to what from what in terms of CWDM as a percentage of the data center percentage in total revenue.

Stefan Murry

Sure. So what we said was that in Q1 the CWDM transceivers accounted for 54% of our data center revenue, 54% for CWDM Q1, PSM was 35% of our data center revenue. And that basically doubled from Q1 of last year. In other words the percentage of CWDM relative to the toll more than or approximately doubled from last year.

Paul Silverstein

Okay. And now is for both 100-gig and for 40-gig.

Stefan Murry

Correct. That’s an aggregate of both 40G and 100G CWDM PSM.

Paul Silverstein

All right and then along the same lines the three big what that’s out the same is on Facebook and Microsoft. So they were 10% customers this quarter, I recognize you don’t want to go too far into detail on anyone in them. But if I could ask you generic way in terms of one of them being less than 10% is that just the vagaries or rollouts, any insight you can share in terms of what’s going on with that – the one that was not 10% in particular.

Stefan Murry

Sure. It’s very much the same as we said last quarter that there are some rollout vagaries as you put it that are occurring there. We believe very strongly that we have not lost market share with this customer that it’s just overall kind of a slow type time for them in their deployments as they get ready to gear up 100-gig and we expect them to grow in the future. And again, I don’t think we’ve lost and share.

Thompson Lin

We had – Stefan has said, we believe both of this three customer would be 10% customer in this year.

Paul Silverstein

All right. Guys just to be clear read my last question on this. As of now you don’t see, you don’t foresee, you don’t anticipate being intercepted in a meaningful way at any of the Amazon, Microsoft or Facebook there’s nothing you’re aware of at this point that would cause you concern that there’s a share shift to one or more other competitors.

Stefan Murry

That’s correct.

Paul Silverstein

I appreciate it. I’ll pass it.

Stefan Murry

Thanks.

Operator

Our next question comes from Troy Jensen from Piper. Please go ahead with your question.

Troy Jensen

Hey, gentlemen congrats on the great quarter.

Stefan Murry

Thanks, Troy.

Troy Jensen

Hey, Stefan I got a question for you. If I look back at some of your investors slide deck and I think it was exiting the year, you said, you are making 400,000 lasers per month at that time. And you expect to be at 700,000 to 1 million by the end of this year. I’m curious to know where you are currently. I like to want just kind of a connection obviously again some visibility from customers to say that but when we look at that type of doubling of lasers what is that means to revenues by the end of the year.

Stefan Murry

Well, I won’t give you the exact number that – we’re certainly well on track for the plans that we’ve outlined. As far as our plans for the use of those devices right now we’re using every device that we can make in our internal production basically and given the forecast that we see from the customers, I don’t see that situation changing. That is I would anticipate that all the lasers or substantially all the lasers that we’re producing at least the ones that are destined for data center applications those will go straight into our own transceivers and be sold to our customer.

So, if we double the number of lasers that we’re making that would double the number of transceivers essentially.

Troy Jensen

So would it double your revenues?

Stefan Murry

Well, there is a number of factors there, right I mean it would depend on the type of transceivers. Obviously, we see a trend towards more 100-gig and more CWDM as I mentioned in the remarks. So those generally carry higher ASPs without getting too much into the details on specifics but certainly those carry higher ASPs than 40-gig, PSM type products. The trends are all there that would anticipate not a reduction in unit prices.

Troy Jensen

Yes. My point exactly, all right. Then just quickly on – just on the gross margin guidance, it’s little bit below the Q1 level. I’m just curious now if there conservatives on your – I guess I want to talk scale and then mix some benefit to gross margins. Just curious you received any pricing dynamics there.

Stefan Murry

The difference there is really coming from our cable TV segment mostly the difference is coming from the cable TV segment. We’re seeing relative to last quarter we’re seeing a little bit more orders for products that would be destined for sort of emerging market type cable TV networks, which generally carry a lower gross margin for us. So it’s really a product mix within that cable segment.

Troy Jensen

Okay. Understood, and keep up good work guys.

Stefan Murry

Thank you, Troy.

