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Applied Optoelectronics Vendor

Summary Report
July 11, 2023

Vendor Summary Reports examine recent quarterly results and items of interest about key vendors in
the optical market. Occasionally we also write in-depth profiles of companies that we think are
interesting. This vendor report covers Applied Optoelectronicsʼ 1Q23 results reported Jun 13, 2023.
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Founded in 1997 with its US headquarters in Sugar Land, Texas, Applied Optoelectronics (AOI) is one

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Founded in 1997 with its US headquarters in Sugar Land, Texas, Applied Optoelectronics (AOI) is one
of very few optical component makers with its own US-based manufacturing capabilities. With
quarterly revenues of around $50 million, AOI is dwarfed by North American competitors Coherent
($1.2 billion) and Lumentum ($380 million) but the company has managed to carve out a successful
niche for itself in the datacom and telecom optical components market.

AOI recently made news with the announcement last September of its intention to sell its Chinese
manufacturing facilities and the revelation in its recent 8K filing that Microso� has tagged the
company to develop datacenter lasers to Microso�ʼs specifications.

In this report, we cover:

• AOIʼs Product Mix: What the company makes, primarily in the datacenter and MSO markets.
• AOIʼs Vertical Integration: How owning its own manufacturing, especially its US manufacturing
facility, sets AOI apart.
• Sale of Chinese Manufacturing: The reasons behind AOIʼs decision to sell its PRC-based
manufacturing and path forward.
• Microso� Partnership: What is included, why Microso� chose AOI, and why AOI sees this
partnership as validation of its high-yield, US-based VCSEL manufacturing process.
• CHIPS Act: The companyʼs plans with regard to the US CHIPS Act.
• Quarterly Results: How AOI fared in 1Q23 overall and in the optical components areas included in
Cignal AIʼs reports.

Product Mix
Much of AOIʼs strength lies in the CATV/MSO market, which accounts for about half of its revenue.
Despite the company name, not all of its products are optical, including electrical amplifiers for the
CATV market. The company has an Atlanta location, which has been advantageous for talent
acquisition in this area as Cisco has wound down its former Scientific Atlanta location.

On the optical side, AOI manufactures DFB lasers designed for the broadband MSO market, mostly
O-band (1310nm), but with some C-band and CWDM o�erings as well. AOI has optical components
designed to enable cable companies upgrade to DOCSIS 4.0 and 1.8GHz operation. Cable companies
are just starting these upgrades, and AOI is well-positioned to benefit, as the competitive market is
much smaller than it was a decade ago with CommScope as the main supplier remaining (no more
Scientific Atlanta or Arris).

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In addition, AOI o�ers DML lasers for telecom and datacom applications and sells datacom

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transceivers at 100GbE, 200GbE, and (recently added) 400GbE rates. In Q1, 78% of corporate datacom
revenue came from 100Gbps products, with 6% from 40Gbps and 8% from 200 and 400Gbps products.

Source: AOI 1Q23 Investor Presentation

Vertical Integration
AOI is, at the moment (see Sale of Chinese Manufacturing below), a fully vertically integrated
company. AOI owns manufacturing facilities in Texas, China (PRC), and Taiwan, where the company
performs a full range of functions from wafer fabrication to device manufacturing to transceiver
assembly. The companyʼs investor presentation lists molecular beam epitaxy (MBE), Metal-Organic
Chemical Vapor Deposition (MOCVD), proprietary Silicon Photonics capability, significant automation,
and “Light Engine Assembly” among its internal capabilities.

The company sees its vertical integration as a competitive advantage, allowing it to keep costs low
and respond quickly to unique customer demands. AOI includes customer NRE (funds provided for
specific product development) as a key source of income enabled by its vertical integration.

AOIʼs Texas facility has the capability to produce about 1.5 million lasers per month when at full 
capacity. That amount will increase to 2.5-3 million per month a�er the company transitions to a

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capacity. That amount will increase to 2.5-3 million per month a�er the company transitions to a
4-inch wafer process (see Microso� below). Those numbers are maximum capacity, which is rarely
met as production lines are tweaked and maintained, but they demonstrate a capability to meet
current and near-future demands with existing US-based facilities.

