Applied Optoelectronics, Inc. — Q1 2019 Form 10-Q
Business context and period: AOI designs and manufactures fiber-optic networking products for data center, cable television (CATV), telecommunications and fiber-to-the-home markets. This unaudited report covers the three months ended March 31, 2019; comparisons are with Q1 2018 unless otherwise noted. Financial amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Revenue | $52.7 million | $65.2 million; down 19.2% |
| Gross profit and margin | $12.4 million; 23.4% | $25.8 million; 39.6% |
| Operating income (loss) | $(11.9) million | $2.2 million |
| Net income (loss) | $(10.5) million; $(0.53) per diluted share | $2.1 million; $0.11 per diluted share |
| Operating expenses | $24.2 million | $23.7 million |
| Operating cash flow | $0.04 million | $(4.1) million |
| Investing cash flow | $(9.0) million | $(12.2) million |
| Cash, cash equivalents and restricted cash | $77.5 million at March 31 | $58.0 million at December 31, 2018 |
Revenue mix and material changes
- Data center revenue was $38.5 million, down 23.9%; CATV was $12.0 million, up 13.2%; telecom was $1.7 million, down 51.5%; and FTTH was $0.1 million.
- Management attributed the revenue decline primarily to reduced shipments of certain 100 Gbps transceivers to one customer, which it believes had excess inventory. The company said it was assessing the effect on future deliveries.
- Gross margin fell 16.2 percentage points. Cost of goods sold rose 2.4% despite lower revenue; AOI cited higher production costs for 100G data center products associated with enhanced quality-control testing.
- R&D expense decreased 4.7% to $11.2 million. General and administrative expense increased 10.4% to $10.4 million, primarily due to higher share-based compensation and depreciation.
- The top ten customers accounted for 92.1% of revenue, compared with 94.3% in Q1 2018. AOI does not generally have long-term purchase commitments with customers.
Cash, debt and liquidity
- Cash from operations was approximately break-even. Working-capital movements included a $7.3 million reduction in inventory, partly offset by lower accrued liabilities and accounts payable and higher accounts receivable.
- Capital spending included $12.8 million of property, plant and equipment purchases. The company reported $9.0 million of net investing cash outflow.
- On March 5, AOI issued $80.5 million of 5% convertible senior notes due 2024, receiving $76.4 million net. It used about $37.8 million to repay BB&T term loans; remaining proceeds were for general corporate purposes. The initial conversion price was approximately $17.55 per share.
- At March 31, notes payable and long-term debt had a $35.7 million carrying amount; convertible notes had a $76.4 million carrying amount; and bank acceptance payables were $5.2 million. AOI reported approximately $117.3 million of consolidated indebtedness. The company had $36.7 million of unused borrowing capacity and was in compliance with its BB&T covenants.
- Operating lease adoption added a right-of-use asset of $8.3 million and lease liabilities totaling $9.5 million to the balance sheet. AOI said adoption did not affect income statements.
- AOI estimated a $27.5 million cost for its Ningbo, China factory construction contract; about $12.0 million had been incurred by March 31. Completion was expected in early 2020.
Outlook, risks and other notable items
- Management stated existing cash, operating cash flows and available credit should be sufficient for anticipated needs over the next 12 months. The filing gives no quantified revenue or earnings guidance.
- Key risks include highly concentrated customers and demand forecasts, potential excess inventory, product quality and testing costs, competition, fixed manufacturing costs, and exposure to China/Taiwan operations, foreign exchange and trade policy.
- Inventory was $84.5 million, down from $93.3 million at year-end. The lower-of-cost-or-market inventory charge was $2.3 million, versus $0.9 million in Q1 2018.
- AOI disclosed securities class actions and related derivative litigation. A motion to dismiss in the 2017 class action had been denied, and the case entered early discovery. The company said it could not yet estimate the likelihood or amount of loss. A separate books-and-records suit was filed April 10, 2019.
- Management concluded disclosure controls and procedures were effective as of March 31, 2019. The filing reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the major data-center customer’s excess inventory continues to reduce 100G shipments, and whether new customers offset the decline.
- Whether added product testing and quality-control measures improve reliability and gross margin, and whether related costs persist.
- Customer concentration, order visibility and inventory exposure, given the lack of long-term purchase commitments.
- Debt service, covenant flexibility, potential dilution from conversion of the 2024 notes, and the company’s ability to fund factory construction and operations.
- Developments and potential financial exposure from the disclosed litigation; the filing does not provide a clear loss estimate.