Applied Optoelectronics(AAOI) - 2023 Q4 - Annual Report

Part I Business Applied Optoelectronics, Inc. (AOI) is a vertically integrated fiber-optic product provider, with its internet data center market becoming the largest revenue source in 2023 at 64.9%, driven by AI demand, despite a slight revenue decrease to $217.6 million and high customer concentration Key Financial Performance (2021-2023) (in millions) | Metric | 2023 | 2022 | 2021 | | :--- | :--- | :--- | :--- | | Revenue | $217.6M | $222.8M | $211.6M | | Gross Margin | 27.1% | 15.1% | 17.8% | | Net Loss | ($56.0M) | ($66.4M) | ($54.2M) | | Accumulated Deficit | ($265.1M) | ($209.1M) | - | Revenue by Market (2023 vs 2022) (in millions) | Market | 2023 Revenue | 2023 % of Total | 2022 Revenue | 2022 % of Total | | :--- | :--- | :--- | :--- | :--- | | Internet Data Center | $141.2M | 64.9% | $77.1M | 34.6% | | CATV | $59.9M | 27.5% | $118.2M | 53.0% | | Telecom | $13.8M | 6.4% | $24.7M | 11.1% | | FTTH & Other | $2.7M | 1.2% | $2.8M | 1.3% | - The company relies heavily on a small number of customers. In 2023, Microsoft was the largest customer, accounting for 46.6% of revenue, a significant increase from 18.4% in 2022. ATX and Digicomm were other key customers, contributing 15.6% and 11.3% of revenue, respectively[18][82] - AOI operates a vertically integrated and geographically distributed manufacturing model with facilities in Sugar Land, Texas (laser chip fabrication); Ningbo, China (labor-intensive components, CATV equipment); and Taipei, Taiwan (optical components, transceivers)[29][49][50] - As of December 31, 2023, the company had 233 employees in R&D, including nine with Ph.D. degrees. R&D departments are located in Texas, Georgia, China, and Taiwan[44] - The company held 176 U.S. issued patents and 150 patents issued in China and Taiwan as of December 31, 2023, with expiration dates ranging from 2024 to 2043[47] Risk Factors The company faces substantial risks from high customer concentration (92.7% of 2023 revenue), volatile demand, manufacturing disruptions, high fixed costs, international trade policies, and an ongoing arbitration related to a terminated divestiture - The company is highly dependent on a few key customers. In 2023, the top ten customers accounted for 92.7% of revenue. Specifically, Microsoft represented 46.6%, ATX 15.6%, and Digicomm 11.3%. The loss of any of these customers would materially harm financial results[81][82] - The company's vertically integrated model results in a high fixed cost base, making gross profits highly sensitive to sales volume fluctuations and potentially leading to high inventory carrying costs if demand falls[99][100] - A significant portion of manufacturing occurs in China and Taiwan, exposing the company to risks from natural disasters, geopolitical tensions, and changes in international trade policies, such as U.S. tariffs on Chinese imports[124][146][151] - The termination of the agreement to sell its China manufacturing facilities to Yuhan Optoelectronic has resulted in an arbitration claim filed by the purchaser seeking specific performance. The outcome is uncertain and could adversely affect the business[164][165] - As of December 31, 2023, the company had approximately $114.9 million of consolidated indebtedness, which could limit cash flow for operations and expose it to financial risks[131] - The company's ability to use its U.S. NOLs of approximately $112 million and other tax credits may be limited by Section 382 of the Internal Revenue Code if an ownership change occurs[115] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[181] Cybersecurity The company manages cybersecurity risk through a comprehensive program overseen by the Board and management, involving cross-functional threat mitigation, annual risk assessments, technical safeguards, and incident response plans - The Board of Directors oversees the management of cybersecurity risk and receives regular reports from management[188] - The company's cybersecurity strategy is built on collaboration, annual risk assessments, technical safeguards, incident response planning, and employee education[182][183][184] - Primary responsibility for assessing and managing cybersecurity risks lies with the General Manager and MIS Director, who have over 20 years of relevant experience[188] Properties The company owns administrative, manufacturing, and R&D facilities in Sugar Land, Texas, and Ningbo, China, while leasing sites in Duluth, Georgia, and Taipei, Taiwan Company Facilities | Location | Ownership | Approx. Sq. Footage | Use | | :--- | :--- | :--- | :--- | | Sugar Land, Texas | Owned | 139,450 | Admin, Sales, Mfg, R&D | | Duluth, Georgia | Leased | 10,459 | Sales, R&D | | Ningbo, China | Owned | 458,849 | Admin, Sales, Mfg, R&D | | Taipei, Taiwan | Leased | 268,797 | Admin, Sales, Mfg, R&D | Legal Proceedings The company is involved in an arbitration with Yuhan Optoelectronic Technology (Shanghai) Co., Ltd. regarding a terminated agreement to sell its China manufacturing facilities, with the outcome currently indeterminable - The company is subject to an arbitration proceeding filed by Yuhan Optoelectronic Technology (Shanghai) Co., Ltd. in Hong Kong[194][507] - The dispute relates to the company's termination of an agreement to sell its China manufacturing facilities. The purchaser is seeking specific performance, and the company has filed counterclaims[507] Mine Safety Disclosure This item is not applicable to the company - Not Applicable[194] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NASDAQ Global Market under "AAOI", with 35 holders of record as of February 20, 2024, and no cash dividends have ever been paid or are anticipated - Common stock trades on the NASDAQ Global Market under the symbol "AAOI"[196] - The company has never declared or paid cash dividends and does not intend to in the foreseeable future[197] Reserved This item is reserved Management's Discussion and Analysis of Financial Condition and Results of Operations In 2023, revenue slightly decreased by 2.3% to $217.6 million, driven by a 49.3% CATV decline offset by an 83.2% data center surge, while gross margin improved to 27.1% and liquidity was bolstered by a $70 million ATM offering and debt refinancing Results of Operations In 2023, total revenue decreased by 2.3% to $217.6 million, with an 83.2% data center increase offsetting CATV and Telecom declines, while gross margin improved to 27.1% and net loss was $56.0 million Revenue by Market (2023 vs. 2022) (in thousands) | Market | 2023 Revenue | 2022 Revenue | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | CATV | $59,942K | $118,169K | ($58,227K) | (49.3)% | | Data Center | $141,213K | $77,094K | $64,119K | 83.2% | | Telecom | $13,831K | $24,727K | ($10,896K) | (44.1)% | | FTTH | $56K | $129K | ($73K) | (56.6)% | | Total Revenue | $217,646K | $222,818K | ($5,172K) | (2.3)% | - Gross margin increased to 27.1% in 2023 from 15.1% in 2022. This was primarily due to a strategic shift to selling branded products directly to MSOs in the CATV segment, price increases, a favorable product mix in the datacenter segment, and non-recurring engineering (NRE) revenue from Microsoft[240] - General and administrative expenses increased by $6.6 million (14.1%) in 2023, mainly due to higher professional service fees and share-based compensation expense[245] - Total other expense increased by $7.3 million, primarily due to a $4.7 million increase in other expense related to the non-cash cost of debt extinguishment for the 2024 Notes and a $3.1 million increase in interest expense from higher interest rates[246][247] Liquidity and Capital Resources As of December 31, 2023, the company held $55.1 million in cash and $22.5 million in unused borrowing capacity, having bolstered liquidity by raising $69.1 million from an ATM offering and refinancing $80.2 million in convertible debt - As of December 31, 2023, the company had $55.1 million in cash, cash equivalents, and restricted cash, and $22.5 million of unused borrowing capacity[251][268] Cash Flow Summary (in thousands) | Activity | 2023 | 2022 | 2021 | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | $(7,929) | $(14,022) | $(11,644) | | Net cash used in investing activities | $(14,761) | $(3,834) | $(10,546) | | Net cash provided by financing activities | $40,578 | $10,753 | $14,087 | - In 2023, the company completed an "at-the-market" (ATM) offering, selling 7.8 million shares for net proceeds of approximately $69.1 million[255][256] - In December 2023, the company issued $80.2 million of 5.250% convertible senior notes due 2026 and used the proceeds to exchange or repurchase its 5.00% convertible senior notes due 2024[258][447] Critical Accounting Policies and Estimates Critical accounting policies involve significant judgment in inventory valuation, leading to an $8.7 million charge in 2023, impairment testing of long-lived assets, and income tax accounting, where a $78.1 million valuation allowance is maintained against deferred tax assets due to cumulative losses - Valuation of inventories is a critical estimate. The company recorded excess