NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Description of Business
Business Overview
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: cable television ("CATV"), internet data center, 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.
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.
Interim Financial Statements
The unaudited condensed consolidated financial statements of the Company as of September 30, 2022 and December 31, 2021 and for the three and nine months ended September 30, 2022 and September 30, 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 and nine months ended September 30, 2022 are not necessarily indicative of the results expected for the entire fiscal year. All significant inter-company accounts and transactions have been eliminated.
Use of Estimates
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, revenue recognition, allowance for credit losses, inventory reserve, impairment of long-lived assets, service and product warranty costs, share-based compensation expense, estimated useful lives of property and equipment, and taxes.
Divestiture Agreement with Yuhan Optoelectronic Technology (Shanghai) Co., Ltd
On September 15, 2022, the Company entered into a definitive purchase agreement with Yuhan Optoelectronic Technology (Shanghai) Co., Ltd ("Purchaser"), which is a company incorporated in the People's Republic of China ("PRC"), to divest the Company's manufacturing facilities in PRC and certain assets related to its transceiver business and multi-channel optical sub-assembly products. The closing of the transactions subject to the satisfaction of certain closing conditions, including the approval from the Committee on Foreign Investment in the United States ("CFIUS").
The purchase price will be an amount equal to the $150 million USD equivalent of Renminbi, less a holdback amount. Prior to the closing of the transaction the Company anticipates investing an amount equal to between 4% and 10% of the estimated proceeds from the transaction in exchange for a 10% equity interest in the Purchaser.
Our management has performed an evaluation as required by ASC-360-10-45-9 to determine whether to classify certain our assets and liabilities as held for sale as of September 30, 2022. ASC 360 requires that a company classifies a business as held for sale in the period in which management commits to a plan to sell the business, the business is available for immediate sale in its present condition, an active program to complete the plan to sell the business is initiated, the sale of the business within one year is probable and the business is being marketed at a reasonable price in relation to its fair value. The proposed sale is subject to CFIUS' approval and the probability is less likely to be deemed "probable" as of September 30, 2022. Additionally, there is no financial disincentive for the buyer not to request additional changes. As a result, our management concludes that none of our assets or liabilities are required to be classified as held for sale.
Note 2. Significant Accounting Policies
There have been no changes in the Company’s significant accounting policies for the three and nine months ended September 30, 2022, as compared to the significant accounting policies described in its 2021 Annual Report, except as described below.
Recent Accounting Pronouncements
Recent Accounting Pronouncements Yet to be Adopted
To date, there have been no recent accounting pronouncement not yet effective that have significance, or potential significance, to our Consolidated Financial Statements.
Note 3. Revenue Recognition
Disaggregation of Revenue
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.”
Revenue is also classified by major product category and is presented below (in thousands):
| | Three months ended September 30, | |
| | | | | | % of | | | | | | | % of | |
| | 2022 | | | Revenue | | | 2021 | | | Revenue | |
CATV | | $ | 31,260 | | | | 55.2 | % | | $ | 23,101 | | | | 43.4 | % |
Data Center | | | 17,697 | | | | 31.2 | % | | | 23,929 | | | | 44.9 | % |
Telecom | | | 6,821 | | | | 12.0 | % | | | 5,148 | | | | 9.7 | % |
FTTH | | | - | | | | 0 | % | | | 62 | | | | 0.1 | % |
Other | | | 915 | | | | 1.6 | % | | | 1,027 | | | | 1.9 | % |
Total Revenue | | $ | 56,693 | | | | 100.0 | % | | $ | 53,267 | | | | 100.0 | % |
| | Nine months ended September 30, | |
| | | | | | % of | | | | | | | % of | |
| | 2022 | | | Revenue | | | 2021 | | | Revenue | |
CATV | | $ | 79,953 | | | | 49.6 | % | | $ | 69,339 | | | | 44.1 | % |
Data Center | | | 60,608 | | | | 37.5 | % | | | 72,259 | | | | 46.0 | % |
Telecom | | | 18,362 | | | | 11.4 | % | | | 12,959 | | | | 8.2 | % |
FTTH | | | 124 | | | | 0.1 | % | | | 784 | | | | 0.5 | % |
Other | | | 2,186 | | | | 1.4 | % | | | 1,816 | | | | 1.2 | % |
Total Revenue | | $ | 161,233 | | | | 100.0 | % | | $ | 157,157 | | | | 100.0 | % |
Note 4. Leases
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.
