Applied Optoelectronics
Annual Report 2018

Plain-text annual report

Table of Contentse MpUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K(Mark One)☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2018 OR ☐☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 001-36083 Applied Optoelectronics, Inc.(Exact name of registrant as specified in its charter) Delaware76-0533927(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.) 13139 Jess Pirtle Blvd.Sugar Land, TX 77478(Address of principal executive offices) (281) 295-1800(Registrant’s telephone number) Securities registered pursuant to Section 12(b) of the Act: (Title of each class) (Name of each exchange on which registered)Common Stock, Par value $0.001 NASDAQ Global Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933 Yes ☐ No ☒ Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act Yes ☐ No ☒ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit suchfiles). Yes ☒ No ☐ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ☒ Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or anemerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and “emerging growth company” inRule 12b-2 of the Exchange Act. (Check one):Large accelerated filer☒ Accelerated filer☐ Non-accelerated filer☐ Smaller reporting company☐ Emerging growth company☐ If an emerging growth company, indicate by check mark whether the registrant has elected not to use the extended transition period for complying with anynew or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ As of June 30, 2018, the aggregate market value of the common stock held by non-affiliates of the Registrant was $715,024,373 based upon the closing salesprice of the Registrant’s common stock as reported on the NASDAQ Global Markets on June 29, 2018 of $44.90 per share. Shares of common stock held byofficers, directors and holders of more than ten percent of the outstanding common stock have been excluded from this calculation because such persons may bedeemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 20, 2019, the Registrant had 19,882,613 outstanding shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCEPortions of the Registrant’s definitive Proxy Statement for the Registrant’s 2019 Annual Meeting of Stockholders are incorporated by reference in Part III of thisAnnual Report on Form 10-K to the extent stated herein. The Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation14A not later than 120 days of the Registrant’s fiscal year ended December 31, 2018. Table of ContentsApplied Optoelectronics, Inc.Table of Contents Page Part I 3 Item 1. Business3 Item 1A. Risk Factors14 Item 1B. Unresolved Staff Comments35 Item 2. Properties35 Item 3. Legal Proceedings36 Item 4. Mine Safety Disclosure36 Part II 37 Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities37 Item 6. Selected Financial Data39 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations41 Item 7A. Quantitative and Qualitative Disclosures about Market Risk60 Item 8. Financial Statements and Supplementary Data61 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure61 Item 9A. Controls and Procedures61 Item 9B. Other Information64 Part III 65 Item 10. Directors, Executive Officers and Corporate Governance65 Item 11. Executive Compensation65 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters65 Item 13. Certain Relationships and Related Transactions, and Director Independence65 Item 14. Principal Accounting Fees and Services65 Part IV 66 Item 15. Exhibits, Financial Statements Schedules66 Item 16. Form 10-K Summary66 Signatures 752 Table of Contents PART I Forward-Looking Information This Annual Report on Form 10-K contains forward-looking statements that are based on our management’s beliefsand assumptions and on information currently available to our management, including statements appearing under theheading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. The statementscontained in this Annual Report on Form 10-K that are not purely historical are forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, orthe Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. In some cases,you can identify forward-looking statements by terminology such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘expects,’’ ‘‘plans,’’‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,” “strategy,” “future,” “likely,” or “would” or by other similar expressions that conveyuncertainty of future events or outcomes. These forward-looking statements involve risks and uncertainties, as well asassumptions and current expectations, which could cause the company’s actual results to differ materially from thoseanticipated in such forward-looking statements. These risks and uncertainties include but are not limited to: reduction in thesize or quantity of customer orders; change in demand for the company’s products due to industry conditions; our ability tomaintain sufficient liquidity; changes in manufacturing operations; volatility in manufacturing costs; delays in shipments ofproducts; disruptions in the supply chain; change in the rate of design wins or the rate of customer acceptance of newproducts; the company’s reliance on a small number of customers for a substantial portion of its revenues; pricing pressure; adecline in demand for our customers’ products or their rate of deployment of their products; general conditions in the internetdata center, cable television or CATV, telecommunications or telecom and fiber-to-the-home or FTTH; changes in the worldeconomy (particularly in the United States and China); the negative effects of seasonality; impact of the Tax Cuts and JobsAct of 2017, including impact on deferred tax assets and the one-time transition tax on unremitted foreign earnings;realization of deferred tax assets; and other risks and uncertainties described more fully under “Risk Factors” in this AnnualReport on Form 10-K and those discussed in the company’s other documents filed with or furnished to the Securities andExchange Commission. You should not rely on forward-looking statements as predictions of future events. All forward-looking statements in this Annual Report on Form 10-K are based upon information available to us as of the date hereof, andqualified in their entirety by this cautionary statement. Except as required by law, we assume no obligation to updateforward-looking statements for any reason after the date of this report to conform these statements to actual results or tochanges in the company’s expectations. Item 1. Business BUSINESS Overview Applied Optoelectronics, Inc. (the “Company”) is a leading, vertically integrated provider of fiber-optic networkingproducts, primarily for four networking end-markets: internet data center, cable television, or CATV, telecommunications, ortelecom, and fiber-to-the-home, or FTTH. We design and manufacture a range of optical communications products at varyinglevels of integration, from components, subassemblies and modules to complete turn-key equipment. In designing products for our customers, we begin with the fundamental building blocks of lasers and lasercomponents. From these foundational products, we design and manufacture a wide range of products to meet our customers’needs and specifications, and such products differ from each other by their end market, intended use and level of integration.We are primarily focused on the higher-performance segments within all four of our target markets, which increasinglydemand faster connectivity and innovation. The four end markets we target are all driven by significant bandwidth demand fueled by the growth of network-connected devices, video traffic, cloud computing and online social networking. To address this increased bandwidthdemand, CATV and telecommunications service providers are competing directly against each other by providing bundles ofvoice, video and data services to their subscribers and investing to enhance the capacity, reliability and capability of theirnetworks. The trend of rising bandwidth consumption also impacts the internet data center market, as reflected in the shift tohigher speed server connections. As a result of these trends, fiber-optic networking technology3 Table of Contentsis becoming essential in all four of our target markets, as it is often the only economical way to deliver the desiredbandwidth. The internet data center market is our largest and fastest growing market. Our customers in this market are generallylarge internet-based (“Web 2.0”) data center operators, to whom we supply optical transceivers that plug into switches andservers within the data center and allow these network devices to send and receive data over fiber optic cables. The majorityof the data center optical transceivers that we sell utilize our own lasers and subassemblies (we refer to the transceiverssubassemblies as “light engines”), and we believe that our in-house technology and manufacturing capability for these lasersand subassemblies gives us an advantage over many of our competitors who often lack either development or manufacturingcapabilities for these advanced optical modules. The CATV market is our most established market, for which we supply a broad array of products, including lasers,transmitters and transceivers, and turn-key equipment. Sales of headend, node and distribution equipment have contributedsignificantly to our revenue in recent years as a result of our ability to meet the needs of CATV equipment vendors who havecontinued to outsource both the design and manufacturing of this equipment. As the complexity of CATV networks hasincreased over the years, equipment vendors, many of whom are our customers, have been under pressure to supply a widervariety of increasingly complex equipment to CATV multiple system operators (MSOs). In order to meet these demands,many equipment vendors have looked to engage with suppliers like AOI who have the capability to design and manufacturevarious network equipment or subassemblies, rather than always developing these devices themselves. This outsourcingtrend has been a significant contributor to the revenue we derive from the CATV market. We believe that our extensive high-speed optical, mixed-signal semiconductor and mechanical engineering capabilities position us well to continue to benefitfrom these industry dynamics. Our vertically integrated manufacturing model provides us several advantages, including rapid productdevelopment, fast response times to customer requests and control over product quality and manufacturing costs. We design,manufacture and integrate our own analog and digital lasers using a combination of Metal Organic Chemical VaporDeposition, or MOCVD, and our proprietary Molecular Beam Epitaxy, or MBE, fabrication process, which we believe isunique in our industry. We manufacture the majority of the laser chips and optical components that are used in our products.The lasers we manufacture are tested extensively to enable reliable operation over time and our devices are often highlytolerant of changes in temperature and humidity, making them well-suited to the CATV and FTTH markets where networkingequipment is often installed outdoors. In 2018, 2017 and 2016, our revenue was $267.5 million, $382.3 million and $260.7 million and our gross marginwas 32.8%, 43.5% and 33.4%. We have grown our annual revenue at a compound annual growth rate, or CAGR, of 30.1%between 2009 and 2018. In the years ended December 31, 2018, 2017 and 2016, we had net income (loss) of $(2.1) million,$74.0 million and $31.2 million, respectively. At December 31, 2018 and 2017, our retained earnings were $36.0 million and$38.1 million, respectively. In 2018, we earned 74.9% of our total revenue from the internet data center market and 19.3% ofour total revenue from the CATV market. In 2018, our key customers in the data center market included Facebook, Inc.