AAOI 10-Q Quarter ended March 31, 2022

Note 1. Description of Business​

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Business Overview

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Applied Optoelectronics, Inc. (“AOI” or the “Company”) is a Delaware corporation. The Company is a leading, vertically integrated provider of fiber-optic networking products, primarily for four networking end-markets: internet data center, cable television ("CATV"), telecommunications ("telecom") and fiber-to-the-home ("FTTH"). The Company designs and manufactures a wide range of optical communications products at varying levels of integration, from components, subassemblies and modules to complete turn-key equipment.

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The Company has manufacturing and research and development facilities located in the U.S., Taiwan and China. In the U.S., at its corporate headquarters and manufacturing facilities in Sugar Land, Texas, the Company primarily manufactures lasers and laser components and performs research and development activities for laser component and optical module products. In addition, the Company also has a research and development facility in Duluth, Georgia. The Company operates in Taipei, Taiwan and Ningbo, China through its wholly-owned subsidiary Prime World International Holdings, Ltd. (“Prime World”, incorporated in the British Virgin Islands). Prime World operates a branch in Taipei, Taiwan, which primarily manufactures transceivers and performs research and development activities for the transceiver products. Prime World is also the parent of Global Technology, Inc. (“Global”, incorporated in the People’s Republic of China). Through Global, the Company primarily manufactures certain of its data center transceiver products, including subassemblies, as well as CATV systems and equipment, and performs research and development activities for the CATV products.

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Interim Financial Statements

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The unaudited condensed consolidated financial statements of the Company as of March 31, 2022 and December 31, 2021 and for the three months ended March 31, 2022 and March 31, 2021 , have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim information and with the instructions on Form 10 -Q and Rule 10 - 01 of Regulation S- X pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In accordance with those rules and regulations, the Company has omitted certain information and notes required by GAAP for annual consolidated financial statements. In the opinion of management, the condensed consolidated financial statements contain all adjustments, except as otherwise noted, necessary for the fair presentation of the Company’s financial position and results of operations for the periods presented. The year-end condensed balance sheet data was derived from audited financial statements. These condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10 -K (“Annual Report”) for the fiscal year ended December 31, 2021 . The results of operations for the three months ended March 31, 2022 are not necessarily indicative of the results expected for the entire fiscal year. All significant inter-company accounts and transactions have been eliminated.

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Use of Estimates

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The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported. Actual results could differ from those estimates in the consolidated financial statements and accompanying notes. Significant estimates and assumptions that impact these financial statements and the accompanying notes relate to, among other things, allowance for credit losses, inventory reserve, product warranty costs, share-based compensation expense, estimated useful lives of property and equipment, and taxes.

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Note 2. Significant Accounting Policies

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There have been no changes in the Company’s significant accounting policies for the three months ended March 31, 2022 , as compared to the significant accounting policies described in its 2021 Annual Report, except as described below.

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Note 3. Revenue Recognition

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Disaggregation of Revenue

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Revenue is classified based on the location where the product is manufactured. For additional information on the disaggregated revenues by geographical region, see Note 17, "Geographic Information.”

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Revenue is also classified by major product category and is presented below (in thousands):

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Note 4. Leases

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The Company leases space under non-cancellable operating leases for manufacturing facilities, research and development offices and certain storage facilities and apartments. These leases do not contain contingent rent provisions. The Company also leases certain machinery, office equipment and a vehicle. Many of its leases include both lease (e.g. fixed payments including rent, taxes, and insurance costs) and non-lease components (e.g. common-area or other maintenance costs) which are accounted for as a single lease component as the Company has elected the practical expedient to group lease and non-lease components for all leases. Several of the leases include one or more options to renew which have been assessed and either included or excluded from the calculation of the lease liability of the right of use ("ROU") asset based on management’s intentions and individual fact patterns. Several warehouses and apartments have non-cancellable lease terms of less than one -year and therefore, the Company has elected the practical expedient to exclude these short-term leases from its ROU asset and lease liabilities.

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As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Based on the applicable lease terms and current economic environment, the Company applies a location approach for determining the incremental borrowing rate.

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The components of lease expense were as follows for the periods indicated (in thousands):

Maturities of lease liabilities are as follows for the future one -year periods ending March 31, 2022 (in thousands):

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The weighted average remaining lease term and discount rate for operating leases were as follows for the periods indicated:

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Supplemental cash flow information related to operating leases was as follows for the periods indicated (in thousands):

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Note 5. Cash, Cash Equivalents and Restricted Cash

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The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the statement of financial position that sum to the total of the same such amounts in the statement of cash flows (in thousands):

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Restricted cash includes guarantee deposits for customs duties, China government subsidy fund, and compensating balances required for certain credit facilities. As of March 31, 2022 and December 31, 2021, there was $ 4.5 million and $ 3.0 million of restricted cash required for bank acceptance notes issued to vendors, respectively. In addition, there was $ 2.5 million and $ 2.4 million certificate of deposit associated with credit facilities with a bank in China as of March 31, 2022 and December 31, 2021, respectively. There was $ 1.1 million and $ 1.0 million guarantee deposits for customs duties as of March 31, 2022 and December 31, 2021.

