for those of you who listened to the AGM, you’ll recall that on more than one occasion Suresh and David indicated others are feeling the pain with respect to product margins.  IMO, this article from SA provides a real example of the pain they are talking about.  If nothing else, take note of the numbered list (my bold for emphasis), which pretty much sums up what Suresh et al expect (hope) to address with the platform they are constructing.  IMO, successful products based on the OI platform will be very good news for some and extremely bad news for others.  Of course, they must deliver!

Applied Optoelectronics: Not Out Of The Woods Yet

Business QuantOct. 5, 2019 7:56 PM ET

• Shares of Applied Optoelectronics have collapsed by 65% over the past year, but the downtrend may still continue.
• Analysts have been lowering their EPS forecasts for the company.
• Although Applied has a few growth opportunities, its risk factors seem to be more significant and prominent.
• Shares of Applied Optoelectronics (AAOI) are down by about 65% over the past year alone, but the downtrend could still continue. Unfortunately, for its long-side investors at least, the company is still surrounded by a number of risk factors, its shares are seemingly overvalued compared to other semiconductor stocks, and the company is lacking material growth catalysts.

Opportunities

I’ve explained in my past articles that it’s vitally important for Applied Optoelectronics to diversify its operations. Its management has been struggling to grow sales in their largest datacenter segment due to a hyper-competitive industry and sluggish market environment. So, it makes sense for them to focus on other segments. This would open up new growth avenues for the company and reduce its reliance on one single segment. It seems like Applied’s management is trying to do exactly that.

Applied Optoelectronics started volume shipments of its Remote PHY products back in Q4 FY18. Their initial sales volume wasn’t enough to impact the sales of its parent segment, CATV systems, by a meaningful amount. However, Applied’s management noted during the Q2 earnings call that they are expecting significant order wins for their Remote PHY products. From the Q2 FY19 earnings call:

“We believe that our Remote PHY product is a key enabling technologies for these new distributed access networks and we are excited about the customer interest in Remote PHY. We expect to receive our first significant orders for our Remote PHY product soon.”

It remains to be seen how big of a revenue driver these Remote PHY products exactly turn out to be. Applied's management hasn’t disclosed the sales contribution of these new products, but I believe Remote PHY can quickly start to account for a meaningful portion of its CATV segment’s revenue as the segment itself isn’t very huge.  So, investors should look out for this growth driver.

Secondly, Cisco (NASDAQ:CSCO) decided to acquire Acacia Communications in July earlier this year. This can result in a shakeup among customers of the joint entity. My guess is that some of its customers would want to reduce their reliance on one single networking hardware vendor and add others, such as Applied Optoelectronics, to the mix.

Thomas Fallon of Infinera, another networking hardware company, shed light on this very dynamic during their Q2 FY19 earnings call:

“We have been approached in regard to our ICE6 by some people who I think maybe in conjunction with this Acacia, Cisco announcement are now interested in diversifying and working with other suppliers.”

Granted these aren’t seemingly huge growth drivers that can potentially double or triple Applied’s sales down the line, but its shares have been beaten down by so much that it won't take much to reverse the trend. Even a hint of positivity could send its shares soaring. Also, it’s very much possible that one of the larger networking companies (Arista (NYSE:ANET)?) may consider acquiring Applied to better compete with Cisco. So, readers and investors may want to keep an eye out on the above-mentioned growth catalysts.

Risks

But with that said, it seems like the Street is forecasting Applied Optoelectronics’ sluggish performance to continue going forward as well. Analysts have been lowering their EPS forecasts for the company over the past few weeks. The reduction isn't much, but it just goes to highlight that Applied’s financial performance hasn’t bottomed out yet.

Applied’s management has been undertaking a slew of cost-cutting measures to keep up with the hyper competitive market environment. So, a reduction in its EPS forecasts is an important development. It highlights the Street’s view on how Applied may continue to be margin challenged in the coming quarters.

This isn’t surprising actually. The entire sector isn’t doing very well, largely because:

1. Optical transceiver manufacturers have been undercutting each other in a bid to win market share. This has hurt the larger players and crippled the smaller ones over the past two years.
2. Sluggish demand from Chinese customers (as noted by Applied Opto’s management).
3. Rivaling Silicon Photonics-based offerings pose a threat to the entire industry. We don’t know how much market share manufacturers of this new tech have gained over the past year.

While I continue to believe that Applied Optoelectronics houses a competitive think tank, I also believe that its management needs to do more to deliver sustainable financial growth.  The industry-wide transition to 400G transceivers isn't here yet and so the company needs positive catalysts to kick start its growth engine in the meantime. This could be achieved by way of targeting CATV and Telecom customers more aggressively, or introducing new 100G products to win new customers until 400G becomes the mainstream standard.

Besides, its valuation seems to be a risk factor at the current levels. Applied Optoelectronics is trading at a premium compared to some of the other names in the semiconductor space, in spite of its shares collapsing by about 65% over the last year. So, its shares may not be done falling yet.

Final Takeaway

Applied Optoelectronics does have opportunities ahead of it, but its gains from these catalysts seem to be limited. Also, there's no telling if any major networking companies would actually be interested in acquiring Applied, so counting on it is akin to gambling.  On the other hand, the stock seems pricey even after collapsing 65% over the past year. Its operational and financial performance has been underwhelming, and analysts are lowering their EPS forecasts for the overall company.  All this casts doubt on its future prospects and its growth catalysts. So, I'm led to suggest that Applied Optoelectronics is still a risky bet. Its shares may offer hope, but not tangible growth, at least as per its current state of affairs.

https://seekingalpha.com/article/4295229-applied-optoelectronics-woods-yet?ifp=0