You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes appearing elsewhere in this Quarterly Report on Form 10-Q for the period ended
March 31, 2022and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2021included in our Annual Report. References to " Applied Optoelectronics," "we," "our" and "us" are to Applied Optoelectronics, Inc.and its subsidiaries unless otherwise specified or the context otherwise requires. This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Terminology such as "believe," "may," "estimate," "continue," "anticipate," "intend," "should," "could," "would," "target," "seek," "aim," "believe," "predicts," "think," "objectives," "optimistic," "new," "goal," "strategy," "potential," "is likely," "will," "expect," "plan," "project," "permit," or by other similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and industry and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in "Part II -Item 1A. Risk Factors" provided below, and those discussed in other documents we file with the SEC, including our Report on Form 10-K for the year ended December 31, 2021and subsequent Quarterly Reports on Form 10-Q. Furthermore, such forward-looking statements speak only as of the date of this Quarterly Report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of this Quarterly Report.
We are a leading, vertically integrated provider of fiber-optic networking products. We target four networking end-markets: internet data centers, CATV, telecom and FTTH. We design and manufacture a range of optical communications products at varying levels of integration, from components, subassemblies and modules to complete turn-key equipment. In designing products for our customers, we typically begin with the fundamental building blocks of lasers and laser components. From these foundational products, we design and manufacture a wide range of products to meet our customers' needs and specifications, and such products differ from each other by their end market, intended use and level of integration. We are primarily focused on the higher-performance segments within the internet data center, CATV, telecom and FTTH markets which increasingly demand faster connectivity and innovation. Our vertically integrated manufacturing model provides us several advantages, including rapid product development, fast response times to customer requests and control over product quality and manufacturing costs. The four end markets we target are all driven by significant bandwidth demand fueled by the growth of network-connected devices, video traffic, cloud computing and online social networking. Within the internet data center market, we benefit from the increasing use of higher-capacity optical networking technology as a replacement for copper cables, particularly as speeds reach 100 Gbps and above, as well as the movement to open internet data center architectures and the increasing use of in-house equipment design among leading internet companies. Within the CATV market, we benefit from a number of ongoing trends including the build-out of CATV infrastructure in the US and other countries, the move to higher bandwidth networks among CATV service providers and the outsourcing of system design among CATV networking equipment companies. In the FTTH market, we benefit from continuing PON deployments and system upgrades among telecom service providers. In the telecom market, we benefit from deployment of new high-speed fiber-optic networks by telecom network operators, including 5G networks. Our vertically integrated manufacturing model provides us several advantages, including rapid product development, fast response times to customer requests and greater control over product quality and manufacturing costs. We design, manufacture and integrate our own analog and digital lasers using a proprietary Molecular Beam Epitaxy, or MBE, and Metal Organic Chemical Vapor Deposition (MOCVD) fabrication process, which we believe is unique in our industry. We manufacture the majority of the laser chips and optical components that are used in our products. The lasers we manufacture are tested extensively to enable reliable operation over time and our devices are often highly tolerant of changes in temperature and humidity, making them well-suited to the CATV, FTTH and 5G telecom markets where networking equipment is often installed outdoors. We have three manufacturing sites:
Sugar Land, Texas, Ningbo, Chinaand Taipei, Taiwan. Our research and development functions are generally partnered with our manufacturing locations, and we have an additional research and development facility in Duluth, Georgia. In our Sugar Landfacility, we manufacture laser chips (utilizing our MBE and MOCVD processes), subassemblies and components. The subassemblies are used in the manufacture of components by our other manufacturing facilities or sold to third parties as modules. We manufacture our laser chips only within our Sugar Landfacility, where our laser design team is located. In our Taiwan location, we manufacture optical components, such as our butterfly lasers, which incorporate laser chips, subassemblies and components manufactured within our Sugar Landfacility. Additionally, in our Taiwan location, we manufacture transceivers for the internet data center, telecom, FTTH and other markets. In our Chinafacility, we take advantage of lower labor costs and manufacture certain more labor intensive components and optical equipment systems, such as optical subassemblies and transceivers for the internet data center market, CATV transmitters (at the headend) and CATV outdoor equipment (at the node). Each manufacturing facility conducts testing on the components, modules or subsystems it manufactures and each facility is certified to ISO 9001:2015. Our facilities in Ningbo, China, Taipei, Taiwan, and Sugar Land, Texasare all certified to ISO 14001:2015. Our business depends on winning competitive bid selection processes to develop components, systems and equipment for use in our customers' products. These selection processes are typically lengthy, and as a result our sales cycles will vary based on the level of customization required, market served, whether the design win is with an existing or new customer and whether our solution being designed in our customers' product is our first generation or subsequent generation product. We do not have any long-term purchase commitments (in excess of one year) with any of our customers, most of whom purchase our products on a purchase order basis. However, once one of our solutions is incorporated into a customer's design, we believe that our solution is likely to continue to be purchased for that design throughout that product's life cycle because of the time and expense associated with redesigning the product or substituting an alternative solution.
