Applied Optoelectronics (NASDAQ:AAOI) Q2 2026 Earnings Call

0:00 Good afternoon. I will be your conference operator. And at this time, I would like to welcome everyone to Applied Optoelectronics Second Quarter twenty twenty six Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

0:20 And then also please note that this call is being recorded. I would now like to turn the conference over to Lindsay Savarice, Investor Relations for AOI. Ms. Savarice, you may begin. Thank you. I'm Lindsey Savarice, Investor Relations for Applied Optoelectronics. I'm pleased to welcome you to AOI's second quarter twenty twenty six financial results conference call. After the market closed today, AOI issued a press release announcing its second quarter twenty twenty six financial results and provided its outlook for the third quarter of twenty twenty six. The release is also available on the company's website at aoinc.com. This call is being recorded and webcast live.

1:05 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 Doctor. Thompson Lin, AOI's Founder, Chairman, and CEO and Doctor. Stephen Murray, AOI's Chief Financial Officer and Chief Strategy Officer. Thompson will give an overview of AOI's Q2 results, and Stefan will provide financial details and the outlook for the third quarter of twenty twenty six. 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.

2:08 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.

2:44 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 twenty twenty six and for the full year of 2026.

3:23 Except as required by law, AAOI 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 ks and quarterly reports on Form 10 Q. Also, 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.

4:13 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 AOI's website. Before moving to the financial results, I would like to note that AOI management is attending Rosenblatt's sixth Annual Technology Summit virtually on August 18. This discussion will be webcast live, and a link to the webcast will be available on the Investor Relations section of the AOI website. Lastly, I would like to note that the date of AOI's third quarter twenty twenty six earnings call is currently scheduled for 11/05/2026. Now I would like to turn the call over to Doctor. Thompson Lin, AOI's Founder, Chairman and CEO.

5:01 Thompson? Thank you, Lindsey, and thank you for joining our call today. We are pleased to deliver solid second quarter result 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.

5:50 Because of this, we continue to anticipate steady sequential revenue growth this year and continued non GAAP profitability. During the second quarter, we delivered revenue of $191,900,000 and non GAAP gross margin of 29.8%, in line with our expected guidance range and our non GAAP income per share of $06 came in above our expectations. Importantly, during the quarter, we saw continued robust customer engagement around our 800 gs and 1.6 therapy products. In line with our expectation, we saw a strong volume ramp of our 800 gs dope product in Q2, which more than doubled sequentially.

6:44 Looking ahead, forecast demand continued to outpace our production capacity through mid-twenty twenty seven. We are working hard to add additional capacity to meet this demand. We continue to believe our 2026 revenue will be around $1,100,000,000 this year. With that, I will turn the call over to Stefan to review the detail of our Q2 performance and outlook for Q3. Stefan? 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 and we achieved an important milestone as we returned to non GAAP profitability in the quarter.

7:36 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 $191,900,000 which was in line with our guidance range of $180,000,000 to $198,000,000 We recorded non GAAP gross margin of 29.8%, which was in line with our guidance range of 29% to 30%.

8:32 And our non GAAP income per share of $06 was above our guidance range of a loss of $03 to earnings of $03 Notably, we continued to make progress on our key priorities in the second quarter, which included: one, scaling our next generation data center products, including both our 400 gs and 800 gs solutions, by expanding our production capacity in a disciplined manner two, diversifying our revenue base and three, 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 800 gs and 1.6 terabit products, particularly as AI driven data center investments accelerate.

9:25 In line with our expectations, we saw a strong volume ramp of our 800 gs products in the second quarter. 800 gs revenue, up $12,800,000 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 800 gs products to grow by nearly five 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 400 gs business. 400 gs revenue of $48,400,000 or 45% of our total data center revenue increased more than fourfold year over year and 27.4% sequentially in the second quarter.

10:19 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 two new volume orders from this customer for our 800 gs single mode transceivers. We began delivering these 800 gs orders in Q2, and 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 800 gs and 1.66 terabit modules are projected to continue to exceed our production capacity through mid-twenty twenty seven.

