Applied Optoelectronics(AAOI) - 2019 Q1 - Quarterly Report

Part I. Financial Information This section presents the unaudited condensed consolidated financial statements and related notes for Applied Optoelectronics, Inc. for the quarter ended March 31, 2019 Item 1. Condensed Consolidated Financial Statements (Unaudited) This section provides the unaudited condensed consolidated financial statements, including balance sheets, statements of operations, comprehensive income, stockholders' equity, and cash flows, with detailed explanatory notes Condensed Consolidated Balance Sheets The balance sheet shows a slight increase in total assets and liabilities from December 31, 2018, to March 31, 2019, primarily driven by an increase in cash and cash equivalents and the introduction of convertible senior notes | Metric (in thousands) | March 31, 2019 | December 31, 2018 | | :-------------------- | :------------- | :---------------- | | Total Assets | $491,205 | $466,840 | | Total Liabilities | $167,587 | $137,746 | | Total Stockholders' Equity | $323,618 | $329,094 | - Cash and cash equivalents increased from $55,646 thousand to $74,930 thousand[7] - Convertible senior notes of $76,439 thousand were recognized as a new liability as of March 31, 2019[7] Condensed Consolidated Statements of Operations The company reported a net loss of $10.474 million for the three months ended March 31, 2019, a significant decline from a net income of $2.120 million in the prior-year period, primarily due to decreased revenue and gross profit, and increased operating expenses and interest expense | Metric (in thousands, except per share data) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :------------------------------------------- | :-------------------------------- | :-------------------------------- | | Revenue, net | $52,719 | $65,239 | | Gross profit | $12,351 | $25,836 | | Income (loss) from operations | $(11,869) | $2,170 | | Net income (loss) | $(10,474) | $2,120 | | Basic Net income (loss) per share | $(0.53) | $0.11 | | Diluted Net income (loss) per share | $(0.53) | $0.11 | - Revenue decreased by 19.2% year-over-year[10] - Gross profit decreased by 52.2% year-over-year[10] Condensed Consolidated Statements of Comprehensive Income (Loss) The company reported a comprehensive loss of $8.126 million for the three months ended March 31, 2019, compared to a comprehensive income of $8.455 million in the prior-year period, primarily driven by the net loss and a lower gain on foreign currency translation adjustment | Metric (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :-------------------- | :-------------------------------- | :-------------------------------- | | Net income (loss) | $(10,474) | $2,120 | | Gain on foreign currency translation adjustment | $2,348 | $6,335 | | Comprehensive income (loss) | $(8,126) | $8,455 | Condensed Consolidated Statements of Stockholders' Equity Total stockholders' equity decreased from $329.094 million at January 1, 2019, to $323.618 million at March 31, 2019, mainly due to the net loss incurred during the period, partially offset by share-based compensation and foreign currency translation adjustments | Metric (in thousands) | January 1, 2019 | March 31, 2019 | | :-------------------- | :-------------- | :------------- | | Total Stockholders' Equity | $329,094 | $323,618 | | Net Loss | — | $(10,474) | | Share-based compensation | — | $2,942 | | Foreign currency translation adjustment | — | $2,348 | Condensed Consolidated Statements of Cash Flows For the three months ended March 31, 2019, the company generated $40 thousand in cash from operating activities, used $9.035 million in investing activities, and provided $28.019 million from financing activities, resulting in a net increase in cash, cash equivalents, and restricted cash of $19.455 million | Metric (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :-------------------- | :-------------------------------- | :-------------------------------- | | Net cash provided by (used in) operating activities | $40 | $(4,064) | | Net cash used in investing activities | $(9,035) | $(12,220) | | Net cash provided by financing activities | $28,019 | $14,576 | | Net increase (decrease) in cash, cash equivalents and restricted cash | $19,455 | $(649) | - Financing activities were significantly boosted by $76.378 million from the issuance of convertible senior notes in 2019[17] Notes to Condensed Consolidated Financial Statements (Unaudited) This section provides detailed disclosures and explanations for the financial statements, covering accounting policies, revenue, leases, debt, equity, and other financial details Note 1. Description of Business Applied Optoelectronics, Inc. is a vertically integrated provider of fiber-optic networking products for internet data centers, cable television (CATV), telecommunications, and fiber-to-the-home (FTTH) markets, with manufacturing and R&D facilities in the U.S., Taiwan, and China - AOI is a leading, vertically integrated provider of fiber-optic networking products[19] - Key end-markets include internet data center, cable television, telecommunications, and fiber-to-the-home[19] - Manufacturing and R&D facilities are located in the U.S. (Sugar Land, TX; Duluth, GA), Taiwan (Taipei), and China (Ningbo)[20] Note 2. Significant Accounting Policies The company adopted new accounting standards for leases (ASC 842) and nonemployee share-based payment accounting (ASU 2018-07) on January 1, 2019. The lease standard materially impacted the balance sheet by recognizing ROU assets and lease liabilities, while the share-based payment standard had no impact on financial statements. A new standard on credit losses (ASU 2016-13) is not expected to have a material impact upon adoption in 2019 - Adopted ASU 2016-02, Leases (ASC 842) on January 1, 2019, recognizing ROU assets and lease liabilities on the balance sheet, particularly for its Taiwan branch[24] - Adopted ASU 2018-07, Compensation-Stock Compensation, on January 1, 2019, with no impact on consolidated financial statements[25] - ASU 2016-13, Financial Instruments - Credit Losses, effective after December 15, 2019, is not expected to have a material impact[26] Note 3. Revenue