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.
The components of lease expense were as follows for the periods indicated (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Operating lease expense | | $ | 283 | | | $ | 311 | | | $ | 882 | | | $ | 922 | |
Financing lease expense | | | 8 | | | | 8 | | | | 24 | | | | 24 | |
Short Term lease expense | | | 34 | | | | 4 | | | | 55 | | | | 17 | |
Total lease expense | | $ | 325 | | | $ | 323 | | | $ | 961 | | | $ | 963 | |
Maturities of lease liabilities are as follows for the future one-year periods ending September 30, 2022 (in thousands):
| | | Operating | | | | Financing | |
2023 | | | 1,194 | | | | 22 | |
2024 | | | 1,118 | | | | 49 | |
2025 | | | 1,101 | | | | 0 | |
2026 | | | 1,064 | | | | 0 | |
2027 | | | 1,038 | | | | 0 | |
2028 and thereafter | | | 1,757 | | | | 0 | |
Total lease payments | | | 7,272 | | | | 71 | |
Less imputed interest | | | (704 | ) | | | (4 | ) |
Present value | | | 6,568 | | | | 67 | |
The weighted average remaining lease term and discount rate for the leases were as follows for the periods indicated:
| | Nine months ended September 30, | |
| | 2022 | | | 2021 | |
Weighted Average Remaining Lease Term (Years) - operating leases | | | 6.41 | | | | 7.38 | |
Weighted Average Remaining Lease Term (Years) - financing leases | | | 1.08 | | | | 2.33 | |
Weighted Average Discount Rate - operating leases | | | 3.22 | % | | | 3.23 | % |
Weighted Average Discount Rate - financing leases | | | 5.00 | % | | | 5.00 | % |
Supplemental cash flow information related to the leases was as follows for the periods indicated (in thousands):
| | Nine months ended September 30, | |
| | 2022 | | | 2021 | |
Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
Operating cash flows from operating leases | | | 903 | | | | 980 | |
Operating cash flows from financing lease | | | 3 | | | | 4 | |
Financing cash flows from financing lease | | | 14 | | | | 13 | |
Right-of-use assets obtained in exchange for new operating lease liabilities | | | - | | | | 121 | |
Note 5. Cash, Cash Equivalents and Restricted Cash
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):
| | September 30, | | | December 31, | |
| | 2022 | | | 2021 | |
Cash and cash equivalents | | $ | 26,268 | | | $ | 34,656 | |
Restricted cash | | | 8,307 | | | | 6,480 | |
Total cash, cash equivalents and restricted cash shown in the statement of cash flows | | $ | 34,575 | | | $ | 41,136 | |
Restricted cash includes guarantee deposits for customs duties, China government subsidy fund, and compensating balances required for certain credit facilities. As of September 30, 2022 and December 31, 2021, there was $6.4 million and $3.0 million of restricted cash required for bank acceptance notes issued to vendors, respectively. In addition, there was $0.8 million and $2.4 million certificate of deposit associated with credit facilities with a bank in China as of September 30, 2022 and December 31, 2021, respectively. There was $11.2 million and $1.0 million guarantee deposits for customs duties as of September 30, 2022 and December 31, 2021, respectively.
Note 6. Earnings (Loss) Per Share
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.