11:14 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 800 gs 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 United States. 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 1,600,000 square feet 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 square foot facility, which is just a few 100 yards away from our headquarters.

12:06 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 800 gs 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 800 gs 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 twenty twenty seven.

13:05 Currently, our total manufacturing capacity is approaching 200,000 units per month, up from nearly 100,000 units per month of 800 gs 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 800 gs 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 800 gs 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 800 gs and 1.6 terabit products.

13:55 It's important to note, as a reminder, our 800 gs 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 800 gs 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 800 gs 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 800 gs 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.

14:56 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 line width 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.

15:51 We believe that in the future, CPO will continue to drive increased demand for high power lasers, and we plan to continue to expand our laser manufacturing capacity in Texas in order to accommodate these future growth drivers.

16:06 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.

16:34 During the quarter, direct tariffs had a $1,900,000 impact on our income statement. With the overturn of the AIPA tariffs, we have received a refund of approximately $5,700,000 We are still evaluating the potential impact of the new tariffs recently announced in The U. S, but at the present time, we don't expect any material change from tariffs as a result of this announcement.

16:56 Turning to our second quarter results. Our total revenue was a record $191,900,000 which increased 86% year over year and increased 27% sequentially off a strong Q1 and was in line with our guidance range of $180,000,000 to $198,000,000 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.

17:27 In our data center business, Q2 revenue of $107,700,000 increased 140.4% year over year and 32.3% sequentially. Sales of our 100 gs products increased 31.3% year over year, while sales for our 400 gs products increased more than fourfold year over year and sales of our 800 gs products increased more than tenfold year over year.

17:54 In the second quarter, 38.3% of data center revenue was from 100 gs products, 45% was from 200 gs and 400 gs transceiver products, 11.9% was from 800 gs transceiver products, and 4.4% was from 10 gs and 40 gs transceiver products. We currently expect to see a decline in 100 gs business in Q3 due to one of our customers' inability to source sufficient 100 gs switches to meet their initial forecast. We believe that the shortage of switches is related to memory shortage and expect that 100 gs weakness will persist until the memory supply recovers. Even with this temporary weakness in 100 gs, we continue to believe that by mid-twenty twenty seven, 100 gs and 400 gs revenue will be approximately $90,000,000 800 gs revenue will be approximately $217,000,000 and 1.6 terabit revenue will be approximately $164,000,000 monthly.

18:53 In total, this is about $471,000,000 per month of data center transceiver revenue.

19:00 In our CATV business, we saw record CATV revenue of $80,600,000 which was up 43.8% year over year and 20.6 sequentially and was slightly above our expectations of $75,000,000 and $80,000,000 Similar to the last couple of quarters, we shipped a significant quantity of 1.8 gigahertz amplifiers to our largest CATV customer in Q2.

19:28 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 Quantum Link 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 $100,000,000 and $110,000,000 Looking further ahead, we continue to expect to generate over $325,000,000 annually in CATV.

20:22 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 2624% 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% to 30% and compared to 29.2% in Q1 twenty twenty six and thirty point four percent in Q2 twenty twenty five.

21:14 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 operation.

21:40 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 $1,200,000 Total non GAAP operating expenses in the second quarter were $67,600,000 or 35% of revenue, which compared to $42,100,000 or 41% of revenue in Q2 of the prior year.

22:16 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 and D spending as we have been asked by customers to qualify new 800 gs and 1.6T products in the quarter.

22:33 We believe that R and 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 $70,000,000 to $80,000,000 per quarter. Non GAAP operating loss in the second quarter was $10,300,000 compared to an operating loss of $10,800,000 in Q2 of the prior year. GAAP net loss for Q2 was $22,800,000 or a loss of $0.28 per basic share compared with a GAAP net loss of $9,100,000 or a loss of $0.16 per basic share in Q2 of the prior year.

