Applied Optoelectronics(AAOI) - 2019 Q3 - Quarterly Report

Part I Item 1. Condensed Consolidated Financial Statements (Unaudited) Unaudited Q3 and YTD 2019 financials reflect declining revenue and profitability, net losses, increased liabilities, and reduced operating cash flow Condensed Consolidated Balance Sheets Condensed Consolidated Balance Sheet Highlights (in thousands) | Account | Sep 30, 2019 | Dec 31, 2018 | Change | | :--- | :--- | :--- | :--- | | Total current assets | $190,647 | $194,275 | ($3,628) | | Inventories | $82,118 | $93,256 | ($11,138) | | Total Assets | $483,878 | $466,840 | $17,038 | | Total current liabilities | $64,423 | $77,418 | ($12,995) | | Convertible senior notes | $76,835 | $0 | $76,835 | | Total Liabilities | $181,593 | $137,746 | $43,847 | | Total Stockholders' Equity | $302,285 | $329,094 | ($26,809) | Condensed Consolidated Statements of Operations Condensed Consolidated Statements of Operations (in thousands, except per share data) | Metric | Q3 2019 | Q3 2018 | 9 Months 2019 | 9 Months 2018 | | :--- | :--- | :--- | :--- | :--- | | Revenue, net | $46,084 | $56,386 | $142,214 | $209,447 | | Gross profit | $11,976 | $17,537 | $34,865 | $77,236 | | Income (loss) from operations | ($10,996) | ($9,604) | ($36,693) | $1,509 | | Net income (loss) | ($8,780) | ($3,732) | ($30,620) | $6,422 | | Diluted EPS | ($0.44) | ($0.19) | ($1.54) | $0.32 | Condensed Consolidated Statements of Cash Flows Condensed Consolidated Statements of Cash Flows (in thousands) | Activity | Nine Months ended Sep 30, 2019 | Nine Months ended Sep 30, 2018 | | :--- | :--- | :--- | | Net cash provided by operating activities | $1,411 | $25,625 | | Net cash used in investing activities | ($26,997) | ($71,025) | | Net cash provided by financing activities | $39,586 | $17,936 | | Net increase (decrease) in cash | $14,372 | ($25,873) | Notes To Condensed Consolidated Financial Statements (Unaudited) - The company is a vertically integrated provider of fiber-optic networking products for internet data centers, cable television (CATV), telecommunications (telecom), and fiber-to-the-home (FTTH) markets, with manufacturing and R&D facilities in the U.S., Taiwan, and China[21][22] Revenue by Market Segment (in thousands) | Market Segment | Q3 2019 Revenue | Q3 2018 Revenue | 9 Months 2019 Revenue | 9 Months 2018 Revenue | | :--- | :--- | :--- | :--- | :--- | | Data Center | $34,006 | $38,954 | $104,311 | $158,577 | | CATV | $8,797 | $14,295 | $30,577 | $39,047 | | Telecom | $2,868 | $2,656 | $6,236 | $10,399 | | Total Revenue | $46,084 | $56,386 | $142,214 | $209,447 | - On March 5, 2019, the company issued $80.5 million of 5% convertible senior notes due 2024, generating net proceeds of $76.4 million. A portion of the proceeds was used to repay existing debt[79][80] - The company is involved in several legal proceedings, including class action and shareholder derivative lawsuits alleging violations of the Exchange Act, and a books and records request. The company disputes the allegations and intends to defend against these claims vigorously[106][109][110] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management attributes Q3 2019 revenue decline to softer data center and CATV demand, impacting gross margin, with liquidity bolstered by convertible note proceeds Results of Operations Revenue Change by Market (Q3 2019 vs Q3 2018, in thousands) | Market | Q3 2019 Revenue | Q3 2018 Revenue | Change Amount | Change % | | :--- | :--- | :--- | :--- | :--- | | Data Center | $34,006 | $38,954 | ($4,948) | (12.7)% | | CATV | $8,797 | $14,295 | ($5,498) | (38.5)% | | Total Revenue | $46,084 | $56,386 | ($10,302) | (18.3)% | - The decrease in revenue was primarily driven by reduced shipments of 100 Gbps transceiver products to a specific customer, believed to be due to their excess inventory. A decrease in sales of CATV products also contributed to the decline[130] - Gross margin decreased year-over-year due to additional production costs for 100 Gbps datacenter products related to enhanced quality control testing, combined with lower selling prices and lower production volumes[132] - Research and development expenses decreased by $3.7 million (26.2%) in Q3 2019 compared to Q3 2018, mainly due to lower costs from R&D work orders, depreciation, and materials usage[136] Liquidity and Capital Resources - As of September 30, 2019, the company had $72.4 million in cash, cash equivalents, and restricted cash, and $57.3 million of unused borrowing capacity[148] - In March 2019, the company issued $80.5 million of 5% convertible senior notes, generating net proceeds of $76.4 million, which significantly bolstered its cash position[149] Cash Flow Summary (Nine Months ended Sep 30, in thousands) | Cash Flow Activity | 2019 | 2018 | | :--- | :--- | :--- | | Operating Activities | $1,411 | $25,625 | | Investing Activities | ($26,997) | ($71,025) | | Financing Activities | $39,586 | $17,936 | Item 3. Quantitative and Qualitative Disclosures About Market Risk The company states that its exposure to market risk has not changed materially since December 31, 2018, as detailed in its Annual Report on Form 10-K for that fiscal year - The company's exposure to market risk is not believed to have changed materially since the end of the previous fiscal year (December 31, 2018)[168] Item 4. Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of September 30, 2019, with no material changes in internal control over financial reporting during the quarter - Based on an evaluation as of September 30, 2019, the CEO and CFO concluded that the company's disclosure controls and procedures were effective[170] - No changes in internal control over financial reporting occurred during the quarter that have materially affected, or are reasonably likely to materially affect, these controls[171] Part II. Other Information Item 1. Legal Proceedings The company is involved in multiple legal proceedings, including securities class action and shareholder derivative lawsuits, which it is vigorously defending - The company and two of its officers are defendants in the Mona Abouzied v. Applied Optoelectronics, Inc. class action lawsuit, filed in August 2017, related to statements about demand for 40G solutions. The case is currently in the discovery phase[174] - A second class action lawsuit, Gaurav Taneja v. Applied Optoelectronics, Inc., was filed in October 2018 concerning the company's revised third-quarter revenue guidance due to an issue with 25G lasers. A motion to dismiss is pending[175] - A shareholder derivative action has been filed and is currently stayed, and a stockholder has filed a complaint in Delaware seeking to inspect corporate books and records, which is also stayed[174][177] Item 1A. Risk Factors The company faces significant risks from customer concentration, demand volatility, manufacturing disruptions, and geopolitical uncertainties, particularly concerning its China operations and trade tensions Risks Inherent in Our Business - The company is highly dependent on key customers, with the top ten accounting for 88.3% of revenue in the first nine months of 2019. In 2018, Facebook, Microsoft, and Amazon represented 38.3%, 22.1%, and 12.1% of revenue, respectively[180] - Customer demand is difficult to forecast, and purchase orders can be increased, decreased, or canceled with little notice, creating risks of excess or insufficient inventory and manufacturing capacity[183][185] - Manufacturing is subject to risks, including potential disruptions at the single Sugar Land, Texas facility where proprietary MBE and MOCVD laser fabrication processes are conducted[209][210] - The company faces risks from U.S.-China trade tensions, as tariffs imposed by both governments have increased the cost of goods sold and could adversely affect business if they escalate[205][206] Risks Related to Our Operations in China - A significant portion of manufacturing and assets are located in China, making the business susceptible to adverse changes in Chinese economic and political policies, laws, and regulations[311][312] - The company's China subsidiary benefits from a preferential 15% tax rate for high-tech enterprises, which expires in November 2020. Failure to renew this status would increase the tax rate to 25%, impacting net income[319] - High turnover of direct labor in China's manufacturing sector and rising labor costs could adversely affect production and profitability[320][328] Risks Related to Our Common Stock - The company's stock price has been and is likely to remain volatile. The company is currently subject to securities class action litigation, which can result in substantial costs and divert management's attention[331][333][334] - The company does not intend to pay dividends on its common stock in the foreseeable future, meaning a return on investment is dependent on stock price appreciation[337][338] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The company reported no unregistered sales of equity securities during the period - None[346] Item 3. Defaults Upon Senior Securities The company reported no defaults upon senior securities during the period - None[346] Item 4. Mine Safety Disclosures This section is not applicable to the company - Not applicable[346] Item 5. Other Information The company reported no other information required to be disclosed in this section - None[346] Item 6. Exhibits This section provides an index of the exhibits filed with the Form 10-Q, including certifications by the CEO and CFO and documents related to debt agreements and corporate governance - The Exhibit Index lists all documents filed as part of the quarterly report, including corporate governance documents, debt agreements, and required certifications[347][348]