Recognition Revenue is recognized when performance obligations are satisfied, typically at the point of product or service transfer. For the three months ended March 31, 2019, total revenue was $52.719 million, with Data Center revenue comprising 73.0% and CATV 22.7%. Data Center revenue decreased significantly year-over-year, while CATV revenue increased - Revenue is recognized when obligations under a contract are satisfied, generally upon transfer of control of products or services[27] Revenue by Product Category (in thousands) | Product Category | Three months ended March 31, 2019 (in thousands) | % of Total Revenue (2019) | Three months ended March 31, 2018 (in thousands) | % of Total Revenue (2018) | | :--------------- | :--------------------------------------------- | :------------------------ | :--------------------------------------------- | :------------------------ | | Data Center | $38,499 | 73.0% | $50,583 | 77.5% | | CATV | $11,962 | 22.7% | $10,568 | 16.2% | | Telecom | $1,738 | 3.3% | $3,586 | 5.5% | | FTTH | $94 | 0.2% | $111 | 0.2% | | Other | $426 | 0.8% | $391 | 0.6% | | Total Revenue | $52,719 | 100.0% | $65,239 | 100.0% | Note 4. Operating Leases The company leases various facilities and equipment under non-cancelable operating leases, recognizing ROU assets and lease liabilities. Total lease expense for the three months ended March 31, 2019, was $352 thousand, with a weighted average remaining lease term of 9.81 years and a discount rate of 3.17% - The company leases manufacturing facilities, R&D offices, storage facilities, apartments, machinery, office equipment, and vehicles under operating leases[30] Lease Expense (in thousands) | Lease Expense (in thousands) | Three months ended March 31, 2019 | | :--------------------------- | :-------------------------------- | | Operating lease expense | $323 | | Short Term lease expense | $29 | | Total lease expense | $352 | Lease Metrics | Metric | March 31, 2019 | | :------------------------------------ | :------------- | | Weighted Average Remaining Lease Term (Years) | 9.81 | | Weighted Average Discount Rate | 3.17% | Note 5. Cash, Cash Equivalents and Restricted Cash As of March 31, 2019, the company's total cash, cash equivalents, and restricted cash amounted to $77.459 million, an increase from $58.004 million at December 31, 2018. Restricted cash primarily includes guarantee deposits for customs duties and compensating balances for credit facilities Cash, Cash Equivalents and Restricted Cash (in thousands) | Metric (in thousands) | March 31, 2019 | December 31, 2018 | | :-------------------- | :------------- | :---------------- | | Cash and cash equivalents | $74,930 | $55,646 | | Restricted cash | $2,529 | $2,358 | | Total cash, cash equivalents and restricted cash | $77,459 | $58,004 | - Restricted cash includes guarantee deposits for customs duties and compensating balances for credit facilities[37] Note 6. Earnings Per Share For the three months ended March 31, 2019, basic and diluted net loss per share were both $(0.53), compared to basic and diluted net income per share of $0.11 in the prior-year period. Potentially dilutive securities, including employee stock options, restricted stock units, and shares for convertible senior notes, were excluded from diluted EPS in 2019 as their effect would have been anti-dilutive due to the net loss Earnings Per Share Data (in thousands, except per share amounts) | Metric (in thousands, except per share amounts) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :---------------------------------------------- | :-------------------------------- | :-------------------------------- | | Net income (loss) | $(10,474) | $2,120 | | Basic weighted average shares | 19,863 | 19,492 | | Diluted weighted average shares | 19,863 | 19,989 | | Basic Net income (loss) per share | $(0.53) | $0.11 | | Diluted Net income (loss) per share | $(0.53) | $0.11 | Antidilutive Securities (in thousands) | Antidilutive Securities (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :------------------------------------- | :-------------------------------- | :-------------------------------- | | Employee stock options | 93 | — | | Restricted stock units | 10 | — | | Shares for convertible senior notes | 4,587 | — | | Total antidilutive shares | 4,690 | — | Note 7. Inventories Total inventory, net of write-downs, decreased to $84.464 million as of March 31, 2019, from $93.256 million at December 31, 2018. The inventory write-down expense for the three months ended March 31, 2019, was $2.3 million, an increase from $0.9 million in the prior-year period Inventory by Category (in thousands) | Inventory Category (in thousands) | March 31, 2019 | December 31, 2018 | | :-------------------------------- | :------------- | :---------------- | | Raw materials | $27,473 | $30,214 | | Work in process and sub-assemblies | $53,642 | $49,192 | | Finished goods | $3,349 | $13,850 | | Total inventory | $84,464 | $93,256 | - Inventory write-down expense increased from $0.9 million in Q1 2018 to $2.3 million in Q1 2019[42] Note 8. Property, Plant & Equipment Net property, plant, and equipment increased to $242.623 million as of March 31, 2019, from $234.211 million at December 31, 2018. Depreciation expense for the three months ended March 31, 2019, was $5.8 million, a decrease from $6.8 million in the prior-year period Property, Plant and Equipment, Net (in thousands) | Category (in thousands) | March 31, 2019 | December 31, 2018 | | :---------------------- | :------------- | :---------------- | | Total property, plant and equipment, net | $242,623 | $234,211 | - Depreciation expense decreased from $6.8 million in Q1 2018 to $5.8 million in Q1 2019[44] - Construction in progress increased to $17.575 million from $16.449 million[44] Note 9. Intangible Assets, net Net intangible assets remained relatively stable at $4.001 million as of March 31, 2019, primarily consisting of patents and trademarks. Amortization expense for intangible assets was $0.1 million for both the three months ended March 31, 2019 and 2018, with a remaining weighted average amortization period of approximately 8 years Intangible Assets, Net (in thousands) | Intangible Asset (in thousands) | March 