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AAOI > SEC Filings for AAOI > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for APPLIED OPTOELECTRONICS, INC.

Form 10-Q for APPLIED OPTOELECTRONICS, INC.


12-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the period ended March 31, 2014 and 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, 2013 included in our Annual Report on Form 10-K. . 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," "might," "objective," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "potential," "will" or the negative of these terms or other similar expressions is 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. 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.

Overview

We are a leading, vertically integrated provider of fiber-optic access networking products. We target three networking end-markets: Cable TV Broadband, or CATV, Fiber-to-the-Home, or FTTH and internet data centers. In designing products for our customers, we begin with the fundamental building blocks of lasers and laser components. From these foundational products, we design and manufacture optical communications products at varying levels of integration, from components, subassemblies and modules to complete turn-key equipment. We tailor our products to our customers' needs and specifications, but leverage fundamental laser technology across our different products.

The three end markets we target are all driven by increasing bandwidth demand fueled by the growth of network-connected devices, video traffic, cloud computing and online social networking. To address this increased bandwidth demand, CATV and FTTH service providers are investing to enhance the capacity and capability of their networks. The trend of rising bandwidth consumption also impacts the internet data center market, as reflected in the shift to higher speed server connections. As a result of these trends, fiber-optic networking technology is becoming essential in all three of our target markets, as it is often the only economic way to deliver the required bandwidth.

Our vertically integrated manufacturing model provides us several advantages, including rapid product development, fast response times to customer requests and better control over product quality and manufacturing costs. The lasers we manufacture are proven to be reliable over time and highly tolerant of changes in temperature and humidity, making them well-suited to the CATV and FTTH markets where networking equipment is often installed outdoors.

We have three manufacturing sites: Sugar Land, Texas, Ningbo, China and Taipei, Taiwan. Our research and development functions are partnered with our manufacturing locations. In our U.S. facility, we manufacture our laser chips, sub-assemblies and components. We manufacture our laser chips only within our U.S. facility, where our laser R&D team is located. In our Taiwan location, we manufacture transceivers for the FTTH and internet data center markets, which incorporate our own laser chips and components made in the U.S. In our China facility, we take advantage of lower labor costs and manufacture most of our CATV equipment systems, such as headend transmitters and outdoor nodes. Each facility conducts testing on the components, modules or subsystems it manufactures and each facility is certified to ISO 9001:2000.

Our sales model focuses on direct engagement and close coordination with our customers to determine product design, qualifications, performance through coordination of our sales, product engineering and manufacturing teams. Our strategy is to use our direct sales force to sell to key accounts within our markets, increasing product penetration within those customers while also growing our overall customer base in certain international and domestic markets. We have direct sales personnel in each of our U.S., Taiwan and China locations focusing on a direct and local interaction with our CATV, FTTH and internet data center customers. Throughout our sales cycle, we work closely with our customers to achieve design wins that we believe provides long-lasting relationships and promotes higher customer retention.

We have grown our revenue at a 33.1% CAGR between 2009 and 2013, including 23.7% growth year-over-year from 2012 to 2013. Our revenue growth in 2013 was driven primarily by increasing revenue from our internet data center customers. Growth in the first three months of 2014 has been driven primarily by increasing revenue from our internet data center customers.

Our principal executive offices are located at 13115 Jess Pirtle Blvd., Sugar Land, TX 77478, and our telephone number is (281) 295-1800.

Results of Operations



The following table set forth our consolidated results of operations for the
periods presented and as a percentage of our revenue for those periods.



                                       Three months ended March 31,
                                         2014                 2013
Revenue, net                                100.0%               100.0%
Cost of goods sold                           65.2%                68.0%
Gross profit                                 34.8%                32.0%
Operating expenses
Research and development                     14.3%                14.0%
Sales and marketing                           5.4%                 6.3%
General and administrative                   14.3%                16.6%
Total operating expenses                     34.0%                36.9%
Income (loss) from operations                 0.8%                -4.9%
Other income (expense)
Interest income                               0.3%                 0.1%
Interest expense                             -0.7%                -2.1%
Other expense, net                           -0.1%                -0.1%
Total other expense                          -0.5%                -2.1%
Income (loss) before income taxes             0.3%                -7.0%
Income taxes                                 -0.1%                 0.0%
Net income (loss)                             0.2%                -7.0%

