Applied Optoelectronics earnings dumper, pain now for gain later?

Applied Optoelectronics Inc. NASDAQ: AAOI is a leader in fiber-optic networking products. The company designs and manufactures advanced fiber optic products, components and modules used in cable broadband networks, telecommunications, fiber-to-home deployments and data centers. High-speed optical transceivers are required at data centers to transmit oceans of data needed to operate artificial intelligence (AI) platforms and high-performance computing (HPC). Applied is a benefactor of secular tailwinds in the data center market.

Surging Secular Tailwinds

Data centers are seeing a growth spurt due to secular tailwinds, including growth in AI platforms, digital transformation, internet-of-things (IoT) and cloud computing. Applied shares have surged over 365% in the trailing twelve months on its deal with Microsoft Co. NASDAQ: MSFT to supply optical equipment to update its data centers. The deal was supposed to generate hundreds of millions in revenue. However, Applied's shares collapsed more than 30% on its Q4 2023 earnings report, where it significantly lowered Q1 2023 guidance estimates.

Modest Earnings Beat

The computer and technology sector company surprised analysts and investors with its lowered guidance estimates. Its Q4 2023 earnings report beat EPS estimates by 4 cents, coming in at 4 cents versus consensus analyst estimates for a breakeven quarter. Revenues fell 3.2% YoY to $60.5 million, falling short of the $65.19 million consensus estimates. Gross margin improvements enabled the company to generate a small non-GAAP net income for the quarter for the first time in several years. While Q4 revenues came in below expectations, gross margins outperformed projections, generating non-GAAP EPS at the high end of its guidance range.

Big Stinker Guidance

The big shocker came on its Q1 2024 downside guidance for EPS losses of 33 cents to 22 cents versus analyst estimates for a loss of 1 cent. Revenues were revised lower between $41 million to $46 million versus consensus estimates of $66.18 million.

Blame it on the Lunar New Year

Applied CFO Stefan Murray pointed out that the majority of the Q1 2024 guidance cut centered around the Chinese Lunar New Year and some price reductions. The Lunar New Year is a 15-day holiday starting on February 10, 2024. He commented, "A lot of these products are made in our China facility, and so the mix of those products shifted a little bit unexpectedly on us towards the end of last year, which resulted in having to make new products essentially that we hadn't necessarily planned for in advance and that's why the Lunar New Year caught us a little bit unprepared this year." The company expects a substantial improvement in Q2 2024.

CEO Insights

Applied Optoelectronics founder and CEO Dr. Thompson Lin commented how they began to see softness in demand late in Q4 2023. The company still delivered non-GAAP gross margins of 36.4%, which was the highest quarterly gross margin seen in the past five years. This was driven by an improved product mix and contribution from non-recurring engineering projects. Total revenues for its data center products more than doubled YoY to $44.5 million but fell 9% sequentially.

Its 400 G product sales rose 8X in the same period. However, total revenues for its CATV segment tanked 67% YoY to $12.6 million. The company is seeing traction for its 400G and 800G products from several new data center customers. Dr. Lin commented during the Q&A session of the conference call, "We have said we have delivered 800G samples to three new hyperscale data centers in the U.S., And we believe the volume will start to build up by, I would say, end of Q2 or early Q3. Same thing, I think we believe that Q2 to 400G may be very strong."

Microsoft Revenues are Not Guaranteed

Applied CFO Stefan Murray commented on how they signed two agreements with Microsoft to develop next-gen lasers for its data centers, for 400G and beyond and next-gen active optical cable (AOC). While not guaranteed, the contracts "suggest that revenue from these products may exceed $300 million over the several years of these build-outs."

Analyst Downgrade

B.Riley Securities analyst Dennis Kang downgraded shares to a Neutral from Buy, lowering its price target to $16 from $22. He specifically noted that the delay in Microsoft's ramp being slower than expected and stepping up the terms of its 400G AOC procurement is worrisome. He noted, "A company the size of MSFT should be consuming millions and millions of AOCs and other optical modules, especially since MSFT has been one of the early adopters of AI. At this point, there seem to be more questions than answers regarding MSFT's relationship with AAOI."

Applied Optoelectronics analyst ratings and price targets are at MarketBeat. Applied Optoelectronics peers and competitor stocks can be found with the MarketBeat stock screener.

 Daily cup pattern

The daily candlestick chart on AAOI shows a cup pattern breakdown. The cup lip line formed at $23.95 on December 15, 2023. AAOI proceeded to sell off to $14.80 lows on January 29, 2024. AAOI formed a rounding bottom to steadily make its way back up to the cup lip line, overshooting it to $24.75 by February 16, 2024. A handle appeared to be forming on the pullback to $18.48 until its Q4 2023 earnings report caused a 30% gap down on forward guidance. AAOL formed the gap down at $14.68. The daily relative strength index (RSI) fell through the 40-band. The daily 200-period moving average (MA) support lies at $11.43. Pullback support levels are at $12.66, $11.31, $9.51 and $8.36.