(Facebook), Microsoft Corp (Microsoft) and Amazon.com (Amazon). In 2018, 2017, and 2016, Facebook accounted for38.3%, 28.6% and 3.6% of our revenue, Microsoft accounted for 22.1%, 13.8%, and 18.3% of our revenue and Amazonaccounted for 12.1%, 35.4%, and 54.6% of our revenue, respectively. In 2018, our key customers in the CATV marketincluded Cisco Systems, Inc. (Cisco); a large CATV equipment company in China; and Arris Group, Inc. (Arris). In 2018,2017 and 2016, Cisco accounted for 9.9%, 4.8%, and 5.4%, of our revenue, respectively; our large China-based customeraccounted for 3.3%, 3.4%, and 1.2% of our revenue, respectively; and Arris accounted for 2.1%, 3.2% and 5.8%, of ourrevenue, respectively. Industry Background During 2018, our four target markets, internet data center, CATV, telecom and FTTH, experienced a significantgrowth in bandwidth consumption and the corresponding need for network infrastructure improvement to support thisgrowth. The prevailing trends in our target markets include: ·Trends in the Internet Data Center Market. To support the substantial increase in bandwidth consumption,internet data center operators are increasing the scale of their internet data centers and accelerating datatransmission rates. As a result, there is an ongoing transition from the use of copper cable,4 Table of Contentstypically at speeds of up to 1 gigabit per second (Gbps), to optical fiber as a transport medium, typicallyproviding speeds from 10 Gbps to 400 Gbps. In recent years, a number of leading internet companies haveadopted more open internet data center architectures, using a mix of systems and components from a variety ofvendors, and in some cases designing their own equipment. For these companies, compatibility of newnetworking equipment with legacy infrastructure is not as important, and consequently, these companies aremore willing to work with non-traditional equipment vendors, which we believe creates an open and growingopportunity for optical device vendors. Moreover, transmission speeds have continued to increase among thecompanies who have previously transitioned from copper-based to fiber-based infrastructure, resulting inopportunities for optical device vendors to supply new optical transceivers capable of operating at these higherdata rates. ·Trends in the CATV Market. In recent years, CATV service providers have invested extensively to support highspeed, two-way communications and we expect that they will continue to do so. In North America, in particular,CATV service providers have begun to upgrade their networks with new technologies like DOCSIS 3.1, whichenables them to offer higher speed connections to their customers. In order to increase available bandwidth fortheir customers beyond the bandwidth possible with the introduction of DOCSIS 3.1, cable MSOs have beenreducing the number of customers that are connected to a single node. By reducing the number of “homes pernode,” the average bandwidth available to each customer is increased. Other new technologies, such asConverged Cable Access Platform (CCAP) and “Remote PHY” are under development by cable equipmentsuppliers. These technologies are being developed to be a cost-effective solution to provide higher availablebandwidth to CATV customers. AOI has developed a unique Remote-PHY product portfolio which started togenerate initial revenue in 2018. We believe this product is well positioned in the marketplace as we expectMSOs to begin to deploy this technology more broadly in 2019. As the complexity of CATV networks has increased over the years, equipment vendors, many of whom are ourcustomers, have been under pressure to supply a wider variety of increasingly complex equipment to CATVMSOs. In order to meet these demands, many equipment vendors have looked to engage with suppliers likeAOI who have the capability to design and manufacture various network equipment or subassemblies, ratherthan always developing these devices themselves. This outsourcing trend has been a significant contributor tothe revenue we derive from the CATV market. ·Trends in the Telecom Market. The telecom market is composed of customers who deploy wireline opticalnetworks, other than Passive Optical Networks, or PONs, for telecommunications access networks, including forbackhaul of cellular telephone signals. As demand for mobile internet connectivity has increased in recentyears, reliable and high-speed optical networks have become increasingly important. In particular, the use ofwavelength division multiplexing (WDM) to expand the capacity of mobile networks has led to increaseddemand for WDM components (including lasers and transceivers) by telecom equipment manufacturers. Incoming years, we believe that the deployment of advanced 5G networks will result in increased demand foroptical components, especially those used in connecting between antennas and base stations, as well as forbackhaul as mentioned above. ·Trends in the FTTH Market. The FTTH market generally refers to the PONs that telecommunications serviceproviders deploy. The most commonly deployed PON technology is Gigabit PON, or GPON, which delivers upto 2.5 Gbps of data, but due to the splitting of the bandwidth among multiple users, the actual bandwidthdelivered to an individual subscriber is far less than 2.5 Gbps. One approach that does support true 1 Gbpsservice to the home is wavelength division multiplexing PON, or WDM-PON, a technology that enables thetransmission of multiple wavelengths of data over a single fiber-optic strand. Our Solutions We experience certain challenges within our target markets, including continuous pressure to innovate and deliverhighly integrated products that perform reliably in harsh, demanding environments and to produce high-quality devices inlarge volumes at competitive prices.5 Table of Contents By addressing the challenges in our target markets, we provide the following benefits to our customers: ·Enable customers to deliver innovative products. We leverage our extensive expertise in high-speed optical,mixed-signal semiconductor and mechanical engineering, and MOCVD and our proprietary MBE laserfabrication process to deliver technologically advanced products to our customers. ·Enhance efficiency and cost effectiveness of our customers’ supply chains. We design and sell products at thelevel of integration desired by a customer, from components to turn-key equipment, providing our customers adependable, cost-effective and simplified supply chain. ·Deliver high quality, reliable products in high volume. As a vertically integrated supplier, we are able tomonitor and maintain quality control throughout the production process, using our internally producedcomponents where possible for our final products. With manufacturing facilities in the U.S., Taiwan and China,we can support high volume production and timely delivery for our customers around the world. ·Provide sophisticated design solutions to our customers. We believe our in-house expertise in both analog anddigital optical engineering enables us to design comprehensive solutions that meet many of the differentnetwork architectures and protocols used by our customers. Our Strengths Our key competitive strengths include the following: ·Proprietary technological expertise and track record of innovation. We continue to develop innovativeproducts by leveraging our technological expertise, including our proprietary MBE and MOCVD laserfabrication process. ·Innovative light engine design and manufacturing. High-speed data center interconnect transceiversincreasingly rely on multiple parallel optical signals. Our expertise in designing and manufacturing lightengines, which combine lasers and photodiodes with channel multiplexing and de-multiplexing elements, givesus the ability to quickly develop new products for our data center customers. ·Proven system design capabilities. We have extensive expertise and proven design capabilities in high-speedoptical, mixed-signal semiconductor and mechanical engineering, which we believe position us to takeadvantage of the continuing shift to outsourced design and manufacturing among CATV equipment vendors. ·Industry-leading position in the CATV market. We have continued to be awarded new design andmanufacturing opportunities for CATV components and equipment. We serve a majority of the largest CATVequipment manufacturers in the world and our knowledge of both their requirements and the needs of theircustomers (the CATV network operators) allows us to access these new opportunities. ·Vertically integrated, geographically distributed manufacturing model. Our vertically integrated design andmanufacturing process encompasses various steps from laser design and fabrication to complete optical systemdesign and assembly. Furthermore, we have geographically distributed our manufacturing by strategicallylocating our operations in the U.S., China and Taiwan to reduce development time and production costs, tobetter support our customers and to help protect our intellectual property. Our Strategy We seek to be the leading global provider of optical components, modules and equipment for each of our four targetmarkets, internet data centers, CATV, telecom and FTTH. Our strategy includes the following key elements: ·Continue to penetrate the internet data center market. In the internet data center market, we primarily targetinternet data center operators who have adopted an open system architecture—one in which the6 Table of Contentsoptical connectivity solutions can be provided by a different vendor than the vendor which provides theirservers and switches. ·Extend our leadership in CATV networking. We intend to maintain our position as a leading producer ofoptical components used in CATV networks, and to capture an increasing share of the CATV equipment marketas the major equipment vendors continue to outsource the design and manufacturing of such products. ·Develop new products for the Telecom market. Our addressable telecom market has often been limited by ourrelatively small portfolio of products for this market. In many cases, our telecom product offerings are identicalor nearly identical to products that we sell in other markets (for example CATV or internet data center). As wecontinue to develop new technological capabilities, we intend to develop products specifically for telecommarkets. ·Continue to penetrate the FTTH market. We believe our WDM-PON technology is a cost-effective solution fordelivering 1 Gbps bandwidth to a home. We intend to capture an increasing share of the FTTH market bydelivering optical modules enabling 1 Gbps synchronous service to the home through our customers, who areeither internet service providers or manufacturers of networking equipment supplying internet service providers. ·Continue to invest in our capabilities and infrastructure. We intend to continue to invest in new products, newtechnology and our production infrastructure and facilities to maintain and strengthen our competitive position.We engage in an active research and development program to develop new products and enhance existingproducts. ·Selectively pursue other opportunities that leverage our existing expertise. Our expertise in designing andmanufacturing outdoor equipment for the CATV industry positions us well to pursue applications that are alsocharacterized by having varying and demanding environments, including wireless and wireline telecominfrastructure, industrial robotics, aerospace and defense, and oil and gas exploration. ·Pursue complementary acquisition and strategic alliance opportunities. We evaluate and selectively pursueacquisition opportunities or strategic alliances that we believe will enhance or complement our current productofferings, augment our technology roadmap, or diversify our revenue base. Our Technology We believe that we have technology leadership in four key areas: semiconductor laser manufacturing, electronictechnologies that enhance the performance of our lasers, optical hybrid integration and mixed-signal semiconductor design. ·Differentiated semiconductor laser manufacturing. We use a combination of MBE and MOCVD processes inthe fabrication of our lasers. We believe that the combination of these two epitaxial processes allows ourproducts to benefit from the advantages afforded by each of these techniques. Among the differentiators of MBErelative to MOCVD fabrication are a lower process temperature and the use of solid phase materials rather thangaseous sources to grow wafers and the growth of more highly strained crystals. These factors contribute tolonger operating lives of our lasers, improved laser efficiency and threshold current, among other performanceattributes that make them well-suited to our target markets. While we believe that these advantages of MBE areimportant, MBE does have disadvantages including the inability to use certain dopant materials (for exampleIron), difficulty in certain types of regrowth, and the necessity to maintain complex ultra-high vacuumequipment. By utilizing MOCVD in a portion of our production process, we are able to ameliorate some of thesedisadvantages. However, the epitaxial and processing steps required in the fabrication of our devices are verycomplex, with numerous critical steps requiring highly precise control. As a result of some of these challenges,production