Our main executive offices are located at
Table of Contents COVID-19 Pandemic We are subject to risks and uncertainties as a result of the COVID-19 pandemic. The extent of the impact of the COVID-19 pandemic on our business is highly uncertain and difficult to predict as coronavirus continues to spread around the world. In
March 2020, we instituted travel restrictions and implemented sanitation and disinfection procedures to safeguard the health and safety of our employees which continue today. Recently, we began allowing certain employee travel, but continue strict sanitation procedures in our facilities. With increased vaccinations and the potential significant reduction of infections, we have implemented procedures for a safe return to the office environment for all of our employees. The spread of COVID-19 has impacted our supply chain operations through restrictions, reduced capacity and shutdown of business activities by suppliers whom we rely on for sourcing components and materials and third-party partners whom we rely on for manufacturing, warehousing and logistics services. Currently, the suppliers who are responsible for most of our supply-chain constraints in 2021 have begun the process of returning to normal operations and have expressed optimism that their deliveries in 2022 will return to normal. However, late in the first quarter of 2022, certain areas of Chinabegan to experience severe restrictions due to COVID-19 outbreaks there. Currently, it is not possible to estimate the impact (if any) of these restrictions because it is not clear how long the restrictions will be in place or the extent to which the restrictions will curtail production by our suppliers in the affected areas. In order to minimize the impact of these and any similar disruptions, we have added additional suppliers for many key components, where it is practical to do so. We believe that these additional suppliers will be able to augment our supply of needed components, although in some cases these new suppliers' materials are more expensive than the pre-existing suppliers so a switch to these alternate suppliers could have a negative impact on gross margins and profitability. However, this is uncertain and we also cannot predict if other suppliers could encounter similar difficulties. Although demand for many of our products has been strong in the short-term as subscribers seek more bandwidth, customers' purchasing decisions over the long-term may be impacted by the pandemic and its impact on the economy, which could in turn impact our revenue and results of operations. The extent to which the COVID-19 pandemic may materially impact our financial condition, liquidity or results of operations is therefore uncertain.
