Applied Optoelectronics, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. The company designs and manufactures fiber-optic networking products for data center, CATV, telecom and FTTH markets. Financial amounts below are in U.S. dollars; statements are unaudited.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $87.8 million | $117.4 million | $153.1 million | $213.6 million |
| Gross profit / margin | $33.9 million / 38.6% | $53.3 million / 45.4% | $59.7 million / 39.0% | $94.8 million / 44.4% |
| Operating income / margin | $8.9 million / 10.2% | $34.3 million / 29.2% | $11.1 million / 7.3% | $58.6 million / 27.2% |
| Net income | $8.0 million | $29.1 million | $10.2 million | $48.9 million |
| Diluted EPS | $0.40 | $1.43 | $0.51 | $2.45 |
Q2 other income was $1.6 million, including a $1.3 million foreign-exchange transaction gain and $0.3 million of government subsidy income. Q2 tax expense was $2.3 million and the effective tax rate was 22.2%. A $0.8 million measurement-period tax benefit related to the U.S. Tax Act affected the quarter; the transition-tax accounting remained provisional.
Liquidity, cash flow and debt
- At June 30, 2018, cash and cash equivalents were $76.2 million and restricted cash was $1.8 million; combined cash, cash equivalents and restricted cash were $77.9 million. Total debt was $61.0 million, including $3.2 million current and $57.9 million long-term.
- Current assets were $230.6 million and current liabilities $71.7 million. Inventory was $93.3 million, up from $75.8 million at year-end 2017.
- For the first half, operating cash flow was $18.1 million versus $49.9 million a year earlier; investing cash outflow was $35.2 million, including $30.9 million of property and equipment purchases and $5.6 million for land-use rights. Financing provided $9.3 million. Cash and restricted cash decreased by $6.0 million.
- The amended BB&T facilities included a $60 million revolving line, a $26 million capital-expenditure loan and a $21.5 million real-estate term loan. At quarter-end, $35.0 million, $4.9 million and $21.1 million, respectively, were outstanding; unused borrowing capacity across facilities was $56.1 million. The company reported covenant compliance.
- Management said existing cash, operating cash flows and available borrowing were expected to meet anticipated cash needs for the next 12 months. Future capital needs depend on growth, R&D and capacity spending; additional financing may be sought if needed.
Changes and management commentary
- Revenue fell 25.2% in Q2 and 28.3% in the first half year over year. The principal driver was a key customer reducing purchases of 40G and 100G transceivers amid changes to its network architecture. Other customers’ 100G demand and telecom deployments partly offset the decline.
- Data center revenue declined 30.5% in Q2 to $69.0 million and 33.1% in the first half to $119.6 million. CATV first-half revenue fell 10.0%, partly attributed to reduced China-factory production capacity following Lunar New Year staff turnover. Telecom revenue increased 35.1% in Q2 and 23.9% in the first half.
- Gross margin contracted 6.8 percentage points in Q2 and 5.4 points in the first half. Management cited lower pricing, particularly for data center products, partly offset by manufacturing efficiency improvements. Inventory valuation charges were $1.5 million in Q2 and $2.4 million in the first half, versus $0.2 million and $0.7 million, respectively, in 2017.
- Operating expenses increased 31.0% in Q2, led by a 56.6% increase in R&D, reflecting personnel, equipment depreciation, materials and project costs. The company cited development work on 40G, 100G and 200/400G data center products and DOCSIS 3.1/remote-PHY CATV products.
- Top ten customers represented 94.4% of Q2 revenue and 94.0% of first-half revenue. The filing states that sales are generally made through purchase orders rather than long-term customer contracts.
- Capital investment continued, with property, plant and equipment net rising to $212.1 million from $197.9 million at year-end. The company adopted Topic 606 in January 2018 with no material change to revenue timing or amount.
Risks, contingencies and outlook
- Key risks include customer concentration and unpredictable orders, data center demand and pricing, product qualification and execution, inventory obsolescence, manufacturing capacity and labor turnover in China, and reliance on a limited supplier base. The filing also highlights competition, foreign-exchange exposure, U.S.-China trade-policy and tariff uncertainty, and the concentration of proprietary laser-chip manufacturing at the Texas facility.
- A shareholder class action against the company and two officers alleges Exchange Act violations tied to 2017 statements about customer demand. The company disputes the allegations and is contesting the case; briefing on its motion to dismiss was complete, with further deadlines stayed pending the court’s decision. The filing does not provide a clear estimate of potential loss.
- The Tax Act transition-tax calculation remained incomplete pending final foreign earnings and profits calculations. Potential additional taxes on repatriation had not been recorded because the company had not decided whether to change its indefinite-reinvestment assertion.
- No specific revenue or earnings guidance is provided in the supplied filing text. Management’s stated liquidity view covers the next 12 months; actual results remain subject to customer demand, pricing, product mix and operating risks.
- Management concluded disclosure controls were effective as of June 30, 2018, and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether data center demand from the affected major customer stabilizes, and whether growth from other customers offsets the reduction.
- Whether gross margins recover despite ongoing pricing pressure, and how inventory reserves and elevated inventory levels develop.
- Whether first-half operating cash generation can support the investment program and debt obligations without additional financing.
- The concentration and terms of debt, remaining borrowing availability, covenant compliance, and exposure to floating LIBOR-based rates.
- Resolution and potential financial impact of the shareholder class action, and finalization of the Tax Act transition-tax accounting.