yields and the performance attributes of laser devices are highly variable and optimizing thesecharacteristics requires numerous enhancements and modifications to standard MBE equipment and the MBEprocess. To our knowledge, we are unique in incorporating MBE processes in the production ofcommunications lasers in high volume,7 Table of Contentsand believe it would be difficult and time-consuming for other vendors to replicate our production technology. ·Laser enhancement technology. Certain properties of the semiconductor lasers predominantly used intraditional communications devices, such as chirp and wavelength drift, negatively affect their ability totransmit signals over long fiber distances or prevent them from transmitting signals with acceptable fidelity incertain applications. We have developed laser enhancement circuitry that can correct many of thesedeficiencies. We believe that our technology will become more essential with wider deployment of highercapacity CATV and FTTH systems, which place more stringent demands on laser performance. ·Optical hybrid-integration technology. Reducing the size, power consumption and complexity of opticaldevices is essential for achieving the price and performance targets of our customers. Our ability to integratemultiple optical networking functions into a single device and to co-package multiple devices into smaller formfactors helps us meet customer requirements, and we believe can also create new opportunities. For instance, thetransmission speed between network elements (switches and servers, for example) within the data center hascontinued to increase. However, the rate at which this data can be converted from electrical signals to opticalsignals by laser diodes has not increased at the same pace. Therefore, to achieve data rates of 40 Gbps andabove, many customers utilize multiple lower data rate lasers co-packaged together into a single opticalmodule, which we refer to as a light engine. The technology required to cost-effectively and reliably co-packagethese lasers and the associated electronic control circuitry is complex. Our extensive experience with theprocesses and the manufacturing technologies required to produce these devices gives us a competitiveadvantage. Similarly, in FTTH and telecom networks, installing new fiber-optic cable is expensive and difficult, and insome situations prohibitively so for a network service provider. As a consequence, network operators seek tomaximize the utilization of their installed fiber plant. In long-haul and metropolitan networks, the number ofservice providers who deployed WDM technology as fiber utilization rose. Fiber utilization in access networkshas risen, but the use of WDM technology in the access segment has been problematic due to the relatively highcost and power consumption of the requisite optical devices. We have developed proprietary miniaturizedoptical packaging, electronic control circuitry and testing algorithms to create a hybrid WDM-PON solutionthat addresses these historical impediments that we believe will make WDM-PON a cost-effective alternative fordeployment. ·Mixed-signal design. As CATV providers continue to evolve from primarily broadcast-video content providersto a mixture of HD video content together with data-connectivity providers, the networks they utilize to offerthese services must evolve as well. Older analog networks are giving way to hybrid networks that incorporateboth analog and digital signals. For example, many newer networks are being designed with “digital return-path” capabilities, and certain MSOs have begun to deploy “Remote-PHY” technologies. Both of thesetechnologies involve transporting certain network signals in digital format, and then converting these signals toand from analog signals at various points in the MSO’s network. This combination of analog and digitalsignaling creates unique design challenges. Our engineers have many years of experience in developingequipment, modules and components that are well suited to these sorts of mixed-signal architectures. Webelieve that having deep experience in both digital and analog signaling allows us to offer superior solutions toour customers, compared with companies who have expertise in only one of these signal types. Our Products Our products include an array of optical communications solutions at varying levels of integration. We begin fromthe fundamental building blocks of lasers and laser components. From these foundational products, we design andmanufacture a wide range of products from optical modules to complete turn-key equipment. We design our products totarget customers in our identified markets to meet their needs and specifications. Our components often incorporate one or more of our optical laser chips inside a precision housing that providesmechanical protection as well as standardized electrical contacts. More complex optical components may also includeoptical filters (for example, for use in WDM) or other optical elements by which optical signals are routed internally withinthe component. These more advanced components may also include coolers, heaters and sensors that8 Table of Contentsallow the temperature of the laser chip to be measured and controlled. We manufacture the majority of the laser chips andoptical components that are used in our own products. At the next level of integration, our module or sub-assembly products typically contain one or more of our opticalcomponents and some additional control circuitry. Examples of modules include our transceiver line primarily used ininternet data center markets, telecom markets, and FTTH markets. At the highest level of integration and complexity, our equipment products typically contain one or more opticalcomponents, modules and additional electronic control circuitry required to enable these subsystems to operateindependently. For example, our CATV transmitter equipment requires utilization of our optical components and assemblyonto a circuit board and to an external housing. Examples of equipment include our CATV transmitter and CATV nodes. Intellectual Property We rely on a combination of patent, copyright, trademark trade secret laws and unfair competition laws, as well asconfidentiality and licensing arrangements, to establish and protect our intellectual property. We employ various methods toprotect these intellectual property rights, including maintaining a technological infrastructure with significant securitymeasures, limiting disclosure and restricting access to only those individuals with an operational need for such information,and having employees, consultants and suppliers execute confidentiality agreements with us. While we expect ourintellectual property to provide competitive advantages, we also find meaningful value from unpatented proprietary processknowledge, know-how and trade secrets. Patents As of December 31, 2018, we owned a total of 124 U.S. issued patents and 141 patents issued in China and Taiwan,plus a number of pending U.S. and foreign/international patent applications. Our issued U.S. and foreign patents will expirebetween 2019 and 2037. While our patents are an important element of our success, our business as a whole is not dependenton any one patent or group of patents. We do not anticipate any material effect on our business due to any patents expiring in2019, and we continue to obtain new patents through our ongoing research and development. Our portfolio of patents and patent applications covers several different technology families including: ·laser structure and design; ·optical signal conditioning and laser control; ·laser fabrication; ·photodiode and optical receiver design and fabrication; ·optical device and module designs; ·optical device packaging equipment and techniques; and ·optical network enhancements. Trademarks We have registered the trademarks APPLIED OPTOELECTRONICS, INC., AOI and our logo with the U.S. Patent andTrademark Office on the Principal Register. These marks are also registered in, or have applications for registration pendingin, various foreign trademark offices. Research and Development To maintain our growth and competitiveness, we engage in an active research and development program to developnew products and enhance existing products. As a result of these efforts, we anticipate releasing various new or9 Table of Contentsenhanced products over the next several years. Our research and development expenses were approximately $49.9 million,$35.4 million, and $31.8 million for the years 2018, 2017 and 2016, respectively. As of December 31, 2018, we had a total of 305 employees working in the R&D department, including 15 with Ph.D.degrees. We continue to recruit talented engineers to further enhance our research and development capabilities. We haveresearch and development departments in our facilities in Texas, Georgia, China and Taiwan. Our research and developmentteams collaborate on joint projects, and by co-locating with our manufacturing operations enable us to achieve an efficientcost structure and improve our time to market. A key factor in our research and development success is our highly collaborative process for new productdevelopment. Particularly in our equipment and module businesses, we often collaborate very closely with our customersfrom a very early stage in product development. By purposefully fostering this close collaboration, we believe that we canmore rapidly develop leading solutions meeting the needs of our customers. Manufacturing and Operations We have three manufacturing sites: Sugar Land, Texas, Ningbo, China and Taipei, Taiwan. Our research anddevelopment functions are generally partnered with our manufacturing locations, and we have an additional research anddevelopment facility in Duluth, Georgia. In our Sugar Land facility, we manufacture laser chips (utilizing our MBE andMOCVD processes), subassemblies and components. The subassemblies are used in the manufacture of components by ourother manufacturing facilities or sold to third parties as modules. We manufacture our laser chips only within our Sugar Landfacility, where our laser design team is located. In our Taiwan location, we manufacture optical components, such as ourbutterfly lasers, which incorporate laser chips, subassemblies and components manufactured within our Sugar Land facility.In addition, in our Taiwan location, we manufacture transceivers for the internet data center, telecom, FTTH and othermarkets. In our China facility, we take advantage of lower labor costs and manufacture certain more labor intensivecomponents and optical equipment systems, such as optical subassemblies and transceivers for the internet data centermarket, CATV transmitters (at the headend) and CATV outdoor equipment (at the node). Each manufacturing facilityconducts testing on the components, modules or subsystems it manufactures and each facility is certified to ISO 9001:2015.Our facilities in Ningbo, China, Taipei, Taiwan, and Sugar Land, Texas are all certified to ISO 14001:2015. We sell our products to customers worldwide, and in addition to these external customer sales many of our productsare used internally in the production of transceivers and equipment that we manufacture. With a vertically integratedmanufacturing process, we produce many of our own laser chips and other parts required to manufacture our opticalcomponents. Through this model, we are able to reduce development time and product costs as well as actively monitor andcontrol product quality. We incorporate our own components into our transceivers, subsystems and equipment productswherever possible. In instances where we do not produce components ourselves, we source them from external suppliers andregularly evaluate these relationships in an attempt to reduce risk and lower cost. We depend on a limited number of suppliers, including in some cases our own internal supply, for certain rawmaterials and components used in our products. We regularly review our vendor relationships in an attempt to mitigate risksand lower costs, especially where we depend on one or two vendors for critical components or raw materials. Whilemaintaining inventories that we believe are sufficient to meet our near-term needs, we strive not to carry significantinventories of externally sourced raw materials. Accordingly, we maintain ongoing communications with our vendors inorder to help prevent any interruptions in supply, and have implemented a supply-chain management program to maintainquality and lower purchase prices through standardized purchasing efficiencies and design