Applied Optoelectronics, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. Applied Optoelectronics (AOI) designs and manufactures fiber-optic networking products for data center, cable television (CATV), telecommunications and fiber-to-the-home markets. This unaudited quarterly report covers the three and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Financial amounts below are in U.S. dollars.
Key financial results
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue | 2019: $46.1 million; 2018: $56.4 million, down 18.3% | 2019: $142.2 million; 2018: $209.4 million, down 32.1% |
| Gross profit and margin | 2019: $12.0 million and 26.0%; 2018: $17.5 million and 31.1% | 2019: $34.9 million and 24.5%; 2018: $77.2 million and 36.9% |
| Operating expenses | 2019: $23.0 million; 2018: $27.1 million | 2019: $71.6 million; 2018: $75.7 million |
| Operating income (loss) | 2019: $(11.0) million; 2018: $(9.6) million | 2019: $(36.7) million; 2018: $1.5 million |
| Net income (loss) | 2019: $(8.8) million, or $(0.44) per diluted share; 2018: $(3.7) million, or $(0.19) | 2019: $(30.6) million, or $(1.54) per diluted share; 2018: $6.4 million, or $0.32 |
| Operating cash flow | Nine months 2019: $1.4 million; nine months 2018: $25.6 million | |
| Investing cash flow | Nine months 2019: $(27.0) million; nine months 2018: $(71.0) million | |
| Financing cash flow | Nine months 2019: $39.6 million; nine months 2018: $17.9 million |
Financial position and material changes
- At September 30, 2019, cash, cash equivalents and restricted cash were $72.4 million, compared with $58.0 million at December 31, 2018. Current assets were $190.6 million and current liabilities $64.4 million.
- Total liabilities were $181.6 million and stockholders’ equity was $302.3 million. The company disclosed approximately $129.1 million of consolidated indebtedness. This included $80.5 million principal of 5% convertible senior notes due 2024 and $48.2 million of notes payable and long-term debt, net of issuance costs; bank acceptance payables were another $4.1 million.
- AOI issued $80.5 million of convertible notes in March 2019, receiving $76.4 million net proceeds. It used approximately $37.8 million to repay two BB&T term loans; the remainder was designated for general corporate purposes. Interest expense rose to $4.0 million for the nine-month period from $0.6 million in 2018.
- Unused borrowing capacity was $57.3 million at quarter-end, and AOI reported compliance with BB&T loan covenants. The September 30 amendment reduced the U.S. revolving line commitment to $20 million and extended its maturity to April 2021.
- Nine-month capital spending included $26.0 million of property, plant and equipment purchases. Construction of the Ningbo, China factory was expected to finish in early 2020; approximately $22.6 million of estimated $27.5 million construction costs had been incurred by quarter-end.
- Operating cash flow fell sharply year over year. AOI attributed 2019 operating cash generation to working-capital reductions and non-cash adjustments, offset by the $30.6 million net loss. Cash increased by $14.4 million over the nine months, primarily reflecting financing proceeds.
Revenue drivers, margins and management commentary
- Data center revenue was $34.0 million in Q3, down 12.7% year over year; CATV revenue was $8.8 million, down 38.5%. For the nine months, data center revenue declined 34.2% and CATV declined 21.7%.
- Management attributed weaker revenue primarily to reduced shipments of certain 100 Gbps transceivers to a customer believed to have excess inventory, as well as softer CATV equipment demand. AOI said it was engaged with the customer and assessing the potential effect on future deliveries.
- Gross margin contracted as a result of added quality-control testing costs for 100 Gbps data center products, lower selling prices and reduced production volume that spread fixed costs across fewer units. Inventory write-down expense was $6.6 million for the first nine months of 2019, versus $5.5 million in 2018.
- Top ten customers contributed 88.3% of Q3 revenue and 89.0% of nine-month revenue. The filing notes that customers generally order through purchase orders, without long-term purchase commitments.
- Other income included $1.1 million of government subsidies in Q3, primarily associated with product development investment and high-tech enterprise status in China. AOI received an income tax benefit of $7.6 million for the nine months despite its pretax loss; tax rates depend in part on jurisdictional earnings mix and other factors.
Outlook, risks and contingencies
- AOI stated that existing cash, operating cash flows and available credit should meet anticipated cash needs for the next 12 months. It gave no specific revenue or earnings guidance in the supplied filing text. It cautioned that future capital needs depend on growth, research and development, capacity expansion, product introductions and factory construction. A new shelf registration filed October 24, 2019, once effective, would permit offerings of up to $250 million of securities.
- Key business risks include customer concentration and unpredictable order changes, product qualification and manufacturing quality, price pressure and underutilized capacity, inventory obsolescence, and competition. Trade tariffs between the U.S. and China had increased costs, although AOI said the impact had not been material to date; future effects were uncertain.
- Two securities class actions remained pending. In the 2017 case, the motion to dismiss had been denied and class certification was awaiting a court decision; in the 2018 case, a motion to dismiss was pending. AOI disputed the claims and said it could not yet determine the likelihood or amount of loss. Related shareholder derivative litigation was stayed. A separate books-and-records case was also stayed.
- Management concluded disclosure controls and procedures were effective as of September 30, 2019 and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the major data center customer’s excess inventory continues to constrain 100 Gbps orders, and whether demand diversifies across customers and end markets.
- Whether quality-control testing, pricing and production volumes improve sufficiently to stabilize gross margins and reduce inventory write-downs.
- Cash conversion and liquidity: operating cash flow was only $1.4 million for nine months, while capital spending and factory commitments continue; verify available borrowing capacity and covenant terms.
- The full cost and potential dilution implications of the $80.5 million convertible notes, including conversion terms, interest and future debt service.
- Developments in the securities litigation, China-related tariffs and factory construction, together with the timing and terms of any securities issuance under the new shelf registration.