Comparison of Financial Results

Revenue

We generate revenue through the sale of our products to equipment providers for the CATV, FTTH and internet data center 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. We also anticipate that our revenue derived from the FTTH and internet data center markets will increase as a percentage of our revenue as we further penetrate and extend our products into these markets. The following chart provides the revenue contribution from each of the markets we served for the three months ended March 31, 2014 and 2013:

Three months ended March 31,

                   2014                 2013
CATV                   39.2%                57.7%
Data Center            46.6%                25.3%
FTTH                    8.9%                 7.6%
Other                   5.3%                 9.4%
                      100.0%               100.0%




                   Three months ended March 31,                Change
                     2014                 2013           Amount         %
CATV            $        9,748       $        8,259     $  1,489        18.0%
Data Center             11,575                3,620        7,955       219.8%
FTTH                     2,216                1,087        1,129       103.9%
Other                    1,320                1,351          (31 )      (2.3% )
Total Revenue   $       24,859       $       14,317     $ 10,542        73.6%

Revenues in the internet data center market were driven primarily by increasing demand for our 10 gigabits per second transceivers as our customers continued to upgrade their technology infrastructure. Revenues in the FTTH and other markets were driven primarily by the addition of new customers in the FTTH market and increasing sales to existing customers. The increase in revenues in the CATV market was a result of market wide weakness in 2013, particularly in China, as well as delays in orders as a consequence of mergers among several of our CATV customers.

For the three months ended March 31, 2014, our top ten customers represented 81.9% of our revenue.

Cost of goods sold and gross margin

                              Three months ended March 31,
                             2014                      2013                   Change
                                    % of                     % of
                      Amount      Revenue      Amount      Revenue      Amount         %
                                       (in thousands, except percentages)
Cost of goods sold   $ 16,206        65.2%     $ 9,732        68.0%     $ 6,474       66.5%
Gross margin                         34.8%                    32.0%

Cost of goods sold increased by $6.5 million, or 66.5%, from the three months ended March 31, 2014 to the three months ended March 31, 2013, primarily due to an 11.5% increase in sales or 73.6% over the prior year.

Within our markets, we sell similar products in different geographic regions at different prices, and therefore realize different gross margins among these similar products. The increase in gross margin from 32.0% to 34.8% for the three months ended March 31, 2014 was the result of sales of higher margin data center products.

Operating expenses

                                Three months ended March 31,
                              2014                         2013                       Change
                                     % of                         % of
                     Amount         revenue       Amount         revenue       Amount           %
                                           (in thousands, except percentages)
Research and
development         $   3,546          14.3%     $   2,004          14.0%     $   1,542         76.9%
Sales and
marketing               1,333           5.4%           907           6.3%           426         47.0%
General and
administrative          3,554          14.3%         2,374          16.6%         1,180         49.7%
Total operating
expenses            $   8,433          33.9%     $   5,285          36.9%     $   3,148         59.6%

Research and development expense

Research and development expense increased by $1.5 million, or 76.9%, from the three months ended March 31, 2013 compared to the three months ended March 31, 2014. This was primarily due to increases in personnel costs, R&D work orders and project costs related to FTTH and other new product development, and increase in depreciation expenses resulting from additional equipment investments

Sales and marketing expense

Sales and marketing expense increased by $0.4 million, or 47.0%, from the three months ended March 31, 2013 compared to the three months ended March 31, 2014. This was due to an increase in personnel costs from additional sales and marketing staff to better serve our customers and an increase in sales commissions directly related to our revenue growth.

General and administrative expense

General and administrative expense increased by $1.2 million, or 49.7%, from the three months ended March 31, 2013 compared to the three months ended March 31, 2014. This was primarily due to an increase in share-based compensation expense as well as an increase in personnel costs, expenses related to being a public company, professional fees and travel expenses.

Other income (expense), net

                                   Three months ended March 31,
                                   2014                     2013                     Change
                                         % of                     % of
                           Amount      revenue      Amount      revenue       Amount          %
                                              (in thousands, except percentages)
Interest income            $    79         0.3%     $    20         0.1%     $     59        295.0%
Interest expense              (162 )      (0.7% )      (306 )      (2.1% )        144         47.1%
Other expense, net             (27 )      (0.1% )        (8 )      (0.1% )        (19 )     (237.5% )
Total other expense, net   $  (110 )      (0.4% )   $  (294 )      (2.1% )   $    184         62.6%

Total net other expense decreased by $0.2 million from the three months ended March 31, 2013 compared to the three months ended March 31, 2014.

Interest expense decreased overall for the period due to the benefit of lower interest rates as well as lower loan balances.

Interest income increased over the same prior year period due to higher cash and investment balances.