requirements. Customers Our customers are primarily internet data center operators, CATV and telecommunications equipmentmanufacturers, and internet service providers. We generally employ a direct sales model in North America and in the rest ofthe world we use both direct and indirect sales channels. In 2018, 2017 and 2016, we obtained 96.4%, 97.0% and 96.0% ofour revenue, respectively, through our direct sales efforts and the remainder of our revenue through our indirect saleschannels. Our sales channel partners provide logistical services and day-to-day customer support. Where we sell through anindirect sales channel, we work with the end customer to establish technological specifications for our products. Ourequipment customers typically offer our equipment under their brand-name and our equipment is often customized withunique design or performance criteria by each of these customers. We also from time to time offer10 Table of Contentsdesign or manufacturing services to customers to assist them in more effectively using our products and realizing time-to-market advantages. In the last three years, we have taken several actions to increase the diversity of our customer base. These actionsinclude hiring additional sales staff to improve our ability to serve new customers and introduction of new products that webelieve will appeal to new customers. Furthermore, we have developed additional original design manufacturer, or ODM,relationships with customers in each of our target markets which should enable us to diversify our revenue base. In 2018, the three customers who contributed most to our data center revenue were Facebook, Microsoft andAmazon. Our CATV products were used by three large CATV original equipment manufacturers, or OEMs, consisting ofCisco; a large CATV equipment company in China; and Arris (which acquired the Motorola Home Business in 2013 andPace Plc in 2016). In 2018, revenue from the internet data center market, CATV market, the telecom market, FTTH marketand other markets provided 74.9%, 19.3%, 4.9%, 0.3% and 0.6% of our revenue, respectively, compared to 80.2%, 15.9%,3.4%, 0.1% and 0.4%, respectively, in 2017. In our telecom market, we manufacture and sell optical products which include transceivers designed to transmitsignals used in 4G Long Term Evolution, or LTE, mobile networks, and various products targeted at the metro-scaletelecommunications networking market. In 2019, we expect to begin selling products used in advanced 5G mobilenetworks. We have various other products designed for diverse applications, both inside and outside of communicationstechnology, which generally are derivatives of products developed for our four target markets. We support our sales efforts by attendance at industry trade shows, technical conferences, advertising in varioustrade journals and magazines and other promotional efforts. These efforts are aimed at attracting new customers andenhancing our existing customer relationships. Backlog We generally make sales pursuant to short-term purchase orders without deposits and subject to rescheduling,revision or cancellation on short notice. We accordingly believe that purchase orders are not an accurate indicator of ourfuture sales and any backlog of purchase orders is not a reliable indicator of our future revenue. Financial Information by Geographic Region For information regarding our revenue and long-lived assets by geographic region, see Note P to the ConsolidatedFinancial Statements. For risks relating to our operations see “Item 1A. Risk Factors” and particularly the risks under thecaption “Risks related to our operations in China.” Additional Financial Information For certain financial information regarding our business, see “Item 6. Selected Financial Data.” Competition The optical networking market is intensely competitive. Because of the broad nature of our product offerings, we donot believe that we face a single major competitor across all of our markets. We do, however, experience intense competitionin each product area from a number of manufacturers and we anticipate that competition will increase. Our major competitorsin one or more of our markets include EMCORE Corporation, Finisar Corporation, Foxconn Interconnect Technology Ltd.,InnoLight Technology (Suzhou) Ltd., Intel Corporation, Lumentum Holdings, Inc., Mitsubishi, Molex, LLC, SourcePhotonics, Inc. and Sumitomo Electric Industries, Ltd. Many of our competitors are larger than we are and have significantly greater financial, marketing and otherresources. In addition, several of our competitors have large market capitalizations or cash reserves and are much betterpositioned to acquire other companies to gain new technologies or products that may displace our products. Networkequipment providers, who are our customers, and network service providers, who are supplied by our customers, may11 Table of Contentsdecide to manufacture the optical subsystems incorporated into their network systems in-house. We also encounter potentialcustomers that, because of existing relationships, are committed to the products offered by these competitors. We believe the principal competitive factors in our target markets include the following: ·use of internally manufactured components; ·product breadth and functionality; ·timing and pace of new product development; ·breadth of customer base; ·technological expertise; ·reliability of products; ·product pricing; and ·manufacturing efficiency. We believe that we compete favorably with respect to the above factors based on our MBE and MOCVD processes,our vertically integrated model, the performance and reliability of our product offerings, and our technical expertise in lightengine design and manufacture. SeasonalitySee Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Seasonality,” regarding seasonality of certain of the Company’s products. Employees As of December 31, 2018, we employed 2,956 full-time employees, of which 36 held Ph.D. degrees in a science orengineering field. Of our employees, 449 are located in the U.S., 1,057 are located in Taiwan and 1,450 are located in China.None of our employees are represented by any collective bargaining agreement, but certain employees of our Chinasubsidiary are members of a trade union. We have never suffered any work stoppage as a result of an employment relatedstrike or any employee related dispute and believe that we have satisfactory relations with our employees. Environmental Matters Our research and development and manufacturing operations and our products are subject to a variety of federal,state, local and foreign environmental, health and safety laws and regulations, including those governing discharges ofpollutants to air and water, the use, storage, handling and disposal of hazardous materials and solid wastes, employee healthand safety, and the hazardous material content in our products. Our environmental management systems in our facilities inSugar Land, Texas, Ningbo, China and Taipei, Taiwan are all certified to meet the requirements of ISO14001:2015. However,there can be no assurance that violations of applicable laws at any of our facilities will not occur in the future as a result ofhuman error, accident, equipment failure or other causes. We use, store and dispose of hazardous materials and solid wastes inour manufacturing operations and hazardous materials are present in our products. We incur costs to comply withenvironmental, health and safety requirements, and any failure to comply, or the identification of contamination for whichwe are found liable, could cause us to incur substantial costs, including cleanup costs, natural resource damages, monetaryfines, or administrative, civil or criminal penalties, and subject us to property damage and personal injury claims, and resultin injunctive relief including the suspension of production, alteration or upgrades of our manufacturing processes, redesignof our products, or curtailment of sales, and could result in adverse publicity. Liability under environmental, health andsafety laws can be joint and several and without regard to fault or negligence. For example, pursuant to environmental lawsand regulations, including but not limited to the Comprehensive Environmental Response Compensation and Liability Act,or CERCLA, we may be liable for the full12 Table of Contentsamount of any remediation-related costs at properties we currently own or operate or formerly owned, such as our currentlyowned Sugar Land, Texas facility, or at properties at which we previously operated, as well as at properties we will own oroperate in the future, and properties to which we have sent hazardous substances, whether or not we caused thecontamination. We expect that our operations and products will be affected by new environmental requirements on an ongoingbasis. Environmental, health and safety requirements have become more stringent over time, and changes to existingrequirements could restrict our ability to expand our facilities, require us to acquire costly pollution control equipment,requires us to obtain additional permits for our activities, or cause us to incur other significant expenses or to modify ourmanufacturing processes or the hazardous material content of our products. Identification of presently unidentifiedenvironmental conditions, more vigorous enforcement by a governmental authority, enactment of more stringent legalrequirements or other unanticipated events could give rise to adverse publicity, restrict our operations, affect the design ormarketability of our products or otherwise cause us to incur material environmental costs or delays in planned activities. We face increasing complexity in our product design and procurement operations as we adjust to new and upcomingrequirements relating to the materials composition of our products. Some jurisdictions in which our products are sold haveenacted requirements regarding the hazardous material content of certain products. For example, member states of theEuropean Union and China are among a growing number of jurisdictions that have placed restrictions on the use of lead,among other chemicals, in electronic products, which affect the composition and packaging of our products. The passage ofsuch requirements in additional jurisdictions, or the tightening of standards or elimination of certain exemptions injurisdictions where our products are already subject to such requirements, could cause us to incur significant expenditures tomake our products compliant with new requirements, or could limit the markets into which we may sell our products. Othergovernmental regulations may require us to reengineer our products to use components that are more environmentallycompatible, resulting in additional costs to us. Sources of Raw Materials We depend on a limited number of suppliers for certain raw materials, components, and equipment used in ourproducts. We continually review our supplier relationships to mitigate risks and lower costs, especially where we depend onone or two suppliers for critical components or raw materials. While maintaining inventories that we believe are sufficient tomeet our near-term needs, we strive not to carry significant inventories of raw materials. Accordingly, we maintain ongoingcommunications with our suppliers in order to prevent any interruptions in supply, and have implemented a supply-chainmanagement program to maintain quality and lower purchase prices through standardized purchasing efficiencies and designrequirements. To date, we generally have been able to obtain sufficient quantities of critical supplies in a timely manner. We are subject to rules promulgated by the SEC pursuant to the Dodd-Frank Wall Street Reform and ConsumerProtection Act regarding the use of "conflict minerals". These rules have imposed and will continue to impose additionalcosts and may introduce new risks related to our ability to verify the origin of any "conflict minerals" used in our products. Export Regulations The Bureau of Industry and Security (BIS) of the U.S. Department of Commerce is responsible for regulating theexport of most commercial items that are classified as dual-use goods that may have both commercial and militaryapplications. Our products are classified under Export Control Classification Numbers, or ECCNs, 5A991 and 6A995. ExportControl Classification requirements are dependent upon an item’s technical characteristics, the destination, the end-use, andthe end-user, and other activities of the end-user. Should the ECCN change, then the export of our products to certaincountries would be