and obsolete inventory reserve charges of $8.7 million in 2023, compared to $4.9 million in 2022[277][278] - The company evaluates long-lived assets for impairment when triggering events occur. No impairment charges were recorded in 2021, 2022, or 2023[276] - Accounting for income taxes requires significant judgment, particularly regarding the realizability of deferred tax assets. Due to a history of cumulative losses, the company has recorded a valuation allowance of $78.1 million as of December 31, 2023[280][281] Quantitative and Qualitative Disclosures about Market Risk The company's primary market risks stem from foreign exchange rate fluctuations, particularly with the RMB and NT dollar, which accounted for 22% and 16.7% of 2023 operating expenses respectively, while interest rate risk is minimized by fixed-rate debt - The company is exposed to foreign exchange risk as a large portion of its business is in China (RMB) and Taiwan (NT dollar)[289] - In 2023, 22% of operating expenses were denominated in RMB and 16.7% in NT dollars. A 1% adverse change in these exchange rates would have increased operating expenses by $0.4 million[291] - As of December 31, 2023, all company debt bore a fixed interest rate, mitigating exposure to interest rate fluctuations[287] - The company does not currently use derivative financial instruments to hedge against market risks but may consider them in the future[286][293] Financial Statements and Supplementary Data This section incorporates by reference the company's consolidated financial statements and accompanying notes, which begin on page F-1 - The required information is incorporated by reference to the consolidated financial statements and notes beginning on page F-1[294] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting principles, practices, or financial statement disclosure - None reported[294] Controls and Procedures Management, including the CEO and CFO, concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2023, with the independent auditor issuing an unqualified opinion - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of December 31, 2023[297] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2023, based on the COSO framework[300] - The independent auditor, Grant Thornton LLP, issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting[303] - No material changes to internal control over financial reporting occurred during the last fiscal quarter[300] Other Information During Q4 2023, several executive officers, including the CEO and CFO, adopted Rule 10b5-1 trading plans for the potential sale of company common stock on December 14, 2023 Executive Rule 10b5-1 Trading Plan Adoptions (Q4 2023) | Name | Title | Date Adopted | Aggregate of Securities to be Sold | | :--- | :--- | :--- | :--- | | Chih-Hsiang (Thompson) Lin | CEO | 12/14/2023 | 60,000 | | Stefan Murry | CFO | 12/14/2023 | 12,000 | | Hung-Lun (Fred) Chang | SVP/North America GM | 12/14/2023 | 18,195 | | David Kuo | SVP/CLO | 12/14/2023 | 40,000 | Disclosure Regarding Foreign Jurisdictions that Prevent Inspections The company reports no foreign jurisdictions that prevent inspections - None reported[311] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance, including the adopted Code of Business Conduct and Ethics, is incorporated by reference from the 2024 Annual Meeting of Stockholders proxy statement - The required information will be included in the definitive proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated by reference[312] - The company has adopted a Code of Business Conduct and Ethics applicable to all directors, employees, and executive officers[312] Executive Compensation Information regarding executive compensation is incorporated by reference from the definitive proxy statement for the 2024 Annual Meeting of Stockholders - The required information will be included in the definitive proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated by reference[314] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership is incorporated by reference from the definitive proxy statement for the 2024 Annual Meeting of Stockholders - The required information will be included in the definitive proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated by reference[315] Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships, related transactions, and director independence is incorporated by reference from the definitive proxy statement for the 2024 Annual Meeting of Stockholders - The required information will be included in the definitive proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated by reference[316] Principal Accounting Fees and Services Information regarding principal accounting fees and services is incorporated by reference from the definitive proxy statement for the 2024 Annual Meeting of Stockholders - The required information will be included in the definitive proxy statement for the 2024 Annual Meeting of Stockholders and is incorporated by reference[317] Part IV Exhibits, Financial Statements Schedules This section lists exhibits filed with the Form 10-K, including various agreements, and notes that consolidated financial statements are on page F-1, with schedules omitted as information is elsewhere - The consolidated financial statements are listed on the Index to Consolidated Financial Statements beginning on page F-1[319] - Financial statement schedules have been omitted because the required information is included in the Consolidated Financial Statements or the notes thereto[319] Form 10-K Summary This item is not applicable - None[319] Consolidated Financial Statements Report of Independent Registered Public Accounting Firm Grant Thornton LLP issued an unqualified opinion on the 2023 consolidated financial statements, highlighting critical audit matters in inventory reserve valuation and long-lived asset impairment due to significant judgment and subjective assumptions - The auditor, Grant Thornton LLP, issued an unqualified opinion on the consolidated financial statements[336] - A critical audit matter was the Inventory Reserve, due to the significant management judgment required to estimate future demand and obsolescence[341] - A second critical audit matter was the Impairment of Long-Lived Assets, due to the high degree of subjectivity in forecasting future cash flows to assess asset recoverability[343] Financial Statements As of December 31, 2023, total assets were $389.2 million and liabilities $174.3 million, with 2023 revenue of $217.6 million, a net loss of $56.0 million, and $40.6 million net cash provided by financing activities Consolidated Balance Sheet Data (in thousands) | | Dec 31, 2023 | Dec 31, 2022 | | :--- | :--- | :--- | | Total Current Assets | $172,605 | $183,164 | | Total Assets | $389,186 | $408,263 | | Total Current Liabilities | $93,358 | $138,582 | | Total Liabilities | $174,317 | $223,593 | | Total Stockholders' Equity | $214,869 | $184,670 | Consolidated Statement of Operations Data (in thousands) | | 2023 | 2022 | 2021 | | :--- | :--- | :--- | :--- | | Revenue, net | $217,646 | $222,818 | $211,565 | | Gross Profit | $58,921 | $33,627 | $37,715 | | Loss from Operations | $(41,349) | $(58,998) | $(56,766) | | Net Loss | $(56,048) | $(66,397) | $(54,162) | | Net Loss Per Share (Basic & Diluted) | $(1.75) | $(2.38) | $(2.01) | Consolidated Statement of Cash Flows Data (in thousands) | | 2023 | 2022 | 2021 | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | $(7,929) | $(14,022) | $(11,644) | | Net cash used in investing activities | $(14,761) | $(3,834) | $(10,546) | | Net cash provided by financing activities | $40,578 | $10,753 | $14,087 | | Net increase (decrease) in cash | $19,510 | $(5,550) | $(8,979) | Notes to Consolidated Financial Statements The notes detail accounting policies and financial results, including revenue recognition shifts, $80.2 million in new convertible notes, $11.9 million in share-based compensation, a $78.1 million deferred tax asset valuation allowance, and an ongoing arbitration contingency - Revenue is recognized when control of products or services is transferred. For 2023, Data Center revenue was $141.2 million (64.9%) and CATV revenue was $59.9 million (27.5%), a reversal from 2022 where CATV was the dominant market[384][409] - As of Dec 31, 2023, the company had $23.2 million in notes payable and long-term debt, and a net carrying amount of $76.2 million for its convertible senior notes due 2026[439][440][449] - Total share-based compensation expense was $11.9 million in 2023. As of year-end, there was $12.1 million of unrecognized expense for RSUs and $6.6 million for PSUs[489][491][493] - The company maintains a valuation allowance of $78.1 million against its deferred tax assets as of Dec 31, 2023, due to a cumulative loss history making it not more-likely-than-not that the assets will be realized[471] - A significant contingency exists from an arbitration filed by Yuhan Optoelectronic Technology, which is seeking specific performance of a terminated agreement for AOI to sell its China manufacturing facilities. The outcome is currently indeterminable[507]