Other net expense increased due to an unrealized foreign exchange loss recognized resulting from the depreciation of the Asia currencies against the U.S. dollar offset by government subsidies received in China. We qualify as a high-tech enterprise in China and are paid subsidies from time to time based upon the revenue earned in China by the Chinese government to foster local high-tech manufacturing.

Provision for income taxes

Three months ended March 31, 2014 2013 Change

(in thousands, except percentages)

Provision for income taxes $ 25 $ - 25 100.0%

Our income tax expense for the three month ended March 31, 2014 consists of U.S. alternative minimum tax recorded during the period. Due to historic losses in the U.S., our net deferred tax assets are fully offset by a deferred tax valuation allowance.

Liquidity and Capital Resources

From inception until our initial public offering, we financed our operations through private sales of equity securities, cash generated from operations and from various lending arrangements. On October 1, 2013, we completed our initial public offering, in which we issued and sold 3.6 million shares of our common stock at a public offering price of $10.00 per share, providing proceeds of $31.5 million, net of underwriting discounts and commissions and offering expenses. On March 25, 2014, we completed a secondary offering, in which we issued and sold 2.0 million shares of our common stock at an offering price of $24.25 per share, providing proceeds of $45.7 million, net of underwriting discounts and commissions and offering expenses. As of March 31, 2014, our cash, cash equivalents, restricted cash and short-term investments totaled $61.1 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.

The table below sets forth selected cash flow data for the periods presented (in thousands):

                                                           Three months ended March 31,
                                                             2014                 2013
Net cash provided by (used in) operating activities     $         (971 )     $        1,320
Net cash used in investing activities                           (8,708 )               (946 )
Net cash provided by (used in) financing activities             40,030               (2,667 )
Effect of exchange rates on cash and cash equivalents               54                  147
Net increase (decrease) in cash and cash equivalents    $       30,405       $       (2,146 )

Operating activities

For the three months ended March 31, 2014, net cash used in operating activities was $0.1 million. During the three months ended March 31, 2014, we recorded a slight net income. The net income incorporated non-cash charges, including depreciation and amortization of $1.2 million, share-based compensation expenses of $0.5 million and non-cash increases to our inventory reserve account of $0.3 million. Cash used in operating activities primarily related to an increase in accounts receivable from the sale of our products and an increase in inventory related to sales orders, offset by cash provided by an increase in accounts payable and an increase in accrued liabilities.

For the three months ended March 31, 2013, net cash provided by operating activities was $1.3 million. During the three months ended March 31, 2013, we recognized a net loss of $1.0 million. The net loss incorporated non-cash charges, including depreciation and amortization of $0.7 million, share-based compensation expenses of $0.1 million and non-cash increases to our inventory reserve account of $0.1 million. Cash provided by operating activities primarily related to a decrease in accounts receivable from the sale of our products and the decrease in notes receivable from our vendors, offset by cash used in an increase in accrued liabilities and a decrease in other current assets.

Investing activities

For the three months ended March 31, 2014, net cash used in investing activities was $8.7 million for the purchase of additional machinery and equipment and the payment for intellectual property licenses to support new product development efforts and manufacturing activities.

For the three months ended March 31, 2013, net cash used in investing activities was $1.0 million for the purchase of additional machinery and equipment to support new product development efforts and manufacturing activities.

Financing activities

Our financing activities consisted primarily of proceeds from the issuance of common stock and activity associated with our various lending arrangements.

For the three months ended March 31, 2014, our financing activities provided $40.0 million in cash. We received $45.7 million in net proceeds from a secondary offering of common stock. We received $0.1 million from the exercise of stock options. These increases were offset by the repayment of $5.7 million in net borrowings associated with our bank loans and an increase in our restricted cash by $0.1 million, related to the compensating balances required for bank acceptance notes in China.

For the three months ended March 31, 2013, our financing activities used $2.7 million in cash. We repaid $2.5 million in net borrowings associated with our bank loans and increased our restricted cash by $0.3 million, related to the compensating balances required for bank acceptance notes in China. Cash used was offset by $0.1 million received from the exercise of stock options and warrants.

Loans and commitments

We have lending arrangements with several financial institutions, including a loan and security agreement with East West Bank in the U.S., several lines of credit arrangements for our China subsidiary and lines of credit and financing agreements for our Taiwan location.

As of March 31, 2014, our loan and security agreement in the U.S. included a $7.0 million revolving line of credit which matures on November 15, 2015. Also included with the same bank is a term loan with monthly payments of principal and interest that matures on November 15, 2014. As of March 31, 2014, we had nothing outstanding under the revolving line of credit and $3.0 million outstanding on the term loan.