31, 2019 (Net) | December 31, 2018 (Net) | | :------------------------------ | :------------------- | :---------------------- | | Patents | $3,999 | $3,975 | | Trademarks | $2 | $2 | | Total intangible assets, net | $4,001 | $3,977 | - Amortization expense for intangible assets was $0.1 million for both Q1 2019 and Q1 2018[46] - The remaining weighted average amortization period for intangible assets is approximately 8 years[47] Note 10. Fair Value of Financial Instruments As of March 31, 2019, the company's financial instruments measured at fair value on a recurring basis included $77.459 million in total assets (cash, cash equivalents, and restricted cash) and $85.298 million in total liabilities (bank acceptance payable and convertible senior notes). The convertible senior notes, a new liability in 2019, significantly increased total liabilities at fair value Fair Value of Financial Instruments (in thousands) | Metric (in thousands) | March 31, 2019 | December 31, 2018 | | :-------------------- | :------------- | :---------------- | | Total Assets (fair value) | $77,459 | $58,004 | | Total Liabilities (fair value) | $85,298 | $4,628 | | Convertible senior notes | $80,100 | — | - The carrying values of short-term instruments like accounts receivable and payable approximate fair value due to their short maturity[49] Note 11. Notes Payable and Long-Term Debt Total notes payable and long-term debt decreased to $35.703 million as of March 31, 2019, from $83.917 million at December 31, 2018, primarily due to the repayment of CapEx Loan and Term Loan with BB&T using proceeds from convertible senior notes. The company maintains various credit facilities in the U.S., Taiwan, and China, with $36.7 million of unused borrowing capacity as of March 31, 2019 Notes Payable and Long-Term Debt (in thousands) | Metric (in thousands) | March 31, 2019 | December 31, 2018 | | :-------------------- | :------------- | :---------------- | | Sub-total debt | $35,739 | $84,124 | | Less debt issuance costs, net | $(36) | $(207) | | Grand total debt | $35,703 | $83,917 | | Current portion | $(18,168) | $(23,589) | | Non-current portion | $17,535 | $60,328 | - The company fully repaid the CapEx Loan and Term Loan with BB&T using approximately $37.8 million from convertible senior notes proceeds[56][66] - As of March 31, 2019, the company had $36.7 million of unused borrowing capacity[64] Note 12. Convertible Senior Notes On March 5, 2019, the company issued $80.5 million of 5% convertible senior notes due 2024, generating net proceeds of $76.4 million. These notes bear interest semi-annually and are convertible into common stock at an initial rate of 56.9801 shares per $1,000 principal amount, representing an initial conversion price of approximately $17.55 per share - Issued $80.5 million of 5% convertible senior notes due 2024 on March 5, 2019[65] - Net proceeds from the notes were $76.4 million, used partly to repay BB&T loans and for general corporate purposes[66] - Initial conversion rate is 56.9801 shares per $1,000 principal amount, equivalent to $17.55 per share[67] Note 13. Accrued Liabilities Total accrued liabilities decreased to $12.424 million as of March 31, 2019, from $19.291 million at December 31, 2018. This decrease was primarily driven by a reduction in accrued payroll and accrued rent Accrued Liabilities (in thousands) | Accrued Liability (in thousands) | March 31, 2019 | December 31, 2018 | | :------------------------------- | :------------- | :---------------- | | Accrued payroll | $6,139 | $10,772 | | Accrued rent | — | $1,200 | | Accrued employee benefits | $2,609 | $2,862 | | Total accrued liabilities | $12,424 | $19,291 | Note 14. Other Income and Expense Net other expense decreased to $0.155 million for the three months ended March 31, 2019, from $1.027 million in the prior-year period. This improvement was mainly due to a significant reduction in foreign exchange transaction losses, partially offset by government subsidy income Other Income (Expense) (in thousands) | Other Income (Expense) (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :------------------------------------ | :-------------------------------- | :-------------------------------- | | Foreign exchange transaction loss | $(233) | $(1,040) | | Government subsidy income | $87 | — | | Total other expense, net | $(155) | $(1,027) | - Foreign exchange transaction losses decreased significantly from $1.040 million in Q1 2018 to $0.233 million in Q1 2019[75] Note 15. Share-Based Compensation Total share-based compensation expense increased to $2.942 million for the three months ended March 31, 2019, from $2.569 million in the prior-year period, primarily driven by restricted stock units. As of March 31, 2019, there was $25.6 million of unrecognized compensation expense related to RSUs and RSAs, expected to be recognized over 2.6 years Share-Based Compensation (in thousands) | Share-Based Compensation (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :-------------------------------------- | :-------------------------------- | :-------------------------------- | | Total share-based compensation expense | $2,942 | $2,569 | - Unrecognized compensation expense for RSUs and RSAs was $25.6 million as of March 31, 2019, to be recognized over 2.6 years[79] - Restricted stock units accounted for $2.942 million of the share-based compensation expense in Q1 2019[81] Note 16. Income Taxes The company reported an income tax benefit of $2.474 million for the three months ended March 31, 2019, compared to $0.996 million in the prior-year period. The effective tax rate for Q1 2019 was (19%), varying from the federal statutory rate due to the mix of earnings among tax jurisdictions, share-based compensation, and R&D tax benefits. The company intends to indefinitely reinvest $16 million of accumulated undistributed foreign earnings Income Tax Benefit (in thousands) | Metric (in thousands) | Three months ended March 31, 2019 | Three months ended March 31, 2018 | | :-------------------- | :-------------------------------- | :-------------------------------- | | Income tax benefit | $2,474 | $996 | - Effective tax rate for Q1 2019 was (19%), compared to (88.63%) in Q1 2018[83] - The