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Note 6. Earnings (Loss) Per Share

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Basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share has been computed using the weighted-average number of shares of common stock and dilutive potential common shares from stock options, restricted stock units and senior convertible notes outstanding during the period. In periods with net losses, normally dilutive shares become anti-dilutive. Therefore, basic and diluted loss per share are the same.

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The following table sets forth the computation of the basic and diluted net loss per share for the periods indicated (in thousands):

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The following potentially dilutive securities were excluded from the diluted net loss per share as their effect would have been antidilutive (in thousands):

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Note 7. Inventories

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Inventories, net of inventory write-downs, consist of the following for the periods indicated (in thousands):

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The lower of cost or market adjustment expensed for inventory for the three months ended March 31, 2022 and 2021 was $ 2.0 million and $ 0.9 million, respectively.

For the three months ended March 31, 2022 and 2021 , the direct inventory write-offs related to scrap, discontinued products, and damaged inventories we re $ 1.0 million and $ 6.0 million, respectively.

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Note 8. Property, Plant & Equipment

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Property, plant and equipment consisted of the following for the periods indicated (in thousands):

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For the three months ended March 31, 2022 and 2021 , the depreciation expense of property, plant and equipment wa s $ 6.0 million and $ 6.3 million, respectively. For the three months ended March 31, 2022 and 2021 , the capitalized interest was each $ 0.1 million.

As of March 31, 2022 , the Company concluded that its continued loss history constitutes a triggering event as described in ASC 360 - 10 - 35 - 21, Property, Plant, and Equipment .  The Company performed a recoverability test and concluded that future undiscounted cash flows exceed the carrying amount of the Company’s long-lived assets and therefore no impairment charge was recorded.

Note 9. Intangible Assets, net

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Intangible assets consisted of the following for the periods indicated (in thousands):

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For the three months ended March 31, 2022 and 2021 , amortization expense for intangible assets, included in general and administrative expenses on the income statement, was each $ 0.1 million. The remaining weighted average amortization period for intangible assets is approxi mately 6 years.

At March 31, 2022 , future amortization expense for intangible assets is estimated to be (in thousands):

Note 10. Fair Value of Financial Instruments​

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The following table represents a summary of the Company’s financial instruments measured at fair value on a recurring basis for the periods indicated (in thousands):

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The carrying value amounts of accounts receivable, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities approximate fair value because of the short-term maturity of these instruments. The carrying value amounts of note receivable and bank acceptances approximate fair value due to the short-term nature of the debt since it renews frequently at current interest rates. The Company believes that the interest rates in effect at each period end represent the current market rates for similar borrowings.

The fair value of its convertible senior debt is measured for disclosure purpose. The fair value is based on observable market prices for this debt, which is traded in less active markets and are therefore classified as a Level 2 fair value measurement.

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Note 11. Notes Payable and Long-Term Debt

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Notes payable and long-term debt consisted of the following for the periods indicated (in thousands):

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The current portion of long-term debt is the amount payable within one year of the balance sheet date of March 31, 2022 .

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Maturities of long-term debt are as follows for the future one -year periods ending March 31, (in thousands):

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On September 28, 2017, the Company entered into a Loan Agreement (“Loan Agreement”), a Promissory Note, an Addendum to the Promissory Note, a Truist Bank Security Agreement, a Trademark Security Agreement, and a Patent Security Agreement (together the “Credit Facility”) with Truist Bank. The Company’s obligations under the Credit Facility are secured by the Company’s accounts receivable, inventory, intellectual property, and all business assets with the exception of real estate and equipment.

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On December 29, 2021 , the Company executed a Sixth Amendment to the Loan Agreement (the "Sixth Amendment") and a Fifth Amendment to Security Agreement, a Note Modification Agreement, and an Addendum to Promissory Note (together the "Sixth Amended Credit Facility") with Truist Bank. The Sixth Amended Credit Facility extends the $ 20 million line of credit, originally entered into on September 28, 2017, until April 15, 2023. Borrowings will bear interest at a rate equal to the Secured Overnight Financing Rate (SOFR) plus 1.56%, with a SOFR floor of 0.75 %. As of March 31, 2022 , the Company had $ 19.6 million of outstanding borrowings and was in compliance with all covenants under the Sixth Amended Credit Facility.