23:12 On a non GAAP basis, net income for Q2 was $5,500,000 or $06 per diluted share, which was above our guidance range of a loss of $2,500,000 to income of $2,800,000 or non GAAP income per share in the range of a loss of $03 to earnings of $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 $8,800,000 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 $88,100,000 Turning now to the balance sheet. We ended the second quarter with $508,800,000 in total cash, cash equivalents, short term investments and restricted cash. This compares with $449,400,000 at the end of the first quarter of twenty twenty six.

24:08 We ended the second quarter with total debt, excluding convertible debt, of $92,800,000 which compared to $77,000,000 at the end of last quarter. As of June 30, we had $278,800,000 in inventory, which compared to $206,200,000 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.

24:37 As we disclosed in May, we initiated a new at the market offering. To date, we have raised $538,800,000 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 $565,500,000 in capital investments in the second quarter, including $280,000,000 in prepayments on equipment we have on order. These expenditures are mainly for manufacturing capacity expansion for our 400 gs, 800 gs and 1.6 terabit transceiver product. We expect CapEx intensity in the second half of the year will be higher than in the first half as we prepare for increased 400 gs, 800 gs and 1.6 terabit data center production.

25:29 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 $255,000,000 and $290,000,000 representing 130% year over year growth at the midpoint.

26:16 We expect non GAAP gross margin to be in the range of 29% to 30.5%. Non GAAP net income is expected to be in the range of $10,100,000 to $24,000,000 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 92,800,000 shares. Looking more broadly at 2026, we believe our 2026 revenue will be around $1,100,000,000 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 and A session. Operator? Thank you. And And our our first question today will come from George Notter with Wolfe Research. Please go ahead.

27:25 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 US ban on those transceivers being shipped into The US.

27:38 Could you just talk about your perspective on that? What are you seeing, hearing? How might that affect AOI?

27:46 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. 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 tightens that appeal.

28:25 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. So certainly anything that would heighten interest in that is good for us. But it's hard to point to any specific

28:43 ramifications at this point since it's still kind of early. I think this is really not news at all. I think this kind of discussion for quite a while. So this as I mentioned, we have been working very close with three customer for a long term agreement, especially, you know, AAOI making our own laser, and we are maybe the only one company commit to really invest every U. S. For U. S. Manufacturer, not only laser including the transceiver. So with some early, I would say, early feedback. I would say customer more aggressive will give us much more share, okay, especially for U. S. Manufacturer.

29:35 Yes. But how serious or how big it is, we will not because, as I said, right now, our capacity is prepook 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

29:59 I would say U. S. Manufacturer. Okay. And then just as a follow-up, I was just curious about the ramp in 800 gig. It looks like the growth in the business right now is coming from 100, two hundred and four hundred just based on your comments about the mix of transceivers in the quarter. It seems like at this point 800 gig has got to be the driver on the growth in data center. And so I'm kind of wondering like exactly where you guys are. Is all that tooling fully installed and ready? Are those laser datacom 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. No. I mean, as we said in our prepared remarks, look, our ability to deliver revenue in general and specifically when it comes to 800 gs products is limited by our production capacity right now.

30:55 So if we could produce more, we could ship more right now. So 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 1,600,000 square feet of manufacturing space here in Houston. A year ago at this time, we had about 65,000 square feet. So clearly all of that manufacturing space has not been built out, doesn't have equipment in it yet. So 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 800 gs and 1.6. That's not and most of that is going to be 800 gs, given the demand that we're seeing. So that's all incremental new capacity that doesn't exist today.

32:00 And then, you know, growing from there. So no, there's significant room for expansion and we're only kind of getting started on the heat energy ramp now. But by the way, I think I want to emphasize one thing. Right now, the Q3, you can see compared to Q2, average, had 140% growth, okay, something like that, okay, 35% to 45% growth. But the growth is mainly from 800 gs. At the same time, in the screen, we already mentioned because of memory issue for the switch, okay, Actually, the 100 gs will decrease by $20,000,000 to $25,000,000 Otherwise, our Q3 revenue will be the cost should be more than 50%, as I've mentioned. So but this is short term effect. We believe the 100 demand will come back to normal within a few months, okay, either by end of this year or next years.