Operator

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

Brian Alger

Hi guys good afternoon and congrats on the good outlook. Obviously there’s been a fair amount of hand-wringing over the past couple of weeks. I’m wondering where we are in terms of the crossover and what your expectations are as we go through the year. Clearly your 100-gig is ramping but given your customer mix are you still anticipating that you’ll lag the industry in terms of your crossover point.

Stefan Murry

Brian, we you talk about crossover point, what exactly are you referring to?

Brian Alger

Sorry, 100-gig versus 40-gig and then tuck in revenues relative to units.

Stefan Murry

So you’re asking when do we expect the 100-gig revenue will overtake 40-gig revenue.

Brian Alger

Correct.

Stefan Murry

Really disclose that on a forward looking basis. We think that obviously 100-gig is growing, 40-gig for us is also very strong it was – we were actually had another record quarter in 40-gig sales as well. It was pretty much flat over last quarter but it was up ever so slightly. So, we’re expecting good year both in 40-gig and 100-gig but as far as when that crossover happens we don’t really talk about that.

Brian Alger

Well maybe shifting to more about the industry I think at the Analyst Day down at OFC you talked about how the industry as a whole or as a data center customers as a whole are shifting rapidly towards 100-gig. And well that might not pair here up with – you guys given your customer base that that transition was well underway. Can you maybe comment in terms of the progression that the industry has seen moving towards 100-gig versus 40-gig?

Stefan Murry

I don’t have any data on – I mean where the industry is in that transition. I can only speak to our numbers as I said, we’re seeing very strong results for 100-gig and 40-gig. 40-gig actually started with a higher base. So the growth rate there is less, 100-gig is growing very strongly. But I can’t really comment on the overall industry outlook, I don’t have that data.

Brian Alger

Okay, that’s fair. And in terms of just looking at the OpEx you guys have done a really good job of driving a lot of leverage to the bottom line. And we kind of look at the progression here Q2 guidance versus Q1 the sort of sequential evolution of that something we should concerned to be consistent from a dollar basis.

Stefan Murry

Right now we’re basically shipping everything we can manufacture. So the growth rate is not dependent on demand its dependent on our ability to continue to ramp or manufacturing. So, we talked just a moment ago with Troy, he mentioned some of the figures that we had projected in terms of laser sales. I think you can draw some conclusions from there. But there is a limit to how fast we can increase our production capacity. So that’s really the limiting factor to the growth rate.

Brian Alger

Okay. Thanks a lot guys. Appreciate ti.

Operator

And our next question comes from Simon Leopold of Raymond James. Please go ahead with your question.

Simon Leopold

Thanks for taking a question. Couple of things just a quick, quick housekeeping one, I missed you gave us a CapEx number for the quarter.

Stefan Murry

Yes. The CapEx number total was $7.6 million, and if we divided it $5.6 million for production equipment and machinery and $1.1 million for construction and building improvements.

Simon Leopold

And where do you see this going in the balance of the year? Do you have a budget set?

Stefan Murry

Yes. We do have a budget set we don’t really disclose that number for the year on a forward-looking basis. As we’ve said often that CapEx for us is a precursor to revenue and especially that part that’s dedicated to the machinery equipment and we can put that to work very quickly in our production processes. So I would anticipate that if we’re growing our production capacity, which I have indicated that we are – that we will be growing our CapEx through year as well. But as far as how that breaks up quarter-to-quarter and what total year expand growth.

Simon Leopold

Great. And I appreciate the education you provided on the CWDM versus PSM for that was helpful. Just maybe additional level of detail is there different number of lasers used in each of those devices.

Stefan Murry

No, CWDM and PSM both use four lasers in general now, that’s for our technology. There are other technologies that use single laser in the PSM variety. However, that laser is a different laser it’s a higher power device. And it has some other special features on there. So it’s not exactly the same laser that would be used in our PSM approach.

Thompson Lin

Simon, this Thompson, well forward and – is much and it’s much topical to make a picture. And right now, we believe there are some short variety in 25G – and AOI we believe we’re a leader in 25G lasers especially in CWDM area based on performance, quality environment.