On May 24, 2019, the Company’s China subsidiary, Global, entered into a five -year revolving credit line agreement, totaling 180,000,000 RMB (the “SPD Credit Line”), or approximately $ 25.4 million, and a mortgage security agreement (the “Security Agreement”), with Shanghai Pudong Development Bank Co., Ltd ("SPD"). Borrowing under the SPD Credit Line will be used for general corporate and capital investment purposes, including the issuance of bank acceptance notes to Global’s vendors. The total SPD Credit Line of 180 million RMB is inclusive of all credit facilities previously entered into with SPD including: a 30 million RMB credit facility entered into on May 7, 2019; and a 9.9 million RMB credit facility entered into on April 30, 2019 and $ 2 million credit facility entered into on May 8, 2019. Global may draw upon the SPD Credit Line on an as-needed basis at any time during the 5 -year term; however, draws under the SPD Credit Line may become due and repayable to SPD at SPD’s discretion due to changes in Chinese government regulations and/or changes in Global’s financial and operational condition. Each draw will bear interest equal to SPD’s commercial banking interest rate effective on the day of the applicable draw. Global’s obligations under the SPD Credit Line will be secured by real property owned by Global and mortgaged to the Bank under the terms of the Security Agreement. As of March 31, 2022 , $ 19.1 million was outstanding under the SPD Credit Line and the outstanding balance of bank acceptance notes issued to vendors was $ 2.2 million.

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On June 21, 2019, the Company’s China subsidiary, Global, entered into an 18 month credit facility totaling 100,000,000 RMB (the “¥100M Credit Facility”), or approximately $ 14.1 million, with China Zheshang Bank Co., Ltd., in Ningbo City, China (“CZB”). Borrowing under the ¥100M Credit Facility will be used by Global for general corporate purposes. On January 6, 2021, the ¥100M Credit Facility with CZB was extended for three ( 3 ) years until January 5, 2024. Global may draw upon the ¥100M Credit Facility from June 21, 2019 until January 5, 2024 ( the “¥100M Credit Period”). During the ¥100M Credit Period, Global may request to draw upon the ¥100M Credit Facility on an as-needed basi s; however, draws under the ¥100M Credit Facility may become due and repayable to CZB at CZB’s discretion due to changes in Chinese government regulations and/or changes in Global’s financial and operational condition. Each draw will bear interest equal to CZB’s commercial banking interest rate effective on the day of the applicable draw. Global’s obligations under the ¥100M Credit Facility will be secured by real property owned by Global and mortgaged to CZB under the terms of the Real Estate Security Agreement. The agreements for the ¥100M Credit Facility and the Real Estate Security Agreement also contain rights and obligations, representations and warranties, and events of default applicable to the Company that are customary for agreements of this type. As of March 31, 2022 , $ 11.0 million was outstanding under the ¥100M Credit Facility and the outstanding balance of bank acceptance notes issued to vendors was $ 7.7 million.

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On June 21, 2019, the Company’s China subsidiary, Global, entered into a three -year credit facility totaling 50,000,000 RMB (the “¥50M Credit Facility”), or approximately $ 7.1 million, with CZB. Borrowing under the ¥50M Credit Facility will be used by Global for general corporate purposes. Global may draw upon the ¥50M Credit Facility from June 21, 2019 until June 20, 2022 ( the “¥50M Credit Period”). During the ¥50M Credit Period, Global may request to draw upon the ¥50M Credit Facility on an as-needed basis; however, draws under the ¥50M Credit Facility may become due and repayable to CZB at CZB’s discretion due to changes in Chinese government regulations and/or changes in Global’s financial and operational condition. Each draw will bear interest equal to CZB’s commercial banking interest rate effective on the day of the applicable draw. Global’s obligations under the ¥50M Credit Facility will be secured by machinery and equipment owned by Global and mortgaged to CZB under the terms of the Machinery and Equipment Security Agreement. As of March 31, 2022 , $ 7.6 million wa s outstanding under the ¥50M Credit Facility.

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As of March 31, 2022 and December 31, 2021 , the Company had $ 4.3 million and $ 7.4 million of unused borrowing capacity, respectively.

As of March 31, 2022 and December 31, 2021 , there was $ 7.0 million and $ 5.4 million of restricted cash, investme nts or security deposits associated with the loan facilities, respectively.