The following table sets forth the computation of the basic and diluted net loss per share for the periods indicated (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Numerator: | | | | | | | | | | | | |
Net loss | | $ | (15,627 | ) | | $ | (15,797 | ) | | $ | (46,147 | ) | | $ | (39,622 | ) |
Denominator: | | | | | | | | | | | | | | | | |
Weighted average shares used to compute net loss per share | | | | | | | | | | | | | | | | |
Basic | | | 27,839 | | | | 27,097 | | | | 27,640 | | | | 26,791 | |
Diluted | | | 27,839 | | | | 27,097 | | | | 27,640 | | | | 26,791 | |
Net loss per share | | | | | | | | | | | | | | | | |
Basic | | $ | (0.56 | ) | | $ | (0.58 | ) | | $ | (1.67 | ) | | $ | (1.48 | ) |
Diluted | | $ | (0.56 | ) | | $ | (0.58 | ) | | $ | (1.67 | ) | | $ | (1.48 | ) |
The following potentially dilutive securities were excluded from the diluted net loss per share as their effect would have been antidilutive (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Employee stock options | | | — | | | | 1 | | | | — | | | | 3 | |
Restricted stock units | | | 322 | | | | 2 | | | | — | | | | 6 | |
Shares for convertible senior notes | | | 4,587 | | | | 4,587 | | | | 4,587 | | | | 4,587 | |
Total antidilutive shares | | | 4,909 | | | | 4,590 | | | | 4,587 | | | | 4,596 | |
Note 7. Inventories
Inventories, net of inventory write-downs, consist of the following for the periods indicated (in thousands):
| | September 30, 2022 | | | December 31, 2021 | |
Raw materials | | $ | 34,372 | | | $ | 29,469 | |
Work in process and sub-assemblies | | | 48,961 | | | | 41,528 | |
Finished goods | | | 10,928 | | | | 21,519 | |
Total inventories | | $ | 94,261 | | | $ | 92,516 | |
The lower of cost or market adjustment expensed for inventory for the three months ended September 30, 2022 and 2021 was $1.4 million and $1.1 million, respectively. The lower of cost or market adjustment expensed for inventory for the nine months ended September 30, 2022 and 2021 was $3.9 million and $3.3 million, respectively.
For the three months ended September 30, 2022 and 2021, the direct inventory write-offs related to scrap, discontinued products, and damaged inventories were $1.1 million and $4.2 million, respectively. For the nine months ended September 30, 2022 and 2021, the direct inventory write-offs related to scrap, discontinued products, and damaged inventories were $3.8 million and $15 million, respectively.
Note 8. Property, Plant & Equipment
Property, plant and equipment consisted of the following for the periods indicated (in thousands):
| | September 30, 2022 | | | December 31, 2021 | |
Land improvements | | $ | 806 | | | $ | 806 | |
Buildings and improvements | | | 85,078 | | | | 89,698 | |
Machinery and equipment | | | 246,605 | | | | 266,386 | |
Furniture and fixtures | | | 5,303 | | | | 5,658 | |
Computer equipment and software | | | 11,430 | | | | 12,727 | |
Transportation equipment | | | 661 | | | | 726 | |
| | | 349,883 | | | | 376,001 | |
Less accumulated depreciation and amortization | | | (169,898 | ) | | | (167,772 | ) |
| | | 179,985 | | | | 208,229 | |
Construction in progress | | | 30,500 | | | | 33,705 | |
Land | | | 1,101 | | | | 1,101 | |
Total property, plant and equipment, net | | $ | 211,586 | | | $ | 243,035 | |
For the three months ended September 30, 2022 and 2021, the depreciation expense of property, plant and equipment was $5.5 million and $6.2 million, respectively. For the nine months ended September 30, 2022 and 2021, the depreciation expense of property, plant and equipment was $17.2 million and $18.7 million, respectively. For the three months ended September 30, 2022 and 2021, the capitalized interest was $0.1 million and $0.3 million, respectively. For the nine months ended September 30, 2022 and 2021, the capitalized interest was $0.2 million and $0.6 million, respectively.