company has accumulated $16 million in undistributed foreign earnings, which it intends to indefinitely reinvest[84] Note 17. Geographic Information The company operates as one reportable segment, with revenue and long-lived assets disaggregated by geographic region. For the three months ended March 31, 2019, China and Taiwan accounted for the majority of revenue, at $26.701 million and $24.020 million respectively. Long-lived assets are also primarily located in China ($93.895 million) and the U.S. ($92.719 million) - The company operates in one reportable segment, managed on a consolidated basis[85] Revenue by Geographic Region (in thousands) | Geographic Region | Revenue (in thousands) - Q1 2019 | Revenue (in thousands) - Q1 2018 | | :---------------- | :------------------------------- | :------------------------------- | | United States | $1,998 | $3,563 | | Taiwan | $24,020 | $33,202 | | China | $26,701 | $28,474 | | Total | $52,719 | $65,239 | Long-lived Assets by Geographic Region (in thousands) | Geographic Region | Long-lived assets (in thousands) - March 31, 2019 | Long-lived assets (in thousands) - December 31, 2018 | | :---------------- | :------------------------------------------------ | :--------------------------------------------------- | | United States | $92,719 | $88,815 | | Taiwan | $65,904 | $65,451 | | China | $93,895 | $89,736 | | Total | $252,518 | $244,002 | Note 18. Contingencies The company is involved in several legal proceedings, including class action and shareholder derivative lawsuits alleging violations of the Exchange Act related to past revenue guidance and product issues. A motion to dismiss in one class action was denied, and the case is entering discovery. Additionally, a stockholder filed a complaint seeking to inspect corporate books and records. The company intends to vigorously defend against these claims and cannot yet estimate potential losses - Class action lawsuit (Mona Abouzied v. Applied Optoelectronics, Inc., et al.) alleging violations of Sections 10(b) and 20(a) of the Exchange Act, with a motion to dismiss denied on March 28, 2019[88] - Shareholder derivative actions (Lei Jin and Yiu Kwong Ng) consolidated and stayed pending a ruling in the Taneja securities class action[90] - A new class action lawsuit (Gaurav Taneja v. Applied Optoelectronics, Inc., et al.) filed on October 1, 2018, alleging violations related to revised Q3 2018 revenue guidance due to 25G laser issues[91] - Stockholder David Bono filed a complaint on April 10, 2019, seeking to inspect corporate books and records[92] Note 19. Subsequent Events Subsequent to March 31, 2019, the company's Taiwan subsidiary, Prime World, entered into a one-year credit facility totaling $2.6 million with Far Eastern International Bank on April 11, 2019. Additionally, its China subsidiary, Global, secured a $8.9 million revolving line of credit with China Merchants Bank on April 19, 2019, and a $1.5 million one-year credit facility with Shanghai Pudong Development Bank on April 30, 2019 - Prime World (Taiwan subsidiary) entered a $2.6 million credit facility with Far Eastern International Bank on April 11, 2019[94] - Global (China subsidiary) secured an $8.9 million revolving line of credit with China Merchants Bank on April 19, 2019[95] - Global also entered a $1.5 million one-year credit facility with Shanghai Pudong Development Bank on April 30, 2019[96] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial condition and operational results for the three months ended March 31, 2019, highlighting a significant decline in revenue and a net loss, primarily due to decreased demand in the data center market. It also discusses the company's vertically integrated business model, liquidity, capital resources, and critical accounting policies Overview Applied Optoelectronics, Inc. is a vertically integrated provider of fiber-optic networking products for internet data centers, CATV, telecom, and FTTH markets. Its manufacturing model, which includes proprietary laser chip fabrication, offers advantages in product development, response times, quality control, and cost management. The company operates three manufacturing sites and multiple R&D facilities globally - The company is a leading, vertically integrated provider of fiber-optic networking products for internet data centers, CATV, telecom, and FTTH markets[101] - Its vertically integrated manufacturing model, including proprietary Molecular Beam Epitaxy (MBE) and Metal Organic Chemical Vapor Deposition (MOCVD) fabrication processes for laser chips, provides advantages in rapid product development, fast customer response, and control over quality and costs[103][104] - Manufacturing sites are in Sugar Land, Texas (laser chips, subassemblies), Taipei, Taiwan (optical components, transceivers), and Ningbo, China (labor-intensive components, optical equipment systems)[105] Results of Operations The company experienced a significant decline in financial performance for the three months ended March 31, 2019, with total revenue decreasing by 19.2% and a shift from operating income to a substantial operating loss. This was primarily driven by reduced data center product shipments, increased production costs, and higher interest expenses Key Financial Metrics (in thousands, except percentages) | Metric (in thousands, except percentages) | Three months ended March 31, 2019 | % of Revenue (2019) | Three months ended March 31, 2018 | % of Revenue (2018) | | :---------------------------------------- | :-------------------------------- | :------------------ | :-------------------------------- | :------------------ | | Revenue, net | $52,719 | 100.0% | $65,239 | 100.0% | | Cost of goods sold | $40,368 | 76.6% | $39,403 | 60.4% | | Gross profit | $12,351 | 23.4% | $25,836 | 39.6% | | Income (loss) from operations | $(11,869) | (22.5)% | $2,170 | 3.4% | | Net income (loss) | $(10,474) | (19.9)% | $2,120 | 3.3% | Revenue Total revenue decreased by 19.2% to $52.719 million for the three months ended March 31, 2019, compared to $65.239 million in the prior-year period. This decline was primarily due to decreased shipments of 100 Gbps transceivers to a major customer, likely due to excess inventory, partially