Source: AOI 1Q23 Investor Presentation

Sale of Chinese Manufacturing

In September 2022, AOI announced its intention to sell its manufacturing facilities in China to Yuhan
Optoelectronic Technology (YOT) for $150 million, less a holdback amount. AOI will retain its laser
portfolio and manufacturing sites in Texas and Taiwan. There are two main reasons for the sale: (1)
eliminating the remaining PRC component of the company and (2) focusing on the area (lasers) where
AOI has a compelling advantage.

AOIʼs competitive advantage is in its semiconductor fab, not in the assembly of components, which is
the focus of the PRC location. By divesting from the assembly fab, AOI will no longer need to invest in
that part of the process and can instead focus on upgrading its laser capabilities. Also, by eliminating
its remaining manufacturing in China, AOI will not have to cope with increasing and unpredictable
tari� and trade pressures between China and Western countries, eliminating a challenge that a
company of AOIs size is likely ill-equipped to deal with long-term.

AOI will retain the ability to manufacture AOCs (see the Microso� agreement below) in its Taiwan and
Texas facilities. AOI also expects to continue to use the YOT manufacturing capability for its CATV
products, about 80% of which are manufactured in PRC. The other 20% are manufactured in Taiwan,
and AOI could expand that capability if needed in the future. YOT will use the PRC manufacturing
facilities to make datacenter transceiver products, and AOI expects that YOT will continue to use the
AOI laser produced in Texas and Taiwan in those products. 

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AOI plans to use the proceeds from the sale to service its outstanding debt, which is currently around
$130 million, and invest in business expansion. The deal is scheduled to close in 2023 or early 2024,
pending regulatory approval in the US and China.

There is risk in AOIʼs divestiture decision. If other companies with deeper pockets can match AOIʼs
laser manufacturing capabilities, perhaps at a lower price or with more long-term security, then AOIʼs
remaining value will disappear. The company sees its agreement with Microso� as validation that its
unique capabilities and US facilities have long-term value.

Microso� Partnership
In an 8-K filing produced before releasing its 1Q23 results, AOI revealed that it had signed a
development deal with Microso� to make lasers for datacenter applications. AOIʼs manufacturing in
the US was critical to the dealʼs success.

Due to political tensions and recent supply chain issues, Microso� is looking to diversify its supplier
base with a specific focus on moving manufacturing out of China. Microso�, which has been an AOI
customer for 10 years, was looking for a partner to develop VCSEL-based active optical cables (AOCs)
for datacenter and AI applications at 400G and 800G. The original agreement with AOI, inked in
December, was just for the lasers. The agreement now includes manufacturing of the cables
themselves.

What did AOI bring to the table that its much larger competitors did not? First and foremost, AOI has
US-based manufacturing capabilities. With some NRE investment from Microso�, AOIʼs Texas plant
can crank out lasers in the US at rates that meet Microso�ʼs needs. Second, AOI claims to have a
manufacturing process that increases the yield of its laser chips.

All semiconductor lasers for Datacom are made of the same materials using the same basic designs.
Those designs are more complex at higher speeds (400/800Gbps), limiting the number of fabs that can
build these sophisticated designs, but the structure of lasers is similar across manufacturers. For
short-distance lasers like VCSELs, di�erentiation comes primarily from cost. And the primary driver of
cost is yield – how many working lasers can be made from one semiconductor wafer. AOI views the
Microso� agreement as proof of its claims that its VCSEL process for 400/800G has a superior yield
that will lead to lower overall costs for AOCs.