The following table sets forth our consolidated results of operations for the periods presented and as a percentage of our revenues for such periods (in thousands, except percentages):
Three months ended Three months ended March 31, March 31, 2022 2021 Revenue, net
$ 52,242100.0 % $ 49,701100.0 % Cost of goods sold 43,217 82.7 % 38,982 78.4 % Gross profit 9,025 17.3 % 10,719 21.6 % Operating expenses Research and development 9,486 18.2 % 10,928 22.0 % Sales and marketing 2,558 4.9 % 2,960 6.0 % General and administrative 11,220 21.5 % 10,869 21.9 % Total operating expenses 23,264 44.5 % 24,757 49.8 % Loss from operations (14,239 ) (27.3 )% (14,038 ) (28.2 )% Other income (expense) Interest income 28 0.1 % 16 0.0 % Interest expense (1,401 ) (2.7 )% (1,431 ) (2.9 )% Other income, net (450 ) (0.9 )% (169 ) (0.3 )% Total other income (expense), net (1,823 ) (3.5 )% (1,584 ) (3.2 )% Loss before income taxes (16,062 ) (30.7 )% (15,622 ) (31.4 )% Income tax expense - (0.0 )% 0 (0.0 )% Net loss $ (16,062 )(30.7 )% $ (15,622 )(31.4 )%
Comparison of financial results
We generate revenue through the sale of our products to equipment providers and network operators for the internet data center, CATV, telecom and FTTH markets. We derive a significant portion of our revenue from our top ten customers, and we anticipate that we will continue to do so for the foreseeable future. The following charts provide the revenue contribution from each of the markets we served for the three months ended
March 31, 2022and 2021 (in thousands, except percentages): Three months ended March 31, Change % of % of 2022 Revenue 2021 Revenue Amount % Data Center $ 21,41541.0 % $ 25,93952.2 % $ (4,524 )(17.4 )% CATV 24,980 47.8 % 18,638 37.5 % 6,342 34.0 % Telecom 5,265 10.1 % 4,479 9.0 % 786 17.5 % FTTH 98 0.0 % 423 0.9 % (325 ) (1.3 )% Other 484 0.9 % 222 0.4 % 262 118.0 % Total Revenue $ 52,242100.0 % $ 49,701100.0 % $ 2,5415.1 % 20
The increase in revenue during the three months ended
March 31, 2022was driven primarily by increased demand for CATV products. The increase in demand from CATV multiple-system operators ("MSOs") resulted in strong demand for our CATV products, especially those products that are related to architecture improvements to enable delivery of additional bandwidth to consumers. This increase in bandwidth demand is particularly acute in the upstream direction, and sales of products associated with increased return-path bandwidth were notably strong in the quarter. Based on forecasts and current order bookings, we believe that this elevated CATV demand will likely continue through 2022. The increased demand in CATV was offset by decrease demand for datacenter products; this slowdown was related to inventory normalization following the surge in demand that was driven by the shift to working from home during the early stage of COVID-19. In the three months ended March 31, 2022, we began to increase manufacture of our latest generation 400G products for the datacenter. This increase in production is necessary to satisfy orders we began to receive from our customers for these products. We anticipate that as customers begin to order more 400G products, our datacenter business will resume growth. For the three months ended March 31, 2022and 2021, our top ten customers represented 88.6% and 90.5% of our revenue, respectively. We believe that diversifying our customer base is critical for our future success, since reliance on a small number of key customers makes our ability to forecast future results dependent upon the accuracy of the forecasts we receive from those key customers. We continue to prioritize new customer acquisition and growth of diverse revenue streams.
Cost of Goods Sold and Gross Margin
Three months ended March 31, 2022 2021 Change % of % of Amount Revenue Amount Revenue Amount % (in thousands, except percentages)
Cost of Goods Sold
9,025 17.3 % 10,719 21.6 %
Cost of goods sold increased by
Gross margin decreased for the three months ended
March 31, 2022as compared to the three months ended March 31, 2021primarily as a result of changes in the mix of our datacenter and CATV products. In particular, we saw an increase in sales of certain CATV products relative to sales of transceivers. In addition, we experienced higher costs of certain raw materials and global supply chain disruptions due to COVID-19 closures of ports and factories in Asia(see the section above on the COVID-19 pandemic for more details of these challenges). Operating expenses Three months ended March 31, 2022 2021 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Research and development $ 9,48618.2 % $ 10,92822.0 % $ (1,442 )(13.2 )% Sales and marketing 2,558 4.9 % 2,960 6.0 % (402 ) (13.6 )% General and administrative 11,220 21.5 % 10,869 21.9 % 351 3.2 % Total operating expenses $ 23,26444.5 % $ 24,75749.8 % $ (1,493 )(6.0 )%
Research and development costs
Research and development expense decreased by
$1.4 million, or 13.2% for the three months ended March 31, 2022as compared to the three months ended March 31, 2021. Research and development costs consist of R&D work orders, R&D material usage and other project related costs related to 100 Gbps, 200/400 Gbps data center products, DOCSIS 3.1 capable CATV products and other new product development, and depreciation expense resulting from R&D equipment investments. These decreases were primarily due to a decrease in personnel-related costs,share-based compensation expense, and less materials and supplies used in R&D activities. Sales and marketing expense Sales and marketing expense decreased by $0.4 million, or 13.6% for the three months ended March 31, 2022as compared to the three months ended March 31, 2021. These decreases were primarily due to a decrease in personnel-related costs, commission expenses, duties and freight. These decreases were partially offset by a increase in trade show expenses.