On September 10, 2013, our loan and security agreement in the U.S. was amended to add $5.0 million of borrowing capability to the existing credit line, for the purpose of financing equipment. The additional equipment term loan allows us to draw up to the lesser of (i) $5.0 million, or (ii) 90% of the costs of equipment purchased between March 31, 2013 and March 10, 2014. Through March 10, 2014, we are required to pay interest only on the then-outstanding balance, and then pay equal principal payments plus accrued interest monthly for the following 42 months. The interest rate for such equipment term loan is the bank's prime lending rate plus 0.75%, currently a total of 4.0%. As of March 31, 2014, $5.0 million has been drawn against this equipment term loan.

Our loan and security agreement requires us to maintain certain financial covenants, including a minimum current ratio, maximum debt over net worth ratio and minimum debt service coverage. The agreement also restricts our minimum cash deposits and the percentage of deposit with other banks. As of March 31, 2014, we were in compliance with all covenants contained in this agreement.

As of March 31, 2014, our China subsidiary had a line of credit facility with China banks totaling $20.0 million. As of March 31, 2014, a total of $1.6 million was outstanding under various notes, each with its own maturity date and each renewing annually from April 2014 to August 2014. The notes that begin to mature in April 2014 are expected to be extinguished and converted to bank acceptance facility to reduce interest expenses.

As of March 31, 2014, our China subsidiary had a U.S. currency based loan of $1.8 million under various notes with four-month terms.

Our Taiwan location had an outstanding note payable with a financing company to mature on July 31, 2015.

In December 2013, our Taiwan location entered into one year revolving Credit Facility Agreements with Taiwan banks, for a total of $8.0 million. Borrowings under the Credit Facility will be used for general corporate purposes. Our obligations under the credit facility are secured by our $8 million cash deposit in a one-year CD with such banks. Borrowings under the credit facility will bear interest at a rate equal to the Taiwan Time Deposit Interest Rate Index plus 0.41%, which is currently 1.78%. As of March 31, 2014, $7.6 million was outstanding under this credit facility.

A customary business practice in China is for customers to exchange accounts receivable with notes receivable issued by their bank. From time to time we accept notes receivable from certain of our customers in China. These notes receivable are non-interest bearing and are generally due within six months, and such notes receivable may be redeemed with the issuing bank prior to maturity at a discount. Historically, we have collected on the notes receivable in full at the time of maturity.

Frequently, we also direct our banking partners to issue notes payable to our suppliers in China in exchange for accounts payable. Our China subsidiary's banks issue the notes to vendors and issue payment to vendors upon redemption. We owe the payable balance to the issuing bank. The notes payable are non-interest bearing and are generally due within six months of issuance. As a condition of the notes payable lending arrangements, we are required to keep a compensating balance at the issuing banks that is a percentage of the total notes payable balance until the notes payable are paid by our China subsidiary. These balances are classified as restricted cash on our consolidated balance sheets. As of March 31, 2014, our restricted cash totaled $0.8 million.

Future liquidity needs

We believe that our existing cash and cash equivalents, and cash flows from our operating activities, will be sufficient to meet our anticipated cash needs for the next 12 to 24 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 expansion of our manufacturing capacity and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, if at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

Contractual Obligations and Commitments



The following summarizes our contractual obligations as of March 31, 2014 (in
thousands):



                                                        Payments due by period
                         Total         Less than 1 Year       1-3 Years       3-5 Years       More than 5 Years
Bank acceptance
payable and
long-term debt(1)      $   22,579     $           18,754     $     3,111     $       714     $                 -
Operating leases(2)        15,594                    668             982             832                  13,112

Total commitments      $   38,173     $           19,422     $     4,093     $     1,546     $            13,112

(1) We have several loan and security agreements in China, Taiwan and the U.S. that provide various credit facilities, including lines of credit, term loans and bank acceptance notes. The amount presented in the table represents the principal portion of the obligations.
(2) We have entered into various non-cancellable operating lease agreements for our offices in Taiwan and the U.S.

Off-Balance Sheet Arrangements

For the three months ended March 31, 2014, we did not, and we do not currently, have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

In our annual report on Form 10-K for the year ended December 31, 2013, we identified 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 under long-term construction contracts; allowance for doubtful accounts; 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.

JOBS Act

The Jumpstart Our Business Startups Act of 2012, or JOBS Act, contains . . .

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