As of September 30, 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
Intangible assets consisted of the following for the periods indicated (in thousands):
| | September 30, 2022 | |
| | Gross | | | Accumulated | | | Intangible | |
| | Amount | | | amortization | | | assets, net | |
Patents | | $ | 8,865 | | | $ | (5,155 | ) | | $ | 3,710 | |
Trademarks | | | 50 | | | | (20 | ) | | | 30 | |
Total intangible assets | | $ | 8,915 | | | $ | (5,175 | ) | | $ | 3,740 | |
| | December 31, 2021 | |
| | Gross | | | Accumulated | | | Intangible | |
| | Amount | | | amortization | | | assets, net | |
Patents | | $ | 8,597 | | | $ | (4,779 | ) | | $ | 3,818 | |
Trademarks | | | 35 | | | | (17 | ) | | | 18 | |
Total intangible assets | | $ | 8,632 | | | $ | (4,796 | ) | | $ | 3,836 | |
For the three months ended September 30, 2022 and 2021, amortization expense for intangible assets, included in general and administrative expenses on the statement of operations, was $0.2 million and $0.1 million, respectively. For the nine months ended September 30, 2022 and 2021, included in general and administrative expenses on the statement of operations, the amortization expense for intangible assets, was each $0.5 million. The remaining weighted average amortization period for intangible assets is approximately 6 years.
At September 30, 2022, future amortization expense for intangible assets for future one year periods is estimated to be (in thousands):
2023 | | | 616 | |
2024 | | | 616 | |
2025 | | | 616 | |
2026 | | | 616 | |
2027 | | | 616 | |
2028 | | | 616 | |
thereafter | | | 44 | |
| | | 3,740 | |
Note 10. Fair Value of Financial Instruments
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):
| | As of September 30, 2022 | | | As of December 31, 2021 | |
| | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Total | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 26,268 | | | $ | — | | | $ | — | | | $ | 26,268 | | | $ | 34,656 | | | $ | — | | | $ | — | | | $ | 34,656 | |
Restricted cash | | | 8,307 | | | | — | | | | — | | | | 8,307 | | | | 6,480 | | | | — | | | | — | | | | 6,480 | |
Note receivable | | | — | | | | 9 | | | | — | | | | 9 | | | | — | | | | 8,148 | | | | — | | | | 8,148 | |
Total assets | | $ | 34,575 | | | $ | 9 | | | $ | — | | | $ | 34,584 | | | $ | 41,136 | | | $ | 8,148 | | | $ | — | | | $ | 49,284 | |
Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Bank acceptance payable | | $ | — | | | $ | 13,760 | | | $ | — | | | $ | 13,760 | | | $ | — | | | $ | 8,198 | | | $ | — | | | $ | 8,198 | |
Convertible senior notes | | | — | | | | 56,524 | | | | — | | | | 56,524 | | | | — | | | | 67,588 | | | | — | | | | 67,588 | |
Total liabilities | | $ | — | | | $ | 70,284 | | | $ | — | | | $ | 70,284 | | | $ | — | | | $ | 75,786 | | | $ | — | | | $ | 75,786 | |
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 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.
Note 11. Notes Payable and Long-Term Debt
Notes payable and long-term debt consisted of the following for the periods indicated (in thousands):
| | September 30, 2022 | | | December 31, 2021 | |
Revolving line of credit with a U.S. bank up to $20,000 with interest at 4.063% , maturing April 15, 2023 | | $ | 17,831 | | | $ | 14,373 | |
Notes payable to a finance company due in monthly installments with 3.1% interest, matured January 21, 2022 | | | - | | | | 170 | |
Revolving line of credit with a China bank up to $20,185 with interest from 2.95% to 4.57%, maturing June 28, 2023 | | | 17,166 | | | | 19,595 | |
Credit facility with a China bank up to $23,722 with interest of 3.44%~5.43%, maturing March 14, 2023 | | | 16,361 | | | | 13,044 | |
Credit facility with a China bank up to $7,167 with interest of 5.7%, matured June 27, 2022 | | | - | | | | 7,529 | |
Sub-total | | | 51,358 | | | | 54,711 | |
Less debt issuance costs, net | | | (1 | ) | | | (22 | ) |
Grand total | | | 51,357 | | | | 54,689 | |
Less current portion | | | (51,357 | ) | | | (49,689 | ) |
Non-current portion | | $ | - | | | $ | 5,000 | |
| | | | | | |
| | | | | | |
Bank Acceptance Notes Payable | | | | | | |
Bank acceptance notes issued to vendors with a zero percent interest rate | | $ | 13,760 | | | $ | 8,198 | |
The current portion of long-term debt is the amount payable within one year of the balance sheet date of September 30, 2022.
