Applied Optoelectronics, Inc. (NASDAQ: AAOI) — FY 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Business context
AOI designs and manufactures fiber-optic networking products, from laser components to transceivers and network equipment. Its markets are internet data centers, cable television (CATV), telecom, and fiber-to-the-home (FTTH). The data-center market accounted for 75.2% of FY 2019 revenue; CATV accounted for 19.6%.
Financial performance
| Metric | FY 2019 | FY 2018 | Q4 2019 | Q4 2018 |
|---|---|---|---|---|
| Revenue | $190.9 million | $267.5 million | $48.7 million | $58.0 million |
| Gross profit / margin | $46.2 million / 24.2% | $87.8 million / 32.8% | $11.3 million / 23.3% | $10.5 million / 18.2% |
| Operating income (loss) | $(48.7) million | $(10.8) million | $(12.1) million | $(12.3) million |
| Net income (loss) | $(66.0) million | $(2.1) million | $(35.4) million | $(8.6) million |
| Basic and diluted loss per share | $(3.31) | $(0.11) | $(1.76) | $(0.43) |
- Revenue and margins: FY revenue declined 28.6%. Gross margin fell 8.6 percentage points. Management attributed the margin decline mainly to data-center product mix, including greater sales of lower-cost, shorter-reach 100 Gbps transceivers, and quality and testing costs. Q4 revenue declined about 16.1% year over year, while gross margin improved 5.1 points.
- Cash flow: Operating cash flow was $(1.8) million, versus $14.0 million in 2018. Investing cash flow was $(32.1) million, primarily reflecting capital spending; financing provided $42.6 million. Cash, cash equivalents, and restricted cash increased by $9.0 million.
- Liquidity: At year-end, cash and cash equivalents were $60.0 million, restricted cash was $7.1 million, and working capital was $101.4 million. The company reported $48.8 million of unused borrowing capacity. Management said existing cash, operating cash flows, and available credit were expected to cover anticipated needs for the next 12 months.
- Debt: Notes payable and long-term debt totaled $49.9 million, and convertible senior notes had a $77.0 million carrying value ($80.5 million principal). The company also reported $6.3 million of bank acceptance payables. It disclosed approximately $133.3 million of consolidated indebtedness. The 5% convertible notes mature in 2024; approximately $37.8 million of their net proceeds repaid BB&T loans.
- Balance sheet: Total assets were $466.8 million, total liabilities $193.0 million, and stockholders’ equity $273.8 million. Inventory was $85.0 million, down from $93.3 million. The company recorded $6.8 million of inventory reserve expense and $13.4 million of direct inventory write-offs in 2019.
Material changes and notable items
- Data-center revenue decreased 28.3%; CATV revenue fell 27.8%, and telecom revenue fell 35.9%. Management cited lower demand for 40 Gbps and 100 Gbps transceivers, reduced CATV outside-plant spending, and weaker demand for legacy telecom products.
- Customer concentration remains substantial: the top ten customers contributed 88.1% of revenue. Microsoft represented 32.2%, Amazon 24.0%, Facebook 10.9%, and Cisco 10.0%.
- Operating expenses were $94.9 million, or 49.7% of revenue, versus $98.5 million, or 36.8%, in 2018. R&D expense decreased to $43.4 million, while sales and marketing and general and administrative expenses increased.
- Interest expense rose to $5.4 million from $1.1 million, primarily reflecting higher debt and convertible-note costs. A $14.7 million income-tax expense included a valuation allowance on U.S. and state deferred tax assets; a $7.6 million tax benefit was recorded in 2018.
- The company spent $32.1 million on investing activities, including construction of a new China factory. The project was estimated at $27.5 million, with $23.8 million incurred by year-end and completion expected in mid-2020.
Outlook, risks, and contingencies
- Management expected continued 40 Gbps and 100 Gbps sales in 2020, with 100 Gbps sales likely to grow and exceed 40 Gbps sales; it cautioned that results could vary significantly during the technology transition. It was monitoring potential coronavirus effects on operations and revenue.
- Key risks include reliance on a small number of customers, short-term and cancelable purchase orders, pricing pressure, manufacturing yields and product quality, inventory obsolescence, and dependence on China and Taiwan operations and suppliers. Trade restrictions, foreign-exchange movements, and the single U.S. site for proprietary laser fabrication add exposure.
- A securities class action related to 2017 disclosures had been certified as a class; the company could not estimate the likelihood or amount of loss. A separate securities class action related to 2018 guidance was dismissed with prejudice on January 29, 2020, subject to a possible appeal. Related derivative litigation was stayed.
- AOI reported that it was in compliance with its loan covenants at December 31, 2019. It repaid its $20 million revolving credit line in January 2020. Its auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- Whether data-center demand, customer orders, and 100 Gbps product mix support revenue recovery and sustained gross-margin improvement.
- Current purchase volumes and customer concentration, particularly exposure to Microsoft, Amazon, Facebook, and Cisco.
- Cash generation, debt and interest burden, credit availability, covenant compliance, and any dilution from convertible notes or future securities issuance.
- Inventory quality, reserve adequacy, product reliability, and the operational and financial outcome of the China factory expansion.
- Developments in the securities litigation and the effect of coronavirus-related disruption, trade restrictions, and supply-chain risks.