Simon Leopold

So that actually nicely sets up that my next question is we’ve sort of heard this bear case of companies that would sell merchant elements. They would sell lasers and semiconductors to other manufacturers or to contract manufacturers that could then compete with you. So I guess one-side of the bear case about your company is that there’s – there are other competitors taking share. The other side is this sort of unidentified competitor that would buy merchant elements. Can you help us understand the potential for that as a competitive threat? Hopefully that makes sense and I can be more explicit if you want?

Stefan Murry

No I understand what you’re getting. So we have a great deal of vertical integration, as we’ve talked about ever since when we went public. We do a lot of these things in-house, we make our own lasers, we build our own light engines, we do our own production, we do our own testing. Okay. There are companies out there that have talked about sort of disaggregating that if you will and one company it will grow the laser chip, somebody else will do the assembly, somebody else will do the test, somebody makes the chips et cetera et cetera, okay.

Relative to our business model, I mean this has been the big advantage of our business model. And I will point out to you at this point – we’ve got a 5 plus year track record in the data center industry of highly successful business as evidenced by this quarter and our previous – really going back 4, 5 years. You can look at our results. The vertically integrated business model, we believe is the best way to economically manufactured these data center products. And there are competitors out there that are talking about doing different business model. But economically that just doesn’t make sense, if you have to add multiple companies, profit margins in there along with all the vagaries of the manufacturing that is yields and things that change over time and inventory management.

We’ve done the modeling and there is no way that that results in a product is less expensive for the end customer than buying it from AOI even the profit margins, the gross profit levels that we’re at today. Yes, it’s possible to do it that way, potentially but it doesn’t result in a lower cost product.

Simon Leopold

Great. And I just want to – sorry Thompson go on.

Thompson Lin

All of their cost of margins would be based on the mid, we are investing about the gross margin prepared by these company, all would be cost of margin of our phase company doing sending laser, doing such manufacturer, sending transceiver or sending chips.

Stefan Murry

And all of that assumes that they would be as good as AOI at all those operations which we don’t think it’s possible given the fact that we are the demonstrated leader in this industry.

Simon Leopold

Great. I Appreciate that. So one last one if I might is sort of thinking about the trajectory for the company in terms of in one dimension, you’ve mentioned three new data center customers. So one avenue for evolution is adding more customers with the products you have another dimension might be to introduce new products and you’ve mentioned the 10 kilometer products. How should we think about the two dimensions in terms of either diversifying the customer base with products you have versus the waiting of introducing new products? What other things might you introduce? Thank you.

Stefan Murry

Well, yes actually we introduced not only the 10 kilometer product, but we also talked about the 200G product that we showed off at OFC – we believe the only company that really highlighted that 200G product at OFC. And we talked in very general terms about our evolution towards 400G. So we are definitely not slowing down in any way, we’re actually speeding up our development in terms of new products. At the same time though, we are – and we have said, very consistently that our products are very applicable across the wide range of diverse customer base. And we’re working very hard and having quite a bit of success at getting new customers into our fold as well.

Simon Leopold

Great. Thank you for taking my questions.

Stefan Murry

Thank you, Simon.

Operator

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

Richard Shannon

Hi, guys. Thank you for taking my questions. I guess my first one, it might be permutation when I asked earlier. But you talked about expecting I think 80% to 85% growth in data center revenues this year, Stefan. Any way that you can help us think about relative growth between 40 and 100-gig and I think mostly probably interesting whether 40 is expected to grow or not? Any way you can quantify or characterize it would be great here?

Stefan Murry

Well. I think I should mention for us. We talked in the fourth quarter of last year about a new third large data center customer that we had at that time. Started to get business from at that time that customer continues to grow and they are buying significant quantities of 40G. So when you talk about for AOI will 40G be higher in 2017 compared to 2016. The answer is probably yes, however I would caution that doesn’t necessarily mean that – that’s the same thing for the industry right because we added a significant new customer for 40G during the year.

Overall I would say in general terms while I can’t speak to the specifics of the industry, I think it’s widely acknowledged and most people would agree that 100-gig is growing. We were first in market with 100-gig products. First of volume with those products and we believe we’re cost leader on those products. So I think we’re going to be very successful in both 100G and 40G throughout the year.