offset by new customer revenues Revenue by Market Segment (in thousands) | Market Segment | Q1 2019 Revenue (in thousands) | Q1 2019 % of Total | Q1 2018 Revenue (in thousands) | Q1 2018 % of Total | Change Amount (in thousands) | Change % | | :------------- | :----------------------------- | :----------------- | :----------------------------- | :----------------- | :--------------------------- | :------- | | Data Center | $38,499 | 73.0% | $50,583 | 77.5% | $(12,084) | (23.9)% | | CATV | $11,962 | 22.7% | $10,568 | 16.2% | $1,394 | 13.2% | | Telecom | $1,738 | 3.3% | $3,586 | 5.5% | $(1,848) | (51.5)% | | FTTH | $94 | 0.2% | $111 | 0.2% | $(17) | (15.3)% | | Other | $426 | 0.8% | $391 | 0.6% | $35 | 9.0% | | Total Revenue | $52,719 | 100.0% | $65,239 | 100.0% | $(12,520) | (19.2)% | - Decrease in revenue was driven primarily by decreased shipments of 100 Gbps transceivers to one large customer, believed to be due to excess inventory[109] - Top ten customers represented 92.1% of revenue in Q1 2019, down from 94.3% in Q1 2018[111] Cost of goods sold and gross margin Cost of goods sold increased by 2.4% to $40.368 million for the three months ended March 31, 2019, compared to $39.403 million in the prior-year period, primarily due to higher production costs for 100G data center products from enhanced quality control testing. This led to a significant decrease in gross margin from 39.6% to 23.4% Cost of Goods Sold and Gross Margin (in thousands, except percentages) | Metric (in thousands, except percentages) | Q1 2019 Amount | Q1 2019 % of Revenue | Q1 2018 Amount | Q1 2018 % of Revenue | Change Amount | Change % | | :---------------------------------------- | :------------- | :------------------- | :------------- | :------------------- | :------------ | :------- | | Cost of goods sold | $40,368 | 76.6% | $39,403 | 60.4% | $965 | 2.4% | | Gross margin | $12,351 | 23.4% | $25,836 | 39.6% | $(13,485) | (52.2)% | - Increased production costs for 100G data center products due to enhanced quality control testing procedures[111] Operating expenses Total operating expenses increased by 2.3% to $24.220 million for the three months ended March 31, 2019, compared to $23.666 million in the prior-year period. This was driven by increases in sales and marketing and general and administrative expenses, partially offset by a decrease in research and development expenses Operating Expenses (in thousands, except percentages) | Operating Expense (in thousands, except percentages) | Q1 2019 Amount | Q1 2019 % of Revenue | Q1 2018 Amount | Q1 2018 % of Revenue | Change Amount | Change % | | :--------------------------------------------------- | :------------- | :------------------- | :------------- | :------------------- | :------------ | :------- | | Research and development | $11,185 | 21.2% | $11,736 | 18.0% | $(551) | (4.7)% | | Sales and marketing | $2,595 | 4.9% | $2,474 | 3.8% | $121 | 4.9% | | General and administrative | $10,440 | 19.8% | $9,456 | 14.5% | $984 | 10.4% | | Total operating expenses | $24,220 | 45.9% | $23,666 | 36.3% | $554 | 2.3% | - Research and development expense decreased due to lower R&D work orders, depreciation, and travel expenses, offset by higher personnel and material costs[112] - General and administrative expense increased due to higher share-based compensation and depreciation expenses, partially offset by lower professional service fees[114] Other income (expense), net Total other expense, net, remained relatively stable at $(1.079) million for the three months ended March 31, 2019, compared to $(1.046) million in the prior-year period. A significant increase in interest expense (1302.8%) due to higher debt balances and interest rates was largely offset by a substantial decrease in foreign exchange losses Other Income (Expense), Net (in thousands, except percentages) | Other Income (Expense) (in thousands, except percentages) | Q1 2019 Amount | Q1 2019 % of Revenue | Q1 2018 Amount | Q1 2018 % of Revenue | Change Amount | Change % | | :-------------------------------------------------------- | :------------- | :------------------- | :------------- | :------------------- | :------------ | :------- | | Interest income | $72 | 0.1% | $52 | 0.1% | $20 | 38.5% | | Interest expense | $(996) | (1.9)% | $(71) | (0.1)% | $(925) | 1,302.8% | | Other expense, net | $(155) | (0.3)% | $(1,027) | (1.6)% | $872 | (84.9)% | | Total other expense, net | $(1,079) | (2.1)% | $(1,046) | (1.6)% | $(33) | 3.2% | - Interest expense increased by 1302.8% due to higher debt balances, including convertible senior notes, and higher interest rates[116] - Other expense, net, decreased by $0.9 million due to favorable foreign exchange fluctuations[117] Benefit (provision) for income taxes The income tax benefit increased by 148.4% to $2.474 million for the three months ended March 31, 2019, compared to $0.996 million in the prior-year period. The effective tax rate for Q1 2019 was (19.00%), influenced by the mix of earnings across tax jurisdictions, share-based compensation, and R&D tax benefits Benefit for Income Taxes (in thousands, except percentages) | Metric (in thousands, except percentages) | Q1 2019 Amount | Q1 2018 Amount | Change Amount | Change % | | :---------------------------------------- | :------------- | :------------- | :------------ | :------- | | Benefit for income taxes | $2,474 | $996 | $1,478 | 148.4% | - Effective tax rate for Q1 2019 was (19.00%), compared to (88.63%) in Q1 2018[118] - The effective tax rate varied from the federal statutory rate of 21% due to the level and mix of earnings among tax jurisdictions, share-based compensation, and tax benefits related to research and development[118] Liquidity and Capital Resources As of March 31, 2019, the company had $77.5 million in cash, cash equivalents, and restricted cash, along with $36.7 million in unused borrowing capacity. The issuance of $80.5 million in convertible senior notes significantly boosted financing activities, providing $28.0 million in net cash. The company believes its current liquidity and cash flows will be sufficient for the next 12 months, but may explore additional financing for future growth and capital needs, including a new factory construction