Applied Optoelectronics, Inc. — Q2 2019 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended June 30, 2019. Applied Optoelectronics designs and manufactures fiber-optic networking products for data center, CATV, telecom and FTTH markets, with operations in the U.S., Taiwan and China.
Financial performance and position
- Q2 revenue: $43.4 million, down 50.6% from $87.8 million a year earlier. Data center revenue was $31.8 million (73.3% of total), down 53.9%; CATV revenue was $9.8 million, down 30.8%.
- First-half revenue: $96.1 million, down 37.2% from $153.1 million. Data center revenue fell 41.2% to $70.3 million.
- Profitability: Q2 gross profit was $10.5 million and gross margin was 24.3%, versus $33.9 million and 38.6% in Q2 2018. Operating loss was $13.8 million, compared with operating income of $8.9 million; net loss was $11.4 million, or $0.57 per diluted share, versus net income of $8.0 million, or $0.40 per diluted share. First-half gross margin was 23.8% versus 39.0%; net loss was $21.8 million versus net income of $10.2 million.
- Cash flow: First-half operating cash flow was $7.2 million, down from $18.1 million. Investing cash outflow was $20.8 million, including $26.3 million of property and equipment purchases. Financing provided $39.3 million. Cash, cash equivalents and restricted cash totaled $84.0 million at June 30, compared with $58.0 million at year-end 2018.
- Liquidity and debt: Current assets were $201.0 million and current liabilities $68.1 million. Cash and cash equivalents were $81.1 million, with $2.9 million restricted. Notes payable and long-term debt had a net carrying amount of $49.6 million; convertible senior notes were carried at $76.6 million, with $80.5 million principal outstanding. The filing cites approximately $128.8 million of consolidated indebtedness and $64.7 million of unused borrowing capacity. The company reported compliance with its BB&T covenants.
- Other balance-sheet items: Inventory was $81.5 million, down from $93.3 million at December 31, 2018. The company recorded $5.2 million of inventory write-downs in the first half, versus $2.4 million in the prior-year period.
Material changes versus the prior comparable period
- Management attributed the revenue decline primarily to lower shipments of certain 100 Gbps transceivers to one customer, which it believes had excess inventory. The company said it was evaluating the effect on future deliveries.
- Gross margin declined amid additional quality-control testing costs for 100 Gbps data center products, lower selling prices and reduced production volume, which left fixed costs spread over fewer units.
- First-half interest expense rose to $2.5 million from $0.4 million, reflecting higher debt, including the convertible notes. On March 5, 2019, the company issued $80.5 million of 5% convertible senior notes due 2024, receiving $76.4 million net; approximately $37.8 million was used to repay BB&T term loans.
- Operating expenses were $24.4 million in Q2, down slightly from $24.9 million; first-half expenses were $48.6 million in both years. General and administrative expense increased, while research and development expense declined.
Outlook, commentary and risks
- Management stated that cash, operating cash flows and available credit should meet anticipated cash needs for the next 12 months. The filing provides no specific revenue or earnings guidance. Construction of the Ningbo, China factory was expected to be completed in early 2020; estimated total contract cost was approximately $27.5 million, of which $17.7 million had been incurred by June 30, 2019.
- Customer concentration remains high: the top ten customers represented 90.9% of Q2 revenue and 90.5% of first-half revenue. The company generally relies on purchase orders rather than long-term purchase commitments.
- Key disclosed risks include demand and forecast volatility, customer concentration and potential inventory corrections, product quality and qualification, price erosion and fixed-cost absorption, competition, supply constraints, China/U.S. trade measures, foreign-exchange exposure, and reliance on manufacturing operations in China and Taiwan.
- The company disclosed securities class-action and derivative litigation. It disputes the allegations; at this stage it could not determine the likelihood or amount of any loss in the class-action matter. A separate books-and-records case was stayed by agreement while the parties sought resolution.
- Management concluded disclosure controls and procedures were effective as of June 30, 2019 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the large data-center customer’s excess inventory continues to reduce orders, and whether customer demand forecasts or product mix improve.
- Whether quality-control costs, selling-price pressure and lower utilization continue to weigh on gross margin.
- Cash generation relative to capital spending, factory construction commitments, debt service and the stated $64.7 million of available borrowing capacity.
- Terms, potential dilution and future interest obligations associated with the 5% convertible notes, including their conversion terms.
- Developments in the disclosed securities litigation and any resulting financial exposure.