Richard Shannon

Okay. Perfect, that’s helpful. Second question following up on your topic of CWDM 4 versus PSM 4 and by the way I’ll add my thoughts on – that’s a great topic to bring up. Please do so in the future if you can but, you talk about a split between those two that includes both 40 and 100-gig. Does that split? Is that similar on specifically in the 100-gig version spilling that out specifically is that closer or is that skewed a lot from that that percentage.

Stefan Murry

It varies a little bit from quarter-to-quarter again. One of the things that I was trying to illustrate with that rather long technical discussion of PSM versus CWDM is really that, it’s a very complex decision making process that customers have to make, they are very sophisticated about how they make those decisions. And there’s no – if you can’t just say well, one customer uses this or one customer uses PSM, one uses CWDM or all data centers like this are architected this way to that way.

There’s a lot of variation between customers and even from time-to-time within a customer based on the particular part of their network that they’re building out at that time. So it’s not – there’s no really good easy answer to that. Generally speaking I mean there are significant quantities of both PSM and CWDM being used at 100-gig but CWDM is becoming larger as a percentage of overall 100-gig as we move forward that is true.

Richard Shannon

Okay. My last question on gross margin stuff and you guys did an excellent job over the last year getting to this level 42% or so. And your guidance shows you’re exciting to keep that up here looking across the optical space 42% has been difficult number to reach in and to sustain for any period of time. I wish you don’t give hortative guidance past this quarter. But how would you have us think about gross margins going forward in a very high volume markets like 100-gig where you have some very large customers who can be very aggressive on pricing. I wish, you got a good cost structure but is 42% or even a neighborhood can sustainable or how should we – how should we think about that going forward.

Stefan Murry

So, as you pointed out the name of the game is cost, right. We have spent a tremendous amount of time and effort, I mean it’s worth pointing out as we did in our prepared remarks. That this is the 20-year of business for AOI, we’ve been innovating and learning how and developing new manufacturing, advanced manufacturing techniques for these products for 20 years now. We have an excellent business model this vertically integrated business model with a high degree of automation and a design that has been specifically optimized to be low cost over multiple generations of products that has resulted more recently over the last five years in us – in our ability to grow our data center revenue from practically nothing to where it is today. And allowed us to be the market leader there.

So what’s gotten us here is our ability to continually, improve our manufacturing processes and improve our cost structure and therefore keep increasing gross margins even in the phase of what’s already been varies this competition, I mean at no point in this data center business has there been a lack of competition. And we’ve been able to grow as you pointed out our gross margin throughout that time. So we’re happy to stack our manufacturing processes and our capabilities up against anybody in the industry even when it comes to newer technologies that we’re aware.

Thompson Lin

And Richard, this is Thompson. I want to emphasize in the – when I tell you cost out be in – this is much topper to design manufacture product than PSM 4, so there are much less comparator. And for us AOI has much strong cost advantage that cost out the year. So that’s all we update long-term model in that quarter when you call. And we believe that’s how we can maintain even for mountain or even higher.

Richard Shannon

Okay, great. Guys, I appreciate all the details and keep up the great work. That’s all for me.

Stefan Murry

Thanks.

Operator

Our next question comes from Tim Savageaux from Northland Capital Markets. Please go ahead with your question.

Tim Savageaux

Hi. Good afternoon. Kind of question about, you mentioned sort of a market leading position in the web scale transceivers. I wonder if I could ask a couple of questions along those lines. One that, could you speak to your relative share I guess it 40-gig versus 100-gig and I realize you focused on the kind of web scale data content transceivers market directly. There does seem to pretty – be a pretty significant emerging market for QSFP28 as part of kind of the network equipment OEM landscape. I wonder if you could speak to that opportunity if you’re addressing it, if not, why not so sort of our couple questions on 40 versus 100 relative share and also maybe even bisecting that into web scale and OEM if you will?

Stefan Murry

So our plan is to grow our market share going from 40-gig to 100-gig, we’ve been the majority supplier to most of our large data center customers for 40-gig products and we think we can maintain that majority or even grow our market share within those products. As Thompson mentioned CWDM products in particular are very, very difficult to make AOI’s particular prowess in the manufacture of those products and that’s what customers are increasingly needing as they grow their data center.