Maturities of long-term debt are as follows for the future one-year periods ending September 30, (in thousands):
Within one year | | $ | 51,357 | |
Beyond one year | | | - | |
Total outstanding | | $ | 51,357 | |
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.
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 September 30, 2022, the Company had $17.8 million of outstanding borrowings and was in compliance with all covenants under the Sixth Amended Credit Facility.
On September 15, 2020, Prime World entered into an Amendment to the Finance Lease Agreements dated November 29, 2018 and January 21, 2019 (the “Amendment”) with Chailease Finance Co., Ltd. (“Chailease”). The Amendment amends the Finance Lease Agreements, dated November 29, 2018 and January 21, 2019 (hereafter collectively referred to as the “Original Finance Agreements”). Pursuant to the Amendment, Prime World agrees to pay Chailease NT$22,311,381, or approximately $0.8 million for certain leased equipment listed in the Amendment (the “Leased Equipment”). This payment includes all outstanding lease payments, costs and expenses; simultaneously, Chailease agrees to transfer title of such Leased Equipment back to Prime World. Regarding all other equipment contemplated in the Original Finance Agreements but not listed in the Amendment, pursuant to the terms and conditions made under the Original Finance Agreements, Prime World is obligated to pay Chailease monthly lease payments which total NT$159,027,448, or approximately $5.5 million (the “Lease Payments”). The Lease Payments began on September 21, 2020 with the last Lease Payment due on January 21, 2022, title of all other equipment contemplated under the Original Finance Agreements but not listed in the Amendment transferred to Prime World upon completion of the Lease Payments and expiration of the Original Finance Agreements. As of September 30, 2022, the Company has fully repaid the Original Finance Agreements and Amendment.
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 September 30, 2022, $17.1 million was outstanding under the SPD Credit Line and the outstanding balance of bank acceptance notes issued to vendors was $4.9 million.
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. The Company replaced this loan agreement on June 7, 2022.
On June 7, 2022, the Company's China Subsidiary, Global, entered a security agreement with China Zheshang Bank in Ningbo City, China ("CZB") for a five-year credit line agreement, totaling 200,000,000 RMB (the "¥200M Credit Facility"), or approximately $29.9 million. Global may draw upon the ¥200M Credit Facility between June 7, 2022 and June 6, 2027 (" ¥200M Credit Period"). During the ¥200M Credit Period, Global may request to draw upon the ¥200M Credit Facility on an as-needed basis; however, draws under the ¥200M 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 be facilitated by a separate credit agreement specifying the terms of each draw and will bear interest equal to CZB's commercial banking interest rate effective on the day of the applicable draw. Global’s obligations under the ¥200M Credit Facility will be secured by real property owned by Global and mortgaged to CZB under the terms of the Real Estate Security Agreement. As of September 30, 2022, $16.4 million was outstanding under the ¥200M Credit Facility and the outstanding balance of bank acceptance notes issued to vendors was $8.9 million.
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 September 30, 2022, the Company has fully repaid the ¥50M Credit Facility.
As of September 30, 2022 and December 31, 2021, the Company had $12.5 million and $7.4 million of unused borrowing capacity, respectively.
As of September 30, 2022 and December 31, 2021, there was $7.2 million and $5.4 million of restricted cash, investments or security deposits associated with the loan facilities, respectively.
Note 12. Convertible Senior Notes
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.
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.