restricted. However, we currently do not export our products to any countries on the restricted list, andtherefore a change in the ECCN would not materially impact our business. Corporate Information We were incorporated in the State of Texas in 1997. In March 2013, Applied Optoelectronics, Inc., a Texascorporation, converted into a Delaware corporation. Prime World International Holdings, Ltd. (“Prime World”) is a wholly-owned subsidiary of the Company incorporated in the British Virgin Islands on January 13, 2006. Prime World is13 Table of Contentsthe parent company of Global Technology, Inc. (“Global”). Global was established in June 2002 in the People’s Republic ofChina (“PRC”) and was acquired by Prime World on March 30, 2006. Prime World also operates a division in Taiwan, whichis qualified to do business in Taiwan and primarily manufactures transceivers and performs research and developmentactivities. Our principal executive offices are located at 13139 Jess Pirtle Blvd., Sugar Land, TX 77478, and our telephonenumber is (281) 295-1800. Our website address is www.ao-inc.com. Information contained on our website is not incorporatedby reference into this Annual Report on Form 10-K. Available Information We file electronically with the United States Securities and Exchange Commission, or SEC, our annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnishedpursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make available on our website atwww.ao-inc.com free of charge, copies of these reports as soon as reasonably practicable after filing these reports with, orfurnishing them to, the SEC. Item 1A.Risk Factors Investing in our common stock involves a high degree of risk. You should carefully consider the following riskfactors and all other information contained in our Annual Report on Form 10-K, including our consolidated financialstatements and related notes. If any of the following risks actually occur, we may be unable to conduct our business ascurrently planned and our financial condition and results of operations could be seriously harmed. In addition, the tradingprice of our common stock could decline due to the occurrence of any of these risks and you may lose all or part of yourinvestment. Risks Inherent in Our Business We are dependent on our key customers for a significant portion of our revenue and the loss of, or a significant reductionin orders from, any of our key customers would adversely impact our revenue and results of operations. We generate much of our revenue from a limited number of customers. For each year ended 2018, 2017 and 2016,our top ten customers represented 92.9%, 94.9% and 95.5% of our revenue, respectively. In 2018, Facebook represented38.3% of our revenue, Microsoft represented 22.1% of our revenue and Amazon represented 12.1% of our revenue. As aresult, the loss of, or a significant reduction in orders from any of our key customers would materially and adversely affect ourrevenue and results of operations. We typically do not have long-term contracts with our customers and instead rely onrecurring purchase orders. However, many of our current revenue expectations and forecasts reflect significant anticipatedorders from a limited number of key customers. If our key customers do not continue to purchase our existing products or failto purchase additional products from us, our revenue would decline and our results of operations would be adverselyaffected. Changes in our customers’ demands may negatively affect our sales and revenue. For example, several of our largestcustomers have informed us that new architectures being implemented in their datacenters may reduce their demand for 100Gbps optical transceivers compared to their prior forecasts. This would negatively impact our anticipated revenue from thesecustomers. If we cannot sufficiently increase revenue from these new customers and our other existing customers, then ouroverall revenue may be adversely affected. Adverse events affecting our key customers could also negatively affect our ability to retain their business andobtain new purchase orders, which could adversely affect our revenue and results of operations. For example, in recent years,there has been consolidation among various network equipment manufacturers and this trend is expected to continue. We areunable to predict the impact that industry consolidation would have on our existing or potential customers. We may not beable to offset any potential decline in revenue arising from the consolidation of our existing customers with revenue fromnew customers or additional revenue from the merged company. 14 Table of ContentsCustomer demand is difficult to forecast accurately and, as a result, we may be unable to match production with customerdemand. We make planning and spending decisions, including determining the levels of business that we will seek andaccept, production schedules, component procurement commitments, personnel needs and other resource requirements, basedon our estimates of product demand and customer requirements. Our products are typically purchased pursuant to individualpurchase orders. While our customers may provide us with their demand forecasts, they are typically not contractuallycommitted to buy any quantity of products beyond firm purchase orders. Furthermore, many of our customers may increase,decrease, cancel or delay purchase orders already in place without significant penalty. The short-term nature of commitmentsby our customers and the possibility of unexpected changes in demand for their products reduce our ability to accuratelyestimate future customer requirements. On occasion, customers may require rapid increases in production, which can strainour resources, cause our manufacturing to be negatively impacted by materials shortages, necessitate more onerousprocurement commitments and reduce our gross margin. We may not have sufficient capacity at any given time to meet thevolume demands of our customers, or one or more of our suppliers may not have sufficient capacity at any given time to meetour volume demands. If any of our major customers decrease, stop or delay purchasing our products for any reason, we willlikely have excess manufacturing capacity or inventory and our business and results of operations would be harmed. If our customers do not qualify our products for use on a timely basis, our results of operations may suffer. Prior to the sale of new products, our customers typically require us to “qualify” our products for use in theirapplications. At the successful completion of this qualification process, we refer to the resulting sales opportunity as a“design win.” Additionally, new customers often audit our manufacturing facilities and perform other evaluations during thisqualification process. The qualification process involves product sampling and reliability testing and collaboration with ourproduct management and engineering teams in the design and manufacturing stages. If we are unable to accurately predictthe amount of time required to qualify our products with customers, or are unable to qualify our products with certaincustomers at all, then our ability to generate revenue could be delayed or our revenue would be lower than expected and wemay not be able to recover the costs associated with the qualification process or with our product development efforts, whichwould have an adverse effect on our results of operations. In addition, due to rapid technological changes in our markets, a customer may cancel or modify a design projectbefore we have qualified our product or begun volume manufacturing of a qualified product. It is unlikely that we would beable to recover the expenses for cancelled or unutilized custom design projects. Some of these unrecoverable expenses forcancelled or unutilized custom design projects may be significant. It is difficult to predict with any certainty whether ourcustomers will delay or terminate product qualification or the frequency with which customers will cancel or modify theirprojects, but any such delay, cancellation or modification would have a negative effect on our results of operations. Our ability to successfully qualify and scale capacity for new technologies and products is important to our abilityto grow our business and market presence, and we may invest a significant amount to scale our capacity to meet potentialdemand from customers for our new technologies and products. If we are unable to qualify and sell any of our new productsin volume, on time, or at all, our results of operations may be adversely affected. We face intense competition which could negatively impact our results of operations and market share. The markets into which we sell our products are highly competitive. Our competitors range from large, internationalcompanies offering a wide range of products to smaller companies specializing in niche markets. Current and potentialcompetitors may have substantially greater name recognition, financial, marketing, research and manufacturing resourcesthan we do, and there can be no assurance that our current and future competitors will not be more successful than us inspecific product lines or markets. Some of our competitors may also have better-established relationships with our current orpotential customers. Some of our competitors have more resources to develop or acquire new products and technologies andcreate market awareness for their products and technologies. In addition, some of our competitors have the financial resourcesto offer competitive products at below-market pricing levels that could prevent us from competing effectively and result in aloss of sales or market share or cause us to lower prices for our products. In recent years, there has been consolidation in ourindustry and we expect such consolidation to continue. Consolidation involving our competitors could result in even moreintense competition. Network equipment manufacturers, who are our customers, and network service providers may decide tomanufacture the optical subsystems15 Table of Contentsincorporated into their network systems in-house instead of outsourcing such products to companies such as us. We alsoencounter potential customers that, because of existing relationships with our competitors, are committed to the productsoffered by our competitors. We must continually develop successful new products and enhance existing products, and if we fail to do so or if ourrelease of new or enhanced products is delayed, our business may be harmed. The markets for our products are characterized by frequent new product introductions, changes in customerrequirements and evolving industry standards, all with an underlying pressure to reduce cost and meet stringent reliabilityand qualification requirements. Our future performance will depend on our successful development, introduction and marketacceptance of new and enhanced products that address these challenges. If we are unable to make our new or enhancedproducts commercially available on a timely basis, we may lose existing and potential customers and our financial resultswould suffer. In addition, due to the costs and length of research, development and manufacturing process cycles, we may notrecognize revenue from new products until long after such expenditures, if at all, and our margins may decrease if our costsare higher than expected, adversely affecting our financial condition and results of operation. Although the length of our product development cycle varies widely by product and customer, it may take18 months or longer before we receive our first order. As a result, we may incur significant expenses long before customersaccept and purchase our products. Product development delays may result from numerous factors, including: ·modification of product specifications and customer requirements; ·unanticipated engineering complexities; ·difficulties in reallocating engineering resources and overcoming resource limitations; and ·rapidly changing technology or competitive product requirements. The introduction of new products by us or our competitors and other changes in our customer’s demands couldresult in a slowdown in demand for our existing products and could result in a write-down in the value of our inventory. Wehave in the past experienced periodic fluctuations in demand for existing products and delays in new product development,and such fluctuations will likely occur in the future. To the extent we fail to qualify our products and obtain their approvalfor use, which we refer to as a design win, or experience product development delays for any reason, our