32:57 All right. And don't forget and we mentioned by June, July, the overall transceiver revenue will increase from today's number to $471,000,000 per month. There's huge growth. And our growth actually from 800 gs and 1.60 gs and 100 gs will go down. And all this is because the additional capacity we are building, not only in Asia, most of the increased capacity will be in U. S. But even so, let me say that, like I keep emphasize, lead is not good enough for the customer demand. The customer demand is 20% to 40% higher. All right. And actually, we are getting discount demand from several customers almost every week, every month to speed up our delivery schedule. And we're doing everything we get.

33:48 The other is working very close with our key supplier. As you know, I think the DSP, TIA, good news, they are making our own laser. Other lasers, biggest bottleneck right now for the transceiver business. But this is not the only one, okay? That's why we are working with very several key suppliers to increase the volume in the next few quarters to meet in our demand. Great. Thank you very much. And our next question will come from Simon Leopold with Raymond James. Please go ahead. 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 800 gig and 1.6 T revenue in the neighborhood of $330,000,000 I want to make sure that I'm thinking about this correctly first, and then I've got a follow-up.

34:56 Yes, that's about right, directionally. Great. And then recall in the spring that you were talking about the 1.6T ramp and having a commitment for $200,000,000 through an order. And 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 $200,000,000 order you had talked about for 1.6T in the past? So 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.

35:49 And then there be a tail end of the first quarter. But 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. So I wouldn't get too wrapped up on that particular order, that's just the very beginning of it. Great. And then I want to ask a different China related question. Apart from the potential regulatory issues, there's been we've been getting a lot of questions about the suggestion that there will be new manufacturing of lasers coming out of China. And 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?

36:51 Thank you. Let me answer the question. Okay. I think the investor maybe for our estimate, how big is laser market? Let me say that. Right now, for the CPO laser, okay, used in the USAP, it's a 300 milliwatt laser compared to 70 milliwatt laser used at 800 gs transceiver and 100 milliwatt used for the 1.6 kilobytes transceiver. But people don't understand not only the power is made several times bigger, but the size. Okay? The the size is about six times or even high or even more, but E is lower. So overall, you're talking about to meet the demand just for the the I would say the phase one, the ESP is the only the thirteen ten nanometer, okay, for wave ends.

37:53 But I think the next generation of ESP will be using DWDN. So that means because wavelength is so tight, I think the year loss will be easily, okay, 40% to 50% compared to thirteen ten wavelengths, okay? So that means to meet the demand for the CPU market, the operator market needs to be 8,010 speakers compared to today. This is not AOI, Lumen and Coedon, Brocom, everybody will invest huge money to meet the demand in the next few years. Because for lasers, from today, if I order the equipment, it will take minimum, minimum twenty one months to twenty four months to start manufacturing in high volume, okay? That's how long it take.

38:44 It was a semiconductor process, build a long term of the equipment, everything. So I think it's yes, there'll be some new supply in China. We are not surprised because that's what market need. But most of them still working maybe 70 milliwatt or very few can really do 100 milliwatt. But for 300 milliwatt laser, especially DWD and spec, we don't see that, but not in the next two, three years. Especially the demand is so big. Okay? Even combined AOI, Rubellum, COEIDM program altogether is still very tough to meeting the the the customer demand in the next few years. And we are doing everything to speed up the process to expand our capacity. So I think this for me, think no effect at all because the demand is much bigger than the worldwide capacity, even including our company in Taiwan, China or other countries like Japan.

39:58 Our next question will come from Ryan Koontz with Needham and Company. Please go ahead. Great, thanks. Maybe just following up on the question about laser supply and thinking about your own constraints there for indium phosphide, how are you guys feeling about substrates and other raw materials that you need to ramp? And is that a current bottleneck for your products? And which products are the most challenging for you to ramp at the moment? No. I mean, as Thompson mentioned on our last earnings call, and then the situation hasn't changed. I mean, we've secured supply out into next year. So we're not currently limited by substrate capacity. And we've had a lot of discussions with substrate suppliers going back into last year and continuing even until 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. So 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. Yeah. I think the especially right now AOI, we just move into a four inches substrate volume manufacturer.