General and administrative costs
General and administrative expense increased by
$0.4 million, or 3.2% for the three months ended March 31, 2022compared to the three months ended March 31, 2021. These increases were primarily due to an increase in depreciation expense and performance based incentive expenses. These increases were partially offset by a decrease in personnel-related costs and professional service fees. 21
Table of Contents Other income (expense), net Three months ended March 31, 2022 2021 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Interest income
$ 280.1 % $ 160.0 % $ 1275.0 % Interest expense (1,401 ) (2.7 )% (1,431 ) (2.9 )% 30 (2.1 )% Other expense, net (450 ) (0.9 )% (169 ) (0.3 )% (281 ) 166.3 % Total other expense, net $ (1,823 )(3.5 )% $ (1,584 )(3.2 )% $ (239 )15.1 % Interest income increased slightly for the three months ended March 31, 2022compared to the three months ended March 31, 2021. The changes are similar to expected rates of fluctuation with the interest rates and cash balances.
Interest expense decreased slightly for the three months ended
compared to the three months ended
Other expense increased by
$0.3 million, or 166.3%, for the three months ended ended March 31, 2022as compared to the three months ended March 31, 2021. This increase was mainly due to loss in foreign currency transaction.
Benefit (provision) for income tax
Three months ended March 31, 2022 2021 Change (in thousands, except percentages) Benefit (provision) for income taxes $ - $ - -
The Company's effective tax rate for the three months ended
March 31, 2022and 2021 was 0%. For the three months ended March 31, 2022and 2021, the effective tax rate varied from the federal statutory rate of 21% primarily due to the change of the valuation allowance on federal, state, Taiwan, and Chinadeferred tax assets ("DTA").
Cash and capital resources
March 31, 2022, we had $4.3 millionof unused borrowing capacity from all of our loan agreements. As of March 31, 2022, our cash, cash equivalents and restricted cash totaled $40.1 million. Cash and cash equivalents are held for working capital purposes and are invested primarily in money market or time deposit funds. We do not enter into investments for trading or speculative purposes. On October 24, 2019, we filed a Registration Statement on Form S-3 with the Securities and Exchange Commission, which was declared effective on January 9, 2020, providing for the public offer and sale of certain securities of the Company from time to time, at our discretion, up to an aggregate amount of $250 million. On February 28, 2020, we entered into an Equity Distribution Agreement with Raymond James & Associates, Inc.(the "Sales Agent") pursuant to which the Company may issue and sell shares of the Company's common stock having an aggregate offering price of up to $55 million(the "Initial ATM Offering"), from time to time through the Sales Agent. In January 2021, the Company completed its Initial ATM Offering and sold 5.9 million shares at a weighted average price of $9.12per share, providing proceeds of $53.9 million, net of expenses and underwriting discounts and commissions. On February 26, 2021, we entered into another Equity Distribution Agreement (the "Agreement") with the Sales Agent pursuant to which the Company may issue and sell shares of the Company's common stock, par value $0.001per share (the "Shares") having an aggregate offering price of up to $35 million(the "Second ATM Offering"), from time to time through the Sales Agent. Upon delivery of a placement notice and subject to the terms and conditions of the Agreement, sales, if any, of the Shares will be made through the Sales Agent in transactions that are deemed to be "at the market" offerings as defined in Rule 415 of the Securities Act of 1933, as amended (the "Securities Act"), including sales made through the facilities of the Nasdaq Global Market, the principal trading market for the Company's common stock, on any other existing trading market for the Company's common stock, to or through a market maker or as otherwise agreed by the Company and the Sales Agent. In the placement notice, the Company will designate the maximum number of Shares to be sold through the Sales Agent, the time period during which sales are requested to be made, the minimum price for the Shares to be sold, and any limitation on the number of Shares that may be sold in any one day. Subject to the terms and conditions of the Agreement, the Sales Agent will use its commercially reasonable efforts to sell Shares on the Company's behalf up to the designated amount specified in the placement notice. The Company has no obligation to sell any Shares under the Agreement and may at any time suspend offers and sales of the Shares under the Agreement. 22