The following table presents the carrying value of the Notes for the periods indicated (in thousands):
| | September 30, | | | December 31, | |
| | 2022 | | | 2021 | |
Principal | | $ | 80,500 | | | $ | 80,500 | |
Unamortized debt issuance costs | | | (1,202 | ) | | | (1,820 | ) |
Net carrying amount | | $ | 79,298 | | | $ | 78,680 | |
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.
After March 15, 2022, the Company 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.
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.
The Company incurred approximately $4.1 million in transaction costs in connection with the issuance of the Notes. These costs were recognized as a reduction of the carrying amount of the Notes utilizing the effective interest method and are being amortized over the term of the Notes.
The following table sets forth interest expense information related to the Notes (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Contractual interest expense | | $ | 1,006 | | | $ | 1,006 | | | $ | 3,019 | | | $ | 3,018 | |
Amortization of debt issuance costs | | | 208 | | | | 208 | | | | 618 | | | | 618 | |
Total interest cost | | $ | 1,214 | | | $ | 1,214 | | | $ | 3,637 | | | $ | 3,636 | |
Effective interest rate | | | 5.1 | % | | | 5.1 | % | | | 5.1 | % | | | 5.1 | % |
Note 13. Accrued Liabilities
Accrued liabilities consisted of the following for the periods indicated (in thousands):
| | September 30, 2022 | | | December 31, 2021 | |
Accrued payroll | | $ | 5,263 | | | $ | 6,516 | |
Accrued employee benefits | | | 2,535 | | | | 3,471 | |
Accrued state and local taxes | | | 1,358 | | | | 1,897 | |
Accrued interest | | | 432 | | | | 1,475 | |
Accrued shipping and tariff expenses | | | - | | | | 33 | |
Advanced payments | | | 517 | | | | 195 | |
Accrued commission expenses | | | 1,080 | | | | 1,003 | |
Accrued professional fees | | | 652 | | | | 346 | |
Accrued product warranty | | | 135 | | | | 263 | |
Accrued other | | | 472 | | | | 388 | |
Total accrued liabilities | | $ | 12,444 | | | $ | 15,587 | |
Note 14. Other Income and Expense
Other income and (expense) consisted of the following for the periods indicated (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Foreign exchange transaction gain (loss) | | $ | (598 | ) | | $ | (1 | ) | | $ | (1,409 | ) | | $ | 217 | |
Government subsidy income | | | 49 | | | | 826 | | | | 150 | | | | 980 | |
Other non-operating gain | | | 9 | | | | 171 | | | | 54 | | | | 205 | |
Loan forgiveness | | | - | | | | - | | | | - | | | | 6,229 | |
Gain (loss) on disposal of assets | | | (1 | ) | | | 2 | | | | 34 | | | | (3 | ) |
Total other income (expenses) , net | | $ | (541 | ) | | $ | 998 | | | $ | (1,171 | ) | | $ | 7,628 | |
Note 15. Share-Based Compensation
Equity Plans
The Company’s board of directors and stockholders approved the following equity plans:
| ● | the 2006 Share Incentive Plan |
| ● | the 2013 Equity Incentive Plan (“2013 Plan”) |
| ● | the 2021 Equity Incentive Plan (“2021 Plan”) |
The Company issued stock options, restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) to employees, consultants and non-employee directors. Stock option awards generally vest over a four-year period and have a maximum term of ten years. Stock options under these plans have been granted with an exercise price equal to the fair market value on the date of the grant. Nonqualified and Incentive Stock Options, RSAs and RSUs may be granted from these plans. Prior to the Company’s initial public offering in September 2013, the fair market value of the Company’s stock had been historically determined by the board of directors and from time to time with the assistance of third-party valuation specialists.
Stock Options
Options have been granted to the Company’s employees under the two incentive plans and generally become exercisable as to 25% of the shares on the first anniversary date following the date of grant and 12.5% on a semi-annual basis thereafter. All options expire ten years after the date of grant.