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Note 12. Convertible Senior Notes

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On March 5, 2019, the Company issued $ 80.5 million of 5 % convertible senior notes due 2024 (the “Notes”). The Notes were issued pursuant to an indenture, dated as of March 5, 2019 (the “Indenture”), between the Company and Wells Fargo Bank, National Association, as trustee, paying agent, and conversion agent (the “Trustee”). The Notes bear interest at a rate of 5.00% per year, payable in cash semi-annually in arrears on March 15 and September 15 of each year, beginning on September 15, 2019. The Notes will mature on March 15, 2024, unless earlier repurchased, redeemed or converted in accordance with their terms.

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The sale of the Notes generated net proceeds of $ 76.4 million, after deducting the Initial Purchasers’ discounts and offering expenses payable by the Company. The Company used approximately $ 37.8 million of the net proceeds from the offering to fully repay the CapEx Loan and Term Loan with Truist Bank and the remainder will be used for general corporate purposes.

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The following table presents the carrying value of the Notes for the periods indicated (in thousands):

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The Notes are convertible at the option of holders of the Notes at any time until the close of business on the scheduled trading day immediately preceding the maturity date. Upon conversion, holders of the Notes will receive shares of the Company’s common stock, together, if applicable, with cash in lieu of any fractional share, at the then-applicable conversion rate. The initial conversion rate is 56.9801 shares of the Company’s common stock per $ 1,000 principal amount of Notes (representing an initial conversion price of approximately $ 17.55 per share of common stock, which represents an initial conversion premium of approximately 30 % above the closing price of $ 13.50 per share of the Company’s common stock on February 28, 2019 ), subject to customary adjustments. If a make-whole fundamental change (as defined in the Indenture) occurs, and in connection with certain other conversions before March 15, 2022, the Company will in certain circumstances increase the conversion rate for a specified period of time.

Initially there are no guarantors of the Notes, but the Notes will be fully and unconditionally guaranteed, on a senior, unsecured basis by certain of the Company’s future domestic subsidiaries.  The Notes are the Company’s senior, unsecured obligations and are equal in right of payment with existing and future senior, unsecured indebtedness, senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated to the Notes and effectively subordinated to the Company’s existing and future secured indebtedness, to the extent of the value of the collateral securing that indebtedness.  The Note Guarantee (as defined in the Indenture) of each future guarantor, if any, will be such guarantor’s senior, unsecured obligations and are equal in right of payment with existing and future senior, unsecured indebtedness, senior in right of payment to such future guarantor’s existing and future indebtedness that is expressly subordinated to the Notes and effectively subordinated to such future guarantor’s existing and future secured indebtedness, to the extent of the value of the collateral securing that indebtedness.

Holders may require the Company to repurchase their Notes upon the occurrence of a fundamental change (as defined in the Indenture) at a cash purchase price equal to the principal amount thereof plus accrued and unpaid interest, if any.

The Company was not permitted to redeem the Notes prior to March 15, 2022. The Company currently may redeem for cash all or part of the Notes if the last reported sale price per share of the Company’s common stock exceeds 130 % of the conversion price on (i) each of at least 20 trading days, whether or not consecutive, during the 30 consecutive trading days ending on, and including, the trading day immediately before the date the Company sends the related redemption notice; and (ii) the trading day immediately before the date the Company sends such redemption notice.  The redemption price is equal to 100 % of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.  In addition, calling any Note for redemption will constitute a “make-whole fundamental change” with respect to that Note, in which case the conversion rate applicable to the conversion of that Note will be increased in certain circumstances if it is converted after it is called for redemption.

The Indenture contains covenants that limit the Company’s ability and the ability of our subsidiaries to, among other things: (i) incur or guarantee additional indebtedness or issue disqualified stock; and (ii) create or incur liens.

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Pursuant to the guidance in ASC 815 - 40, Contracts in Entity’s Own Equity, the Company evaluated whether the conversion feature of the note needed to be bifurcated from the host instrument as a freestanding financial instrument. Under ASC 815 - 40, to qualify for equity classification (or non-bifurcation, if embedded) the instrument (or embedded feature) must be both ( 1 ) indexed to the issuer’s own stock and ( 2 ) meet the requirements of the equity classification guidance. Based upon the Company’s analysis, it was determined the conversion option is indexed to its own stock and also met all the criteria for equity classification contained in ASC 815 - 40 - 25 - 7 and 815 - 40 - 25 - 10. Accordingly, the conversion option is not required to be bifurcated from the host instrument as a freestanding financial instrument. Since the conversion feature meets the equity scope exception from derivative accounting, the Company then evaluated whether the conversion feature needed to be separately accounted for as an equity component under ASC 470 - 20, Debt with Conversion and Other Options.  The Company determined that notes should be accounted for in their entirety as a liability.