competitive positionwould be adversely affected and our ability to grow our revenue would be impaired. Furthermore, our ability to enter a market with new products in a timely manner can be critical to our successbecause it is difficult to displace an existing supplier for a particular type of product once a customer has chosen a supplier,even if a later-to-market product provides better performance or cost efficiency. The development of new, technologically advanced products is a complex and uncertain process requiring frequentinnovation, highly-skilled engineering and development personnel and significant capital, as well as the accurateanticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture,market or support new or enhanced products successfully or on a timely basis. Further, we cannot assure you that our newproducts will gain market acceptance or that we will be able to respond effectively to product introductions by competitors,technological changes or emerging industry standards. We also may not be able to develop the underlying core technologiesnecessary to create new products and enhancements, license these technologies from third parties, or remain competitive inour markets. Our revenues, growth rates and operating results are likely to fluctuate significantly as a result of factors that are outsideour control, which could adversely impact our operating results. Our revenues, growth rates and operating results are likely to fluctuate significantly in the future as a result of factorsthat are outside our control. We may not achieve similar revenues, growth rates or operating results in future16 Table of Contentsperiods. Our revenues, growth rates and operating results for any prior quarterly or annual period should not be relied upon asany indication of our future revenues, growth rates or operating results. The timing of order placement, size of orders andsatisfaction of contractual customer acceptance criteria, changes in the pricing of our products due to competitive pressuresas well as order or shipment delays or deferrals, with respect to our products, may cause material fluctuations in revenues. Forexample, revenues for the three months ended March 31, 2018 decreased by 32 percent as compared to the three monthsended March 31, 2017 due primarily to lower sales of 40 Gbps data center transceivers, which includes a reduction in averageselling prices for certain products as a result of price negotiations with our customers. Our lengthy sales cycle, which mayextend to more than one year, may cause our revenues and operating results to vary from period to period and it may bedifficult to predict the timing and amount of any variation. Delays or deferrals in purchasing decisions by our customers mayincrease as we develop new or enhanced products for existing and new markets, including automotive and biotechnologymarkets. Our current and anticipated future dependence on a small number of customers increases the revenue impact of eachsuch customer’s decision to delay or defer purchases from us, or decision not to purchase products from us. Our expenselevels in the future will be based, in large part, on our expectations regarding future revenue sources and, as a result,operating results for any quarterly period in which anticipated material orders fail to occur, or are delayed or deferred, couldbe significantly harmed. We are subject to the cyclical nature of the markets in which we compete and any future downturn will likely reducedemand for our products and revenue. In each of our target markets, including the CATV market, our sales depend on the aggregate capital expenditures ofservice providers as they build out and upgrade their network infrastructure. These markets are highly cyclical andcharacterized by constant and rapid technological change, price erosion, evolving standards and wide fluctuations in productsupply and demand. In the past, these markets have experienced significant downturns, often connected with, or inanticipation of, the maturation of product cycles. These downturns have been characterized by diminished product demand,production overcapacity, high inventory levels and accelerated erosion of average selling prices. Our historical results ofoperations have been subject to these cyclical fluctuations, and we may experience substantial period to period fluctuationsin our future results of operations. Any future downturn in any of the markets in which we compete could significantly reducethe demand for our products and therefore may result in a significant reduction in our revenue. Our revenue and results ofoperations may be materially and adversely affected in the future due to changes in demand from individual customers orcyclical changes in any of the markets utilizing our products. We may not be able to accurately predict these cyclicalfluctuations and the impact that these fluctuations may have on our revenue and operating results. If we encounter manufacturing problems, we may lose sales and damage our customer relationships. We may experience delays, disruptions or quality control problems in our manufacturing operations. These andother factors may cause less than acceptable yields at our facility. Manufacturing yields depend on a number of factors,including the quality of available raw materials, the degradation or change in equipment calibration and the rate and timingof the introduction of new products. Changes in manufacturing processes required as a result of changes in productspecifications, changing customer needs and the introduction of new product lines may significantly reduce ourmanufacturing yields, resulting in low or negative margins on those products. In addition, we use our Molecular BeamEpitaxy, or MBE, fabrication process to make our lasers, in addition to Metal Organic Chemical Vapor Deposition, orMOCVD, the technique most commonly used in optical manufacturing by communications optics vendors, and our MBEfabrication process relies on custom-manufactured equipment. If our MBE or MOCVD fabrication facility in Sugar Land,Texas were to be damaged or destroyed for any reason, our manufacturing process would be severely disrupted. Any suchmanufacturing problems would likely delay product shipments to our customers. For example, shipments of certain of our100 Gbps transceiver products to one of our customers decreased during the three months ended September 30, 2018 due tocustomer concerns about failures of similar products shipped previously. During the quarter, we conducted extensive testingof our products to demonstrate that any potentially affected units could be nearly eliminated from future shipments, and wesubsequently resumed shipments with the customer’s agreement. However, additional testing costs and costs to enhance theongoing monitoring of product quality may adversely affect the results of our operations. Manufacturing problems and anysuch delays would negatively affect our sales and revenue and could negatively affect our competitive position andreputation. We may also experience delays in production, typically in February, during the Lunar New Year holiday whenour facilities in China and Taiwan are closed. 17 Table of ContentsGiven the high fixed costs associated with our vertically integrated business, a reduction in demand for our products willlikely adversely impact our gross profits and our results of operations. We have a high fixed cost base due to our vertically integrated business model, including the fact that 2,529 of ouremployees as of December 31, 2018 were employed in manufacturing and research and development operations. We may notbe able to adjust these fixed costs quickly to adapt to rapidly changing market conditions. Our gross profit and gross marginare greatly affected by our sales volume and volatility on a quarterly basis and the corresponding absorption of fixedmanufacturing overhead expenses. In addition, because we are a vertically integrated manufacturer, insufficient demand forour products may subject us to the risk of high inventory carrying costs and increased inventory obsolescence. Given ourvertical integration, the rate at which we turn inventory has historically been low when compared to our cost of sales. We donot expect this to change significantly in the future and believe that we will have to maintain a relatively high level ofinventory compared to our cost of sales. As a result, we continue to expect to have a significant amount of working capitalinvested in inventory. We may be required to write down inventory costs in the future and our high inventory costs may havean adverse effect on our gross profits and our results of operations. Increasing costs and shifts in product mix may adversely impact our gross margins. Our gross margins on individual products and among products fluctuate over each product’s life cycle. Our overallgross margins have fluctuated from period to period as a result of shifts in product mix, the introduction of new products,decreases in average selling prices and our ability to reduce product costs, and these fluctuations are expected to continue inthe future. We may not be able to accurately predict our product mix from period to period, and as a result we may not be ableto forecast accurately our overall gross margins. The rate of increase in our costs and expenses may exceed the rate of increasein our revenue, either of which would materially and adversely affect our business, our results of operations and our financialcondition. If the CATV market does not continue to develop as we expect, or if there is any downturn in this market, our businesswould be adversely affected. Historically, we have generated much of our revenue from the CATV market. In 2018, 2017 and 2016, the CATVmarket represented 19.3%, 15.9% and 16.7% of our revenue, respectively. In the CATV market, we are relying on expectedincreasing demand for bandwidth-intensive services and applications such as on-demand television programs, high-definition television channels, or HDTV, social media, peer-to-peer file sharing and online video creation and viewing fromnetwork service providers. Without network and bandwidth growth, the need for our products will not increase and maydecline, adversely affecting our financial condition and results of operations. Although demand for broadband access isincreasing, network and bandwidth growth may be limited by several factors, including an uncertain regulatory environment,high infrastructure costs to purchase and install equipment and uncertainty as to which competing content delivery solution,such as telecommunications, wireless or satellite, will gain the most widespread acceptance. If the trend of outsourcing for thedesign and manufacture of CATV equipment does not continue, or continues at a slower pace than currently expected, ourcustomers’ demand for our design and manufacturing services may not grow as quickly as expected. If expectations for thegrowth of the CATV market are not realized, our financial condition and results of operations will be adversely affected. Inaddition, if the CATV market is adversely impacted, whether due to competitive pressure from telecommunication serviceproviders, regulatory changes, or otherwise, our business would be adversely affected. We may not be able to offset anypotential decline in revenue from the CATV market with revenue from new customers in other markets. We have limited operating history in the telecom and FTTH markets, and our business could be harmed if these markets donot develop as we expect. For 2018 and 2017, respectively, we generated 4.9% and 3.4% of our revenue from the telecom market and 0.3%,and 0.1% of our revenue from the FTTH market. In the telecom market, we generally have sold products that were originallydesigned for other markets (such as internet data center or FTTH) or are variations of such products. As we gain experience inthis market, we have begun to develop products specifically designed for telecom customers. Given our limited experience inthis market, the products that we develop may prove to be unsuitable for customer use, or we may be unable to derive profitmargins from this market that are similar to what we derive from our other markets. The products that we offer in the FTTHmarket are relatively new and have not yet gained widespread customer acceptance. For example, our WDM-PON productsdesigned for the FTTH market, have not, and may never, gain widespread acceptance by large internet service providers. Ourbusiness in this market is dependent on the deployment of our optical18 Table of Contentscomponents, modules