in China - As of March 31, 2019, cash, cash equivalents, and restricted cash totaled $77.5 million[120] - The company had $36.7 million of unused borrowing capacity from loan agreements[120] - Issued $80.5 million of 5% convertible senior notes due 2024, generating net proceeds of $76.4 million[121] Operating activities Net cash provided by operating activities was $40 thousand for the three months ended March 31, 2019, a significant improvement from a net cash outflow of $4.1 million in the prior-year period. This was primarily due to a net loss offset by non-cash items, a decrease in other receivables and inventory, partially offset by an increase in accounts receivable and decreases in accounts payable and accrued liabilities - Net cash provided by operating activities was $40 thousand in Q1 2019, compared to net cash used of $4.1 million in Q1 2018[122][123][124] - Cash increased due to a $2.8 million decrease in other receivables and a $7.3 million decrease in inventory[123] - Cash decreased due to a $1.6 million increase in accounts receivable, a $1.6 million decrease in accounts payable, and a $5.7 million decrease in accrued liabilities[123] Investing activities Net cash used in investing activities decreased to $9.035 million for the three months ended March 31, 2019, from $12.220 million in the prior-year period. This was mainly due to $12.8 million in machinery and equipment purchases, partially offset by a $3.9 million decrease in non-current assets - Net cash used in investing activities was $9.035 million in Q1 2019, compared to $12.220 million in Q1 2018[122][125] - Purchases of machinery and equipment totaled $12.8 million in Q1 2019[125] Financing activities Net cash provided by financing activities significantly increased to $28.019 million for the three months ended March 31, 2019, from $14.576 million in the prior-year period. This was primarily driven by $76.4 million in proceeds from convertible senior notes, partially offset by $48.1 million in net loan repayments - Net cash provided by financing activities was $28.019 million in Q1 2019, compared to $14.576 million in Q1 2018[122][125][126] - Proceeds from the issuance of convertible senior notes amounted to $76.4 million[125] - Net loan repayments totaled $48.1 million[125] Loans and commitments The company maintains various lending arrangements and credit facilities in the U.S., Taiwan, and China, with $36.7 million of unused borrowing capacity as of March 31, 2019. On March 5, 2019, it issued $80.5 million in 5% convertible senior notes due 2024 - The company has lending arrangements with financial institutions in the U.S., Taiwan, and China[127][128] - As of March 31, 2019, $36.7 million of unused borrowing capacity was available[128] - Issued $80.5 million of 5% convertible senior notes due 2024 on March 5, 2019[129] China factory construction The company is constructing a new factory and facilities in Ningbo, China, with an estimated total cost of $27.5 million. As of March 31, 2019, approximately $12.0 million has been incurred, with completion expected in early 2020 - Construction of a new factory in Ningbo, China, is estimated to cost $27.5 million[129] - Approximately $12.0 million of the total cost has been incurred as of March 31, 2019[129] - Construction is expected to be completed in early 2020[129] Future liquidity needs The company anticipates its existing cash, operating cash flows, and available credit will cover its cash needs for the next 12 months. Future capital requirements depend on growth, R&D, sales and marketing expansion, new product introductions, manufacturing capacity changes, and market acceptance. Additional liquidity sources, such as equity/debt issuance or asset sales, may be explored if needed - Existing cash, operating cash flows, and available credit are expected to meet cash needs for the next 12 months[130] - Future capital requirements are dependent on growth rate, R&D spending, sales and marketing expansion, new product introductions, and manufacturing capacity[130] - Potential additional liquidity sources include issuing equity or debt, incurring secured indebtedness, or selling product lines/assets[130] Contractual Obligations and Commitments As of March 31, 2019, total contractual obligations amounted to $149.268 million, including $41.453 million in notes payable and long-term debt, $96.262 million in convertible senior notes, and $11.553 million in operating leases. A significant portion of these obligations, $86.312 million, is due in 3-5 years, primarily from convertible senior notes Contractual Obligations and Commitments (in thousands) | Obligation (in thousands) | Total | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | | :------------------------ | :--------- | :--------------- | :-------- | :-------- | :---------------- | | Notes payable and long-term debt | $41,453 | $23,691 | $17,762 | $— | $— | | Convertible senior notes | $96,262 | $4,025 | $8,050 | $84,187 | $— | | Operating leases | $11,553 | $1,378 | $2,285 | $2,125 | $5,765 | | Total commitments | $149,268 | $29,094 | $28,097 | $86,312 | $5,765 | - The amounts presented include principal and estimated interest expense for debt obligations[133] Inflation The company believes that the low rate of inflation in the U.S. has not significantly impacted its net sales, revenues, income, or raw material prices. However, expanding operations in China and Taiwan could lead to inflation having a more significant impact on future operating results - Low U.S. inflation has not significantly impacted net sales, revenues, income, or raw material prices[134] - Expansion in China and Taiwan may lead to a more significant impact from inflation on future operating results[134] Off-Balance Sheet Arrangements As of March 31, 2019, the company did not have any off-balance sheet arrangements - No off-balance sheet arrangements existed as of March 31, 2019[135] Critical Accounting Policies and Estimates The company's critical accounting policies and estimates, which involve significant management judgment and affect reported amounts, include revenue recognition, allowance for doubtful accounts, inventory reserves, impairment of long-lived assets, goodwill and other