41:21 As I mentioned, we already had two supplier in Europe, two supplier in Japan, plus three supplier in China. So 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 is the capacity AOI we increase in the next few years. Let me say that, it's much, much more than a factor of 10, okay, to especially for the CPO laser market. So I would say right now, we're in our inventory, we're enough supply until end of next year. But what we are looking for is the I would say, the volume we will need in, I would say, 2028, 2029.

42:14 That's why we are very careful and very aggressive to working with all the suppliers for expansion. Great. Really helpful. And 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 six 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? No, think we have pretty broad based interest among customers. I think as Thompson mentioned, 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.

43:14 So 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. But we're trying to be careful in what we we definitely don't want to overpromise what we can actually deliver. So we're being appropriately circumspecting for that. And let me say we always say, I think as of today, AAOI will be the fourth supplier qualified by one big hyperscale datacenter customer for 1.6 terabyte transceiver. And right now, I think that we will finish most of the qualification, only in the late stage, we should be I think it should be finished within maybe, I would say, three weeks.

44:04 So we're start to deliver, I would say, by end of this quarter. And as you know, right now, we have more than $200,000,000 order in hand. So I would say right now, our target is to finish all the order by sometime in Q2. How much we can deliver in Q4 is I would say yes, I think good news we have already. At the same time, we are working very close with our DSP and TIS supplier. But even so, we still believe we can deliver more than, I would say, 17,000,000 of revenue in Q4 for 1.6 terabyte transceiver. For sure, customer 100 So right now, we are doing everything to speed up. So I think one of the big concern in Q4 for 1.6 terabyte transceiver is the material supply. I think capacity should be already, I would say, within, I would say, two, three weeks.

45:05 But the overall demand is very big. Right now, I think overall, based on the customer feedback, The volume that talking about is more than 500,000 transceiver per month by end of next year. So then you talk about how much money per month. I would say, 300,000,000 to $350,000,000 But as I said, we are working vehicle with customer based on their schedule. We don't want to overpromise and we don't want to be careful, especially in quality is very important, especially in most of expansion in U. S. It take times. But I just say the demand so big, right now, not only the I would say the overall industry may so big because AI, the other for sure is U. S. Manufacturer.

45:56 That's very important factor for the customer. Okay? Right. Yes. Thanks so much. And our next question will come from Michael Genovese with Rosenblatt. Please go ahead. 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, but there has been a push out this year into 4Q. So could you just give us a little bit more color on the challenges of ramping up capacity that were like different than what you expected three months ago and that clearly are going get keep getting better as we go forward. But what are some of these specific challenges where 800 gs, for instance, wasn't quite as big as you thought it would be in 2Q?

46:46 Right now, let me say that, okay. As I mentioned, because of memory issues, okay. So the Q3, I think we lose about 20,000,000 to $25,000,000 of revenue for 100 gs single mode transceiver. In Q4, I think based on air capacity, we should able to deliver, I would say, more than $500,000,000 of revenue, okay? So you can see how big our goals will be. It's like 60% of growth from Q3 to Q4. But right now, the big challenge, as I say, is the DSP and TIA, okay? For 800 gs, a 1.6 gs transceiver. And that's why we are working very close with the supply. For SPAY 1.6 T, I've seen the whole supply chain is very tight.

47:35 But good news is that in the supply put AOI as a fourth priority and it's long term partnership. So we almost have very close discussion with all the key supplier almost every week or twice a week. Okay. Perfect. That's very helpful. AAOI is much better than other competitor. We got the other competitors. Their number one issue is not DSPs at this, and we don't have this problem. Okay? Because AAOI making our own nasal. And that's why the customer come to AAOI, especially with our aggressive expansion plan in the next few years. Now, this is under in green PO, including ESP, right now we already have about five customers.

48:25 They will come up some kind of very aggressive demand for the next three, four years. And that's why our CapEx is so big, because as I said, if I promise any customer the laser like Q3, Q4 twenty twenty eight, I need to start to spend the money by equipment, by the beauty and beauty equipment. And that's the reason our CapEx is increased so fast. 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?