The following is a summary of option activity (in thousands, except per share data):
| | | | | | | | Weighted | | | | | | Weighted | | | | |
| | | | | Weighted | | | Average | | | | | | Average | | | | |
| | | | | Average | | | Share Price | | | Weighted | | | Remaining | | | Aggregate | |
| | Number of | | | Exercise | | | on Date of | | | Average | | | Contractual | | | Intrinsic | |
| | shares | | | Price | | | Exercise | | | Fair Value | | | Life | | | Value | |
| | (in thousands, except price data) | |
Outstanding at January 1, 2022 | | | 269 | | | $ | 10.32 | | | | | | | $ | 5.44 | | | | 1.6879 | | | $ | - | |
Forfeited | | | (5 | ) | | | 6.13 | | | | | | | | 5.04 | | | | | | | | - | |
Outstanding, September 30, 2022 | | | 264 | | | | 10.40 | | | | | | | | 5.45 | | | | 0.9655 | | | | - | |
Exercisable, September 30, 2022 | | | 264 | | | | 10.40 | | | | | | | | 5.45 | | | | 0.9655 | | | | - | |
Vested and expected to vest | | | 264 | | | | 10.40 | | | | | | | | 5.45 | | | | 0.9655 | | | | - | |
As of September 30, 2022, there was no unrecognized stock option expense.
Performance Based Incentive Plan
The Company approved to grant restricted performance stock units (“PSUs”) to senior executives as a part of our long-term equity compensation program starting from June 2021. The number of shares of common stock that will ultimately be issued to settle PSUs granted ranges from 0% to 200% of the number granted and is determined based on certain performance criteria over a three-year measurement period. The performance criteria for the PSUs are based on a combination of the performance of our stock price and the Total Shareholder Return (“TSR”) for the performance period compared with the TSR of certain peer companies or index for the performance period. PSUs granted vest 100% on the third anniversary of their grant, assuming achievement of the applicable performance criteria. We estimated the fair value of the PSUs using a Monte Carlo simulation model on the date of grant. Compensation expense is recognized ratably over the explicit service period. The Company recognized PSU expenses for the three months ended September 30, 2022 and 2021 was $0.2 million and $0.4 million, respectively. The PSU expenses for the nine months ended on September 30, 2022 and 2021 was $1.2 million and $0.4 million, respectively.
Restricted Stock Units/Awards
The following is a summary of RSU/RSA activity, inclusive of performance based incentive plan (in thousands, except per share data):
| | | | | Weighted | | | | | | | |
| | | | | Average Share | | | Weighted | | | Aggregate | |
| | Number of | | | Price on Date | | | Average Fair | | | Intrinsic | |
| | shares | | | of Release | | | Value | | | Value | |
| | (in thousands, except price data) | |
Outstanding at January 1, 2022 | | | 2,170 | | | | | | $ | 11.15 | | | $ | 11,156 | |
Granted | | | 1,874 | | | | | | | 2 | | | | 3,399 | |
Released | | | (760 | ) | | | | | | | 9.5 | | | | 2,131 | |
Cancelled/Forfeited | | | (120 | ) | | | | | | 10.85 | | | | 325 | |
Outstanding, September 30, 2022 | | | 3,164 | | | | | | | 6.14 | | | | 8,607 | |
Vested and expected to vest | | | 3,164 | | | | | | | 6.14 | | | | 8,607 | |
As of September 30, 2022, there was $16.1 million of unrecognized compensation expense related to these RSUs and RSAs. This expense is expected to be recognized over 2.1 years.
Share-Based Compensation
Employee share-based compensation expenses recognized for the periods indicated (in thousands):
| | Three months ended | | | Nine months ended | |
| | September 30, | | | September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Share-based compensation - by expense type | | | | | | | | | | | | | | |
Cost of goods sold | | $ | 121 | | | $ | 222 | | | $ | 371 | | | $ | 689 | |
Research and development | | | 343 | | | | 489 | | | | 1,019 | | | | 1,682 | |
Sales and marketing | | | 231 | | | | 272 | | | | 643 | | | | 820 | |
General and administrative | | | 1,932 | | | | 2,146 | | | | 5,210 | | | | 5,731 | |
Total share-based compensation expense | | $ | 2,627 | | | $ | 3,129 | | | $ | 7,243 | | | $ | 8,922 | |
Note 16. Income Taxes
The Company’s effective tax rate for the three months ended September 30, 2022 and 2021 was 0%. For the three months ended September 30, 2022 and 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 China deferred tax assets ("DTA").