and subassemblies. We are relying on increasing demand for bandwidth-intensive services andtelecommunications service providers’ acceptance and deployment of WDM-PON as a technology supporting 1 Gbps serviceto the home. Without network and bandwidth growth and adoption of our solutions by operators in these markets, we will notbe able to sell our products in these markets in high volume or at our targeted margins, which would adversely affect ourfinancial condition and results of operations. For example, WDM-PON technology may not be adopted by equipment andservice providers in the FTTH market as rapidly as we expect or in the volumes we need to achieve acceptable margins.Network and bandwidth growth may be limited by several factors, including an uncertain regulatory environment, highinfrastructure costs to purchase and install equipment and uncertainty as to which competing content delivery solution, suchas CATV, will gain the most widespread acceptance. In addition, as we enter new markets or expand our product offerings inexisting markets, our margins may be adversely affected due to competition in those markets and commoditization ofcompeting products. If our expectations for the growth of these markets are not realized, our financial condition and results ofoperations will be adversely affected. Our financial results may vary significantly from quarter-to-quarter due to a number of factors, which may lead tovolatility in our stock price. Our quarterly revenue and operating results have varied in the past and will likely continue to vary significantlyfrom quarter-to-quarter. This variability may lead to volatility in our stock price as research analysts and investors respond tothese quarterly fluctuations. These fluctuations are due to numerous factors, including: ·the timing, size and mix of sales of our products; ·fluctuations in demand for our products, including the increase, decrease, rescheduling or cancellation ofsignificant customer orders; ·our ability to design, manufacture and deliver products which meet customer requirements in a timely and cost-effective manner; ·new product introductions and enhancements by us or our competitors; ·the gain or loss of key customers; ·the rate at which our present and potential customers and end users adopt our technologies; ·changes in our pricing and sales policies or the pricing and sales policies of our competitors; ·seasonality of certain of our products and manufacturing capabilities; ·quality control or yield problems in our manufacturing operations; ·supply disruption for certain raw materials and components used in our products; ·capacity constraints of our outside contract manufacturers for a portion of the manufacturing process for some ofour products; ·length and variability of the sales cycles of our products; ·unanticipated increases in costs or expenses; ·the loss of key employees; ·different capital expenditure and budget cycles for our customers, affecting the timing of their spending for ourproducts; ·political stability in the areas of the world in which we operate; 19 Table of Contents·fluctuations in foreign currency exchange rates; ·changes in accounting rules; ·changes in or limitations imposed by trade protection laws or other regulatory orders or requirements in theUnited States or in other countries, including tariffs, sanctions, or other costs or requirements which may affectour ability to import or export our products to or from various countries; ·the evolving and unpredictable nature of the markets for products incorporating our solutions; and ·general economic conditions and changes in such conditions specific to our target markets. The foregoing factors are difficult to forecast, and these, as well as other factors, could materially adversely affectour quarterly and annual operating results. In addition, a significant amount of our operating expenses is relatively fixed innature due to our internal manufacturing, research and development, sales and general administrative efforts. Any failure toadjust spending quickly enough to compensate for a revenue shortfall could magnify the adverse impact of such revenueshortfall on our results of operations. For these reasons, you should not rely on quarter-to-quarter comparisons of our resultsof operations as an indicator of future performance. Moreover, our operating results may not meet our announced guidance orthe expectations of research analysts or investors, in which case the price of our common stock could decrease significantly.There can be no assurance that we will be able to successfully address these risks. We depend on key personnel to develop and maintain our technology and manage our business in a rapidly changingmarket. The continued services of our executive officers and other key engineering, sales, marketing, manufacturing andsupport personnel is essential to our success. For example, our ability to achieve new design wins depends upon theexperience and expertise of our engineers. Any of our key employees, including our Chief Executive Officer, Chief FinancialOfficer, Senior Vice President and North America General Manager and Senior Vice President and Asia General Manager,may resign at any time. We do not have key person life insurance policies covering any of our employees. To implement ourbusiness plan, we also intend to hire additional employees, particularly in the areas of engineering, manufacturing and sales.Our ability to continue to attract and retain highly skilled employees is a critical factor in our success. Competition forhighly skilled personnel is intense. We may not be successful in attracting, assimilating or retaining qualified personnel tosatisfy our current or future needs. Our ability to develop, manufacture and sell our products, and thus our financial conditionand results of operations, would be adversely affected if we are unable to retain existing personnel or hire additionalqualified personnel. We depend on a limited number of suppliers and any supply interruption could have an adverse effect on our business. We depend on a limited number of suppliers for certain raw materials and components used in our products. Some ofthese suppliers could disrupt our business if they stop, decrease or delay shipments or if the materials or components theyship have quality or reliability issues. Some of the raw materials and components we use in our products are available onlyfrom a sole source or have been qualified only from a single supplier. Furthermore, other than our current suppliers, there area limited number of entities from whom we could obtain certain materials and components. We may also face shortages if weexperience increased demand for materials or components beyond what our qualified suppliers can deliver. Our inability toobtain sufficient quantities of critical materials or components could adversely affect our ability to meet demand for ourproducts, adversely affecting our financial condition and results of operations. We typically have not entered into long-term agreements with our suppliers and, therefore, our suppliers could stopsupplying materials and components to us at any time or fail to supply adequate quantities of materials or components to uson a timely basis. It is difficult, costly, time consuming and, on short notice, sometimes impossible for us to identify andqualify new suppliers. Our customers generally restrict our ability to change the components in our products. For morecritical components, any changes may require repeating the entire qualification process. Our reliance on a limited number ofsuppliers or a single qualified vendor may result in delivery and quality problems, and reduced control over product pricing,reliability and performance.20 Table of Contents We depend upon outside contract manufacturers for a portion of the manufacturing process for some of our products. Almost all of our products are manufactured internally. However we also rely upon manufacturers in China, Taiwanand other Asia locations to provide back-end manufacturing and produce the finished portion of a few of our products. Ourreliance on a contract manufacturer for these products makes us vulnerable to possible capacity constraints and reducedcontrol over delivery schedules, manufacturing yields, manufacturing quality/controls and costs. If one or more of ourcontract manufacturers is unable to meet our customer demand in a timely fashion, this could have a material adverse effecton the revenue from our products. If one or more contract manufacturers for one of our products was unable or unwilling tomanufacture such product in required volumes and at high quality levels or to continue our existing supply arrangement, wewould have to identify, qualify and select an acceptable alternative contract manufacturer or move these manufacturingoperations to our internal manufacturing facilities. An alternative contract manufacturer may not be available to us whenneeded or may not be in a position to satisfy our quality or production requirements on commercially reasonable terms,including price. Any significant interruption in manufacturing our products would require us to reduce our supply ofproducts to our customers, which in turn, would reduce our revenue, harm our relationships with the customer of theseproducts and cause us to forego potential revenue opportunities. Our products could contain defects that may cause us to incur significant costs or result in a loss of customers. Our products are complex and undergo quality testing as well as formal qualification by our customers. Ourcustomers’ testing procedures are limited to evaluating our products under likely and foreseeable failure scenarios and overvarying amounts of time. For various reasons, such as the occurrence of performance problems that are unforeseeable intesting or that are detected only when products age or are operated under peak stress conditions, our products may fail toperform as expected long after customer acceptance. Failures could result from faulty components or design, problems inmanufacturing or other unforeseen reasons. Any such failures could delay product shipments to our customers or result in aloss of customers. For example, shipments of certain of our 100 Gbps transceiver products to one of our customers decreasedduring the three months ended September 30, 2018 due to customer concerns about failures of similar products shippedpreviously. As a result, we could incur significant costs to repair or replace defective products under warranty, particularlywhen such failures occur in installed systems. Our products are typically embedded in, or deployed in conjunction with, ourcustomers’ products, which incorporate a variety of components, modules and subsystems and may be expected tointeroperate with modules produced by third parties. As a result, not all defects are immediately detectable and whenproblems occur, it may be difficult to identify the source of the problem. We face this risk because our products are widelydeployed in many demanding environments and applications worldwide. In addition, we may in certain circumstances honorwarranty claims after the warranty has expired or for problems not covered by warranty to maintain customer relationships.Any significant product failure could result in litigation, damages, repair costs and lost future sales of the affected productand other products, divert the attention of our engineering personnel from our product development efforts and causesignificant customer relations problems, all of which would harm our business. Although we carry product liability insurance,this insurance may not adequately cover our costs arising from defects in our products or otherwise. Our loan agreements contain restrictive covenants that may adversely affect our ability to conduct our business. We have lending arrangements with several financial institutions, including loan agreements with Branch Bankingand Trust (BB&T) Bank in the U.S., credit facilities with Taishin International Bank, Development Bank of Singapore andCTBC Bank, a finance lease agreement with Chailease Finance Co., Ltd. in Taiwan and a credit facility with ChinaConstruction Bank Co. in China. Our loan agreements governing our long-term debt obligations in the U.S. and Asia containcertain financial and operating covenants that limit our management’s discretion with respect to certain business matters.Among other things, these covenants require us to maintain certain financial ratios and restrict our ability to incur additionaldebt, create liens or other encumbrances, change the