The NRE from Microso� will allow AOI to move from a 2-inch wafer process to a 4-inch wafer process.
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Larger wafers can yield more devices per manufacturing run, but they require all the equipment in the

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manufacturing line (lithography, epitaxy, ion implantation, etc.) to be upgraded to a larger size. With
the investment from Microso�, AOI is in the process of making those upgrades to its Texas facility.
Microso� has pledged $4 million for this NRE tranche, and AOI has reported that $3 million has been
paid to date.

AOI said on its latest earnings call that the new product development will take several quarters to
complete but the company believes that the upgrade will lead to long-term improvement in
capabilities and a unique position for the companyʼs US-based manufacturing.

CHIPS Act
One would imagine that, as a semiconductor manufacturer in the US, AOI is a prime candidate for
CHIPS Act funding, which is designed to boost domestic semiconductor manufacturing capabilities.
However, AOI maintains some skepticism, as the CHIPS Act investments are aimed at much larger
companies.

Under the CHIPS Act, the federal government provides 10-15% of the cost of building or expanding
semiconductor manufacturing capabilities, but that investment comes with regulatory strings
attached. Those strings would be a small part of the 10-15% investment for a billion-dollar company,
but they may outweigh the benefits for a company like AOI that will be making incremental upgrades
to its capabilities that would likely not total more than $20-30 million.

What AOI is excited about in the CHIPS Act is the 25% refundable tax credit for building US
manufacturing capabilities. AOI has not made any decisions or public statements on the CHIPS Act
overall but will certainly be taking advantage of this benefit of the law.

Quarterly Results
AOIʼs optical components revenue and high-speed datacom transceiver shipments are reported in
Cignal AIʼs Optical Components Report.

• AOIʼs MSO and telecom laser revenue is counted as Telecom component revenue and AOIʼs
transceiver and datacom laser revenue is reported as Datacom revenue.
• AOIʼs datacom optical component revenue is all optical while AOIʼs telecom optical revenue is
about 10% of the total telecom business, which is why AOIʼs public revenue ($53 million) does not
match the revenue reported in Cignal AIʼs reports ($24 million).

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AOI optical components revenue reported in Cignal AIʼs 1Q23 Optical Components Report

• On its quarterly investor call, AOI reported revenue of $53 million, up 2% YoY.
• The optical components data counted by Cignal AI (which does not include, for example,
electrical power amplifiers for MSOs) was down -10% YoY. The smaller Telecom segment (15% of
optical components revenue) was down more than -30% YoY.
• AOI stated that the company has exited several low-profit legacy products, shi�ed R&D away from
low-margin projects, and has actually increased prices with some customers to improve gross
margins.
• The inventory absorption problems experienced by the rest of the optical components industry
have also shown up at AOI. CEO Thompson Lin said on the quarterly earnings call, “Recently we
were notified of some inventory build-up with certain CATV customers which we expect will
negatively impact our Q2 revenue.” Note that optical components are a small part (about 10%) of
AOIʼs MSO revenue.
• AOIʼs QoQ revenues were down -27% compared to a record Q4. The company blames the QoQ
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reduction primarily on the Lunar New Year in China. One would imagine that the renewed

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company focus outside of the PRC will help to eliminate these dips in the future.

Conclusions
AOI is uniquely positioned within the optical components market as a relatively small and nimble
company with US-based manufacturing capability. This capability – along with AOIʼs high-yield VCSEL
process – led to the recent win at Microso�, which validates the companyʼs vertically integrated
strategy. Also, AOIʼs focus on the MSO market, where competition is now more limited, should pay o�
over the next few years.

Concerns about AOI center mostly around its size. With the recent consolidation in the optical
components business, the behemoths Lumentum and Coherent, not to mention Chinese competitors
Innolight, Accelink, Eoptolink, and others, dwarf AOI. While being a niche player with unique
capabilities (e.g., its North American MBE fab) opens doors for AOI, the competition could pivot in its
direction and damage its advantages. However, building successful semiconductor manufacturing,
especially in North America, takes significant capital investment and expertise, and AOI should be
able to retain its unique charms for years to come. Whether or not those charms remain part of a small
company or are absorbed into a larger one is yet to be seen.

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