The Company's effective tax rate for the nine months ended September 30, 2022 and 2021 was 0%. For the nine months ended September 30, 2022 and 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 China DTA.
The Company continually monitors and performs an assessment of the realizability of its DTAs, including an analysis of factors such as future taxable income, reversal of existing taxable temporary differences, and tax planning strategies. In assessing the need for a valuation allowance, the Company considered both positive and negative evidence related to the likelihood of realization of deferred tax assets using a “more likely than not” standard. In making such assessment, more weight was given to evidence that could be objectively verified, including recent cumulative losses. Based on the Company’s review of this evidence, management determined that a full valuation allowance against all of the Company’s net deferred tax assets at September 30, 2022 was appropriate.
Note 17. Geographic Information
The Company operates in one reportable segment. The Company’s Chief Executive Officer, who is considered to be the chief operating decision maker, manages the Company’s operations as a whole and reviews financial information presented on a consolidated basis, accompanied by information about product revenue, for purposes of evaluating financial performance and allocating resources.
The following tables set forth the Company’s revenue and asset information by geographic region. Revenue is classified based on the location of where the product is manufactured. Long-lived assets in the tables below comprise only property, plant, equipment and intangible assets (in thousands):
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Revenues: | | | | | | | | | | | | |
United States | | $ | 2,027 | | | $ | 4,547 | | | $ | 5,732 | | | $ | 11,451 | |
Taiwan | | | 46,716 | | | | 19,562 | | | | 111,700 | | | | 75,282 | |
China | | | 7,950 | | | | 29,158 | | | | 43,801 | | | | 70,424 | |
| | $ | 56,693 | | | $ | 53,267 | | | | 161,233 | | | $ | 157,157 | |
| | As of the period ended | |
| | September 30, | | | December 31, | |
| | 2022 | | | 2021 | |
Long-lived assets: | | | | | | |
United States | | $ | 81,834 | | | $ | 87,709 | |
Taiwan | | | 50,847 | | | | 63,644 | |
China | | | 93,447 | | | | 108,509 | |
| | $ | 226,128 | | | $ | 259,862 | |
Note 18. Contingencies
Litigation
Overview
From time to time, the Company may be subject to legal proceedings and litigation arising in the ordinary course of business, including, but not limited to, inquiries, investigations, audits and other regulatory proceedings, such as described below. The Company records a loss provision when it believes it is both probable that a liability has been incurred and the amount can be reasonably estimated. Unless otherwise disclosed, the Company is unable to estimate the possible loss or range of loss for the legal proceeding described below.
The Company believes that there are no claims or actions pending or threatened against it, the ultimate disposition of which would have a material adverse effect on it.
Other Contingencies
On August 9, 2021, the Company has received a Taxes Notification of Audit Result (“Notice”) from the Texas Comptroller’s Office (the “Comptroller”), for fiscal years between 2016 and 2019, informing the Company that the Comptroller believes the Company did not qualify for certain sales and use tax exemptions on various Research and Development purchases and accordingly the Company is liable for Sale and Use Tax in the amount of approximately $1.0 million including interest charges. The Company paid $0.4 million for the tax notice on May 2021, but challenged the remaining tax assessments and vigorously defended its position. The Comptroller’s office exhausted its redetermination period and therefore moved AOI’s case to hearing process. AOI has not received its amended determination or hearing notice. The management estimated that the additional tax assessment will be in the range of $0.2 million to $0.4 million including interest charges.
Note 19. Subsequent Events
The Company repaid its revolving bank line of credit with Truist Bank in the amount of $16.3 million on October 6, 2022.