indefinite-lived intangible assets, purchase price allocation, service and product warranties, and income taxes. Actual results may differ materially from these estimates - Critical accounting policies and estimates include revenue recognition, allowance for doubtful accounts, inventory reserves, impairment of long-lived assets, goodwill and other indefinite-lived intangible assets, purchase price allocation, service and product warranties, and income taxes[136] - These estimates are based on historical experience and future expectations, but actual results may differ materially[136] Item 3. Quantitative and Qualitative Disclosures About Market Risk The company's exposure to market risk has not materially changed since December 31, 2018, as referenced in its Annual Report on Form 10-K - No material change in market risk exposure since December 31, 2018[137] Item 4. Controls and Procedures The company's management, including the CEO and CFO, evaluated the effectiveness of its disclosure controls and procedures as of March 31, 2019, and concluded they were effective in ensuring timely and accurate financial reporting. No changes in internal control over financial reporting were identified that materially affected or are reasonably likely to materially affect internal control during the quarter - Disclosure controls and procedures were evaluated and deemed effective as of March 31, 2019[139] Changes in Internal Control over Financial Reporting No changes in internal control over financial reporting were identified during the three-month period ended March 31, 2019, that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting - No material changes in internal control over financial reporting during the three months ended March 31, 2019[140] Part II. Other Information This section provides other required information, including legal proceedings, risk factors, and details on equity securities, defaults, mine safety, and exhibits Item 1. Legal Proceedings The company is currently involved in several legal proceedings, including class action and shareholder derivative lawsuits alleging securities law violations related to past revenue guidance and product issues. A motion to dismiss in one class action was denied, and discovery is commencing. Additionally, a stockholder has requested to inspect corporate books and records. The company disputes all allegations and intends to vigorously defend itself, but cannot estimate potential losses at this early stage - Class action lawsuit (Mona Abouzied v. Applied Optoelectronics, Inc., et al.) alleging violations of Sections 10(b) and 20(a) of the Exchange Act, with a motion to dismiss denied on March 28, 2019[142] - Shareholder derivative actions (Lei Jin and Yiu Kwong Ng) consolidated and stayed pending a ruling in the Taneja securities class action[142] - A new class action lawsuit (Gaurav Taneja v. Applied Optoelectronics, Inc., et al.) filed on October 1, 2018, alleging violations related to revised Q3 2018 revenue guidance due to 25G laser issues[142] - Stockholder David Bono filed a complaint on April 10, 2019, seeking to inspect corporate books and records[143] Class Action and Shareholder Derivative Litigation The company faces multiple class action and shareholder derivative lawsuits. The Abouzied class action, alleging securities law violations from August 2017, is proceeding to discovery after a motion to dismiss was denied. Two derivative actions are consolidated and stayed. A separate class action, Taneja, filed in October 2018, alleges violations related to revised Q3 2018 revenue guidance due to 25G laser issues, which the company intends to vigorously contest - Mona Abouzied v. Applied Optoelectronics, Inc., et al. (Case No. 4:17-cv-02399) is a class action alleging violations of Sections 10(b) and 20(a) of the Exchange Act, with a motion to dismiss denied on March 28, 2019[142] - Lei Jin and Yiu Kwong Ng derivative actions (Case No. 4:18-cv-02713 and 4:18-cv-4751) are consolidated and stayed[142] - Gaurav Taneja v. Applied Optoelectronics, Inc., et al. (Case No. 4:18-cv-03544) is a class action alleging violations related to revised Q3 2018 revenue guidance due to 25G laser issues[142] Books and Records Request Stockholder David Bono filed a complaint on April 10, 2019, in the Delaware Court of Chancery, seeking to inspect certain corporate books and records under Section 220 of the Delaware General Corporation Law. The company intends to vigorously dispute the case, arguing the plaintiff has not stated a proper purpose for the inspection - Stockholder David Bono filed a complaint on April 10, 2019, seeking to inspect corporate books and records[143] - The company intends to vigorously dispute the case, asserting the plaintiff has not stated a proper purpose[144] Item 1A. Risk Factors This section outlines significant risks that could adversely affect the company's business, financial condition, and operating results. Key risks include heavy reliance on a few major customers, difficulty in forecasting demand, intense competition, the need for continuous product innovation, cyclical market demand, manufacturing challenges, high fixed costs, and exposure to international trade policies and currency fluctuations. Risks specific to operations in China and those related to common stock volatility are also detailed - High dependence on key customers (top ten customers represented 92.1% of revenue in Q1 2019) makes the company vulnerable to order reductions or losses[147] - Difficulty in accurately forecasting customer demand and matching production, leading to potential excess capacity or inventory[150][151] - Intense competition from larger, more resourced companies and potential in-house manufacturing by customers[156] - Need for continuous development of new and enhanced products in rapidly changing markets, with potential for delays and unrecoverable expenses[157][158][159] - Exposure to the cyclical nature of target markets (CATV, telecom, FTTH) and potential downturns reducing demand[166][167] - Risks associated with manufacturing problems, high fixed costs, and shifts in product mix impacting gross margins[168][169][171] - Indebtedness and restrictive covenants could limit cash