So we think there’s every opportunity to grow our market share as we move into greater and greater quantities of 100-gig. As far as your other question, which concerned the ability to attract OEM customers, one of the three customers that we announced in this earnings call is an OEM customer. So we’re definitely making inroads there. Now, as we cautioned those OEM customers generally are smaller and certainly compared to the hyperscale, they just don’t have the size and quantity in general to be up that scale. But I think it’s a testament to our products that they work and play very well in the OEM realm as evidenced by one of those three new customers that we announced.

Tim Savageaux

And just to come back to that, understanding you’re looking to grow your share. Do you feel like you’re the market share leader in 100-gig web scale transceivers today?

Stefan Murry

Yes. For the long reach right I’m talking about PSM and CWDM type products.

Tim Savageaux

Okay. And then one sort of quick follow-up on the kind of some of the laser math before. And if I’m doing this wrong please let me know. But I guess it’s 400,000 lasers a month, that’s a million to 4 per transceiver, that’s 300,000 units a month based on I mean a quarter – based on your revenue number. Is that your put ASP kind of solidly below 300, am I doing math right and I imagine there’s a pretty wide difference between 40 and 100 but I wonder if you can comment on that overall range and what’s the sort of direction that you’re seeing in terms of pricing in both 40 and 100G?

Stefan Murry

So I mean roughly speaking the math you’re doing is correct. There is obviously some part of our business that’s for example 10-gig and there’s cable TV and other so not all of the businesses direct…

Tim Savageaux

Just checking the data center revenue on that?

Stefan Murry

For data center products, yes, you’re math is correct. As far as – your other question was concerned the ASPs – again, your math is correct that is an average of a large pool of different products. So clearly there are products that are well above that in terms of gross margin and others that are below that or average price rather.

Tim Savageaux

Right. Let me guess the follow up was…

Stefan Murry

In terms of whether that’s pricing…

Tim Savageaux

…any changes there?

Stefan Murry

Yes, I mean the price is not getting higher, it certainly going down. I think there’s been quite a bit of price pressure already in 100-gig and I would anticipate that there will be further price reductions. The key for us to maintain or grow our margin during that process and I think we’ve been able to demonstrate our ability to do that. 40-gig has been relatively stable – there’s occasionally there are some incremental price reductions there, but it’s been relatively stable.

Tim Savageaux

Thanks.

Stefan Murry

You’re welcome.

Operator

And our next question is a follow-up from Paul Silverstein from Cowen. Please go ahead with your follow-up.

Paul Silverstein

I might have missed the answer to previous question. But Stefan, what’s the price differential right now between 40-gig and 100-gig?

Stefan Murry

It depends on the type of products, it’s not an easy answer to give. And I don’t like to get too detailed in pricing. So the differential hasn’t changed dramatically in the last quarter.

Paul Silverstein

I assume there’s a relatively meaningful difference. I guess where I’m going with this is as 100-gig continues to increase as the percentage of the volume, you’ve been allowing for ASP declines in a 100-gig and relatively simple 40-gig. I assume all things being equal and that in itself is going to contribute to growth. Probably get the question to be as a meaningful. And then the related question would be in terms of margins a 100-gig versus 40-gig once again if your already said, my apologize. Well, I trust you don’t want give the numbers but is the differential from a margin perspective meaningful?

Stefan Murry

Yes.

Paul Silverstein

In favor of 100-gig?

Stefan Murry

Correct 100-gig is higher margin, meaningfully.

Paul Silverstein

All right. So all other things being equal as the 100-gig grows as a percentage of revenue, it’s good for revenue, it’s good for margins.

Stefan Murry

Generally, yes.

Paul Silverstein

All right. I’ll ask my follow-up offline. I appreciate it. Thanks guys.

Stefan Murry

Okay.

Operator

And ladies and gentlemen, at this time, I’m showing no additional questions. I’d like to turn the conference call back over to management for any closing remarks.

Thompson Lin

Okay. And 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 on our upcoming conference.

Operator

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

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