nature of our business, sell or otherwise dispose of assets and merge orconsolidate with other entities. These restrictions may limit our flexibility in responding to business opportunities,competitive developments and adverse economic or industry conditions. Any failure by us or our subsidiaries to comply withthese agreements could harm our business, financial condition and operating results. In addition, our obligations under ourloan agreements with BB&T are secured by our accounts receivable, inventory, intellectual property, and all business assetsincluding real estate and equipment. Our credit facilities with China Construction Bank Co. are secured by real estate. Abreach of any of covenants under our loan agreements, or a failure21 Table of Contentsto pay interest or indebtedness when due under any of our credit facilities could result in a variety of adverse consequences,including the acceleration of our indebtedness. We may not be able to obtain additional capital when desired, on favorable terms or at all. We operate in a market that makes our prospects difficult to evaluate and, to remain competitive, we will be requiredto make continued investments in capital equipment, facilities and technological improvements. We expect that substantialcapital will be required to expand our manufacturing capacity and fund working capital for anticipated growth. If we do notgenerate sufficient cash flow from operations or otherwise have the capital resources to meet our future capital needs, we mayneed additional financing to implement our business strategy, which includes: ·expansion of research and development; ·expansion of manufacturing capabilities; ·hiring of additional technical, sales and other personnel; and ·acquisitions of complementary businesses. If we raise additional funds through the issuance of our common stock or convertible securities, the ownershipinterests of our stockholders could be significantly diluted. These newly issued securities may have rights, preferences orprivileges senior to those of existing stockholders. Additional financing may not, however, be available on terms favorableto us, or at all, if and when needed, and our ability to fund our operations, take advantage of unanticipated opportunities,develop or enhance our infrastructure or respond to competitive pressures could be significantly limited. If we cannot raiserequired capital when needed, including under our Registration Statement filed with the SEC in October 2016, we may beunable to meet the demands of existing and prospective customers, adversely affecting our sales and market opportunitiesand consequently our business, financial condition and results of operations. Data breaches and cyberattacks could compromise our operations, our customers’ operations, or the operations of ourcontract manufacturers upon whom we rely, and cause significant damage to our business and reputation. Cyberattacks have become more prevalent and much harder to detect and defend against. Companies, includingcompanies in our industry, have been increasingly subject to a wide variety of security incidents, cyberattacks and otherattempts to gain unauthorized access to their systems or to deny access and disrupt their systems and operations. Thesethreats can come from a variety of sources, ranging in sophistication from an individual hacker to a state-sponsored attack.Cyber threats may be generic, or they may be custom-crafted against our information systems. In the ordinary course of our business, we and our data center customers maintain sensitive data on our respectivenetworks, including intellectual property, employee personal information and proprietary or confidential businessinformation relating to our business and that of our customers and business partners. The secure maintenance of thisinformation is critical to our business and reputation. Despite our implementation of network security measures, our networkand storage applications may be subject to computer viruses, denial of service attacks, ransomware and other forms of cyberterrorism, unauthorized access by hackers or may be breached due to operator error, malfeasance or other system disruptions.Our customers’ network and storage applications may be subject to similar disruptions. It is often difficult to anticipate orimmediately detect such incidents and the damage caused by such incidents. Data breaches and any unauthorized access ordisclosure of our information, employee information or intellectual property could compromise our business, trade secretsand other sensitive business information, any of which could result in legal action against us, exposure of our intellectualproperty to our competitors, damages, fines and other adverse effects. A data security breach could also lead to publicexposure of personal information of our employees, customers and others. Any such theft, loss or misuse of personal datacollected, used, stored or transferred by us to run our business could result in significantly increased security costs or costsrelated to defending legal claims. Cyberattacks, such as computer viruses or other forms of cyber terrorism, may disruptaccess to our network or storage applications. Such disruptions could result in delays or cancellations of customer orders orthe production or shipment of our products. Data security breaches involving our data center customers could affect theirfinancial condition and ability to continue to purchase our products. Further, cyberattacks may cause us to incur significantremediation costs, result in product development delays, disrupt key business operations and divert attention of managementand key information technology resources.22 Table of ContentsThese incidents could also subject us to liability, expose us to significant expense and cause significant harm to ourreputation and business. Changes in U.S. and international trade policies, particularly with regard to China, may materially and adversely impactour business and operating results. The U.S. government has recently made statements and taken certain actions that have led and may lead to furtherchanges to U.S. and international trade policies, including recently-imposed tariffs affecting certain products manufacturedin China. Since the beginning of 2018, there has been increasing rhetoric, in some cases coupled with legislative orexecutive action, from several U.S. and foreign leaders regarding the possibility of instituting tariffs on the foreign imports ofcertain materials. Three rounds of U.S. tariffs on imports from China have become effective in July 2018, August 2018 andSeptember 2018 (respectively the “U.S. Tariffs on China Imports”). A limited number of our products that have a Chinacountry of origin are currently subject to the U.S. Tariffs on China Imports. It is unknown whether and to what extent new tariffs (or other new laws or regulations) will be adopted, or the effectthat any such actions would have on us or our industry. A significant portion of our manufacturing operations is based inNingbo, China; therefore, if any new tariffs, legislation and/or regulations are implemented, or if existing trade agreementsare renegotiated or if China or other affected countries take further retaliatory trade actions, such changes could have amaterial adverse effect on our business, financial condition, results of operations or cash flows. Furthermore, the implementation of trade tariffs both globally and between the U.S. and China specifically carriesthe risk of negatively impacting China’s overall economic condition, which could have negative repercussions on us.Imposition of tariffs could cause a decrease in the sales of our products to customers located in China or other customersselling to Chinese end users, which would directly impact our business. Significant changes to existing international trade agreements could also lead to sourcing or logistics disruptionresulting from import delays or the imposition of increased tariffs on our sourcing partners. For example, the Chinesegovernment could, among other things, require the use of local suppliers, compel companies that do business in China topartner with local companies to conduct business and provide incentives to government-backed local customers to buy fromlocal suppliers. Changes in, and responses to, U.S. trade policy could reduce the competitiveness of our products and causeour sales and revenues to drop, which could materially and adversely impact our business and results of operations. We face a variety of risks associated with our international sales and operations. We currently derive, and expect to continue to derive, a significant portion of our revenue from sales tointernational customers. In 2018, 2017 and 2016, 23.1%, 22.7% and 15.8% of our revenue was derived from sales thatoccurred outside of North America, respectively. In addition, a significant portion of our manufacturing operations is basedin Ningbo, China and Taipei, Taiwan. Our international revenue and operations are subject to a number of material risks,including: ·difficulties in staffing, managing and supporting operations in more than one country; ·difficulties in enforcing agreements and collecting receivables through foreign legal systems; ·fewer legal protections for intellectual property in foreign jurisdictions; ·foreign and U.S. taxation issues and international trade barriers, including the adoption or expansion ofgovernmental trade tariffs; ·difficulties in obtaining any necessary governmental authorizations for the export of our products to certainforeign jurisdictions; ·fluctuations in foreign economies; ·fluctuations in the value of foreign currencies and interest rates; 23 Table of Contents·trade and travel restrictions; ·domestic and international economic or political changes, hostilities and other disruptions in regions where wecurrently operate or may operate in the future; ·difficulties and increased expenses in complying with a variety of U.S. and foreign laws, regulations and tradestandards, including the Foreign Corrupt Practices Act; and ·different and changing legal and regulatory requirements in the jurisdictions in which we currently operate ormay operate in the future. Negative developments in any of these factors in China or Taiwan or other countries could result in a reduction indemand for our products, the cancellation or delay of orders already placed, difficulties in producing and delivering ourproducts, threats to our intellectual property, difficulty in collecting receivables, and a higher cost of doing business.Although we maintain certain compliance programs throughout the Company, violations of U.S. and foreign laws andregulations may result in criminal or civil sanctions, including material monetary fines, penalties and other costs against usor our employees, and may have a material adverse effect on our business. Our business operations conducted in China and Taiwan are important to our success. A substantial portion of ourproperty, plant and equipment is located in China and Taiwan. We expect to make further investments in China and Taiwanin the future. Therefore, our business, financial condition, results of operations and prospects are subject to economic,political, legal, and social events and developments in China and Taiwan. Factors affecting military, political or economicconditions in China and Taiwan could have a material adverse effect on our financial condition and results of operations, aswell as the market price and the liquidity of our common shares. In some instances, we rely on third parties to assist in selling our products, and the failure of those parties to perform asexpected could reduce our future revenue. Although we primarily sell our products through direct sales, we also sell our products to some of our customersthrough third party sales representatives and distributors. Many of such third parties also market and sell products from ourcompetitors. Our third party sales representatives and distributors may terminate their relationships with us at any time, orwith short notice. Our future performance will also depend, in part, on our ability to attract additional third party salesrepresentatives and distributors that will be able to market and support our products effectively, especially in markets inwhich we have not previously distributed our products. If our current third party sales representatives and distributors fail toperform as expected, our revenue and results of operations could be harmed. Changes in our effective tax rate may adversely affect our results of operation and our business