flow and operational flexibility[177][179] - Vulnerability to changes in U.S. and international trade policies, particularly tariffs affecting China-manufactured products[195][196][197] - Significant foreign currency exposure to U.S. dollar, Chinese Renminbi, and New Taiwan dollar fluctuations[213][214] Risks Inherent in Our Business The company faces inherent business risks including significant dependence on a limited number of key customers, making it vulnerable to demand fluctuations and order reductions. Challenges in accurately forecasting customer demand, qualifying new products, and intense market competition can impact sales and market share. The company's high fixed costs and vertically integrated model mean reduced demand can severely affect gross profits. Product defects, restrictive loan covenants, and the inability to secure additional capital also pose substantial risks to operations and financial stability - Top ten customers represented 92.1% of revenue in Q1 2019, with Facebook, Microsoft, and Amazon being significant customers in 2018[147] - Customer demand is difficult to forecast, and customers are not contractually committed beyond firm purchase orders, leading to potential production mismatches and excess inventory[150][151] - Failure to qualify new products or delays in product development can adversely affect revenue and cost recovery[153][154][155] - Intense competition from larger companies and potential in-house manufacturing by customers could lead to loss of sales or market share[156] - High fixed costs from vertical integration mean reduced demand can significantly impact gross profits and lead to high inventory carrying costs[169][170] - Product defects, even after customer acceptance, can lead to significant costs, litigation, and damage to customer relationships[186][187] - Indebtedness and restrictive covenants in loan agreements limit operational flexibility and could lead to acceleration of debt if breached[177][179][189] - Inability to obtain additional capital when needed could limit growth, R&D, and market opportunities[190][191] Risks Related to Our Operations in China The company's significant operations in China expose it to economic, political, legal, and social risks, including potential adverse changes in government policies, uncertain enforcement of laws, and high labor turnover. Preferential tax treatments may expire, increasing tax liabilities. Chinese regulations on loans and direct investment could delay capital contributions, and increasing labor costs may reduce profitability. Challenges in establishing and maintaining Western-style management and financial controls also pose risks - China operations are critical, accounting for 53.6% of revenue in 2018 and 36.8% of property, plant, and equipment[250] - Adverse changes in China's economic and political policies, laws, or regulations, and uncertain enforcement of intellectual property rights, could materially affect business[251][253] - Expiration of preferential 15% tax rate for high-technology enterprises in China (ending November 2020) could increase tax liabilities[256] - High turnover of direct labor in China's manufacturing sector could adversely affect production and results[257][258] - Chinese regulations on loans and direct investment by offshore holding companies may delay or prevent capital contributions to the China subsidiary[259][260][261] - Increasing labor costs in China due to labor laws and unrest could adversely affect profitability[262][263][264] - Difficulty in establishing and maintaining adequate management and financial controls over China operations due to differences in business practices and GAAP familiarity[265][266] Risks Related to Our Common Stock The company's stock price is highly volatile, influenced by market fluctuations, competitor announcements, and general economic conditions. Past volatility has led to class action litigation, and future litigation could incur substantial costs. As a public company, increased expenses and administrative burdens are ongoing. The company does not intend to pay dividends, meaning returns depend solely on stock price appreciation. Charter documents and Delaware law could also prevent favorable takeovers and reduce stock value - The market price of common stock has been and is likely to be volatile due to various factors, including competitor announcements and general economic conditions[269][270] - Past stock price volatility has led to securities class action litigation, which could result in substantial costs and divert management's attention[271] - Increased legal, accounting, and administrative costs as a public company, including compliance with Sarbanes-Oxley Act requirements[272][273] - No current plans to pay dividends on common stock; returns depend solely on stock price appreciation[274] - Charter documents, stock incentive plans, and Delaware law contain provisions that could delay or prevent a change in control, potentially reducing stock market price[275][276][277] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds There were no unregistered sales of equity securities or use of proceeds to report for the period - No unregistered sales of equity securities or use of proceeds[281] Item 3. Defaults Upon Senior Securities There were no defaults upon senior securities to report for the period - No defaults upon senior securities[281] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[282] Item 5. Other Information There is no other information to report for the period - No other information to report[282] Item 6. Exhibits This section lists all exhibits filed with the Quarterly Report on Form 10-Q, including corporate governance documents, debt instruments, purchase agreements, certifications, and XBRL-related documents - Includes Amended and Restated Certificate of Incorporation and Bylaws[284] - Lists Indenture and Form of Note for the 5.00% Convertible Senior Notes due 2024[284] - Contains various loan and purchase agreements, including those with Chailease Finance Co., Ltd. and Branch Banking and Trust Company[284] - Includes certifications from the Chief Executive Officer and Chief Financial Officer (31.1, 31.2, 32.1) and XBRL documents[284][285]