The Agreement provides that the Sales Agent will be entitled to compensation of up to 2% of the gross sales price of the Shares sold through the Sales Agent from time to time. The Company has also agreed to reimburse the Sales Agent for certain specified expenses in connection with the registration of Shares under state blue sky laws and any filing with, and clearance of the offering by, the
Financial Industry Regulatory Authority Inc., not to exceed $10,000in the aggregate, and any associated application fees incurred. Additionally, if the Agreement is terminated under certain circumstances, and the Company fails to sell a minimum amount of the Shares as set forth in the Agreement, then the Company has agreed to reimburse the Sales Agent for reasonable out-of-pocket expenses, including the reasonable fees and disbursements of counsel incurred by the Sales Agent, up to a maximum of $30,000in the aggregate. The Company agreed to indemnify the Sales Agent against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that the Sales Agent may be required to make because of any of those liabilities.
March 5, 2019, the Company issued $80.5 millionof 5% convertible senior notes due 2024 (the "Notes"), bearing interest at a rate of 5% per year maturing on March 15, 2024, unless earlier repurchased, redeemed or converted in accordance with their terms. The sale of the Notes generated net proceeds of $76.4 million, after expenses. Also refer to Note 12 "Convertible Senior Notes" to the consolidated financial statements for further discussion of the Notes. The table below sets forth selected cash flow data for the periods presented (in thousands): Three months ended March 31, 2022 2021 Net cash used in operating activities $ (3,603 ) $ (15,214 )Net cash used in investing activities (1,051 ) (2,422 ) Net cash provided by financing activities 3,736 17,475 Effect of exchange rates on cash and cash equivalents (110 ) (615 ) Net decrease in cash and cash equivalents $ (1,028 )$ (776 ) Operating activities For the three months ended March 31, 2022, net cash used in operating activities was $3.6 million. Net cash used in operating activities consisted of our net loss of $16.1 millionafter exclusion of non-cash items of $11.8 million. Cash decreased due to a decrease in accrued liabilities of $2.3 millionand an increase in inventory of $2.0 million, offset with an decrease in trade receivables from our customers of $7.0 million. For the three months ended March 31, 2021, net cash used in operating activities was $15.2 million. Net cash used in operating activities consisted of our net loss of $15.6 millionafter exclusion of non-cash items of $11.0 million, cash decreased due to a decrease in accrued liabilities of $4.5 million, a decrease in accounts payable to our vendors of $3.3 million, and an increase in accounts receivable from our customers of $4.5 million, offset by a decrease in inventory of $2.8 million. Investing activities For the three months ended March 31, 2022, net cash used in investing activities was $1.1 million, mainly from the purchase of additional plant, machinery and equipment. For the three months ended March 31, 2021, net cash used in investing activities was $2.4 million, mainly from the purchase of additional plant, machinery and equipment. Financing activities For the three months ended March 31, 2022, our financing activities provided $3.7 millionin cash. This increase in cash was due to $2.3 millionnet proceeds from lines of credit and $1.7 millionnet proceeds from acceptances payable. For the three months ended March 31, 2021, our financing activities provided $17.5 millionin cash. This increase in cash was due to $15.1 millionof net proceeds from our At The Market (ATM) Offerings, $13.2 millionnet proceeds from lines of credit offset by net loan repayment of $1.0 millionand net repayment of acceptances payable of $9.5 million. 23
Table of Contents Loans and commitments We have lending arrangements with several financial institutions. In the US, we have a revolving line of credit with
Truist Bank. The line of credit contains financial covenants that may limit the amount and types of debt that we may incur. As of March 31, 2022, we were in compliance with these covenants. In Taiwan, we do not currently have banking facilities for Prime World's Taiwan Branch. In China, we have revolving lines of credit with Shanghai Pudong Development Bank Co., Ltd. and credit facilities with China Zheshang Bank Co., Ltd. for our China Subsidiary, Global .