49:12 The gross margin for sure will be we're still better. But because we needed to pay some extra tax fee for some key supplier, I would say be I would say, I don't know, 32%, 33%. The most important is how much is the 1.60 because it's high gross margin product. The more we deliver for 1.60, the higher gross margin it will be. For sure, by Q3, Q4 next year, when we still deliver the CPO laser or ESFP module for to different customer, the gross margin will be even higher because the gross margin for this is about 55% to 65%.

49:57 For ESAP, the gross margin should be more than 50%. But this is more like Q3, Q4 next year. But in the short term, the gross margin improvement for sure, the most important factor is the percentage of 1.6 terabyte transceiver because of gross margin is very good. So that's why I say, it will start to improve When we start ramping the revenue of 1.6 terabyte transceiver in Q3, especially Q1 next year. As I said right now, even customer won everything in Q4, but right now, while we can commit maybe, I would say, 70,000,000 to $80,000,000 in Q4, not because of capacity, because I would say, material constraint. Q4 should be much better Q1 next year should be much better.

50:46 Okay. If we double our net price therefore Q1 revenue. Not for overall revenue for 1.6 terabyte transceiver revenue, Q1 next year will be double Q4 or more than double. That's our topic right now. Okay. Final question for me to just kind of follow-up on what you said about CPO. I don't think that all the investors kind of know exactly that you're in the CPO market or necessarily have high expectations for you guys in CPO. So any kind of additional update in terms of 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.

51:33 Come on. AAOI is a laser company since day one, okay? Maybe AAOI compared to other supplier in US, AOI is a pure laser supplier since day one since 1997. This is our major technology, the core technology. We have been working very close with at least five customers. But if you took on really high volume, manufacture, I would say more like Q3 next years. As you can see right now, we are adding a lot more CBD, E B, Stapr, everything in Houston. We even have a 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, but that's not enough. So that's why we are building a quinolone of the second fab in Houston area.

52:39 The size will be about four times of the current facility. Just give you some rough idea how aggressive is our extended brand. But let me say, even though they're not good enough for the customer demand in the next few years. So we are still working very hard to expand our laser, including the manufacturer of ESAP module based on customer demand. Mike, if I can just interject there. I mean, 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.

53:28 And then as we expand the fab, like Thompson mentioned, then we'll have more capacity for the ELSFP, for the CPO type laser. So it's not 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. But we just can't make enough of it and still manufacture enough lasers for our transceivers, which has to be the priority. So again, it's all about the same story as we had on the transceiver side of things, it's all about our ability to add capacity, and Thompson just outlined kind of our plans that. I think the investor maybe can understand. AAOI has been working on high power laser, I would say six, seven years ago for LiDAR. The nine way demand is very even much higher than CPO laser.

54:19 And that's why it's not tough for AI to get into CPO laser market. So right now, I would say for thirteen ten CPO laser and ESP, we several customers have qualified AOI. But the focus, as I said, is a DWDM. And right now, this is what customer really want to focus because they'd be very changed. For DWDM, CPO laser and CPO module, like we call it EOSAP, I would believe only few companies in 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 like AOI, momentum, cohesion. Okay?

55:09 So I think that's very important. And that's the additional is your capacity. Let me sneak in one more quick question. I'm sorry to interrupt, but did you think how far away do you think the Chinese are from having three fifty milliwatt lasers? And do you think they'll ever have them? Or how many years away do you think they might be from having CPO lasers out of China? You're talking about reasonable year and no quality issue or pro form a issue, I would say easily at least two, three years or even longer. I should let somebody else ask a question. Thanks so much. That was great. And Stefan, thank you. All right. Thank you. And this will conclude our question and answer session.

55:56 I'd like to turn the call back over to Doctor. Thompson Lin for any closing remarks. Okay. And 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 the fundamental driver of long term demand for our business remains robust and we are in a position to drive value for our risk opportunity. We look forward to seeing many of you at upcoming investor conference. Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.