See Note 11 "Notes Payable and Long-term Debt" and Note 12 "Convertible Senior Notes" of our Condensed Consolidated Financial Statements for a description of our notes payable and long-term debt and convertible senior notes.
February 8, 2018, we entered into a construction contract with Zhejiang Xinyu Construction Group Co., Ltd.for the construction of a new factory and other facilities at our Ningbo, Chinalocation. Construction costs for these facilities under this contract are estimated to total approximately $27.5 million. As of September 30, 2020, construction of the building is complete, and approximately $27.4 millionof this total cost has been paid and the remaining portion will be paid in yearly installments for three years after final inspection. We anticipate additional expenses for building improvements to the factory and we are in the process of evaluating the timing of these expenditures and obtaining bids for any such work. Based on forecasts, we believe that the factory will be placed in service in second half of 2022 or early 2023, and at this time the factory property will be transferred from construction in progress to building and improvements.
Future liquidity needs
We believe that our existing cash and cash equivalents, cash flows from our operating activities, and available credit will be sufficient to meet our anticipated cash needs for the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support our research and development efforts, the expansion of our sales and marketing activities, the introduction of new and enhanced products, the building improvement of a new factory and other facilities at our
Ningbo, Chinalocation, changes in our manufacturing capacity and the continuing market acceptance of our products. In the event we need additional liquidity, we will explore additional sources of liquidity. These additional sources of liquidity could include one, or a combination, of the following: (i) issuing equity or debt securities, (ii) incurring indebtedness secured by our assets and (iii) selling product lines, other assets and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all.
Contractual obligations and commitments
Please refer to Item 7 "Mangement's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2021for a complete discussion of its contractual obligations and commitments. Inflation The annual inflation rate in the US and Taiwan accelerated more than 7% in 2021. Cost inflation included increases in shipping costs, labor rates, and in costs of some raw materials. We currently believe these increases are related to the COVID-19 pandemic (see the section above on the COVID-19 pandemic for more details of these challenges), however we cannot be sure when or if prices will return to pre-pandemic levels. There is no guarantee that we can increase selling prices or reduce costs to fully mitigate the effect of inflation on our costs, which may adversely impact our sales margins and profitability. Compared to other major economies in the world, Chinahas a stable level of inflation, which has not had a significant impact on our sales or operating results.
Significant Accounting Policies and Estimates
In our Annual Report for the year ended
December 31, 2021and in the Notes to the Financial Statements herein, we identify our most critical accounting policies. In preparing the financial statements, we make assumptions, estimates and judgments that affect the amounts reported. We periodically evaluate our estimates and judgments that are most critical in nature which are related to revenue recognition, allowance for credit losses, inventory reserves, impairment of long-lived assets (excluding goodwill and other indefinite-lived intangible assets), goodwill and other indefinite-lived intangible assets, purchase price allocation of acquisitions, service and product warranties, and income taxes. Our estimates are based on historical experience and on our future expectations that we believe are reasonable. The combination of these factors forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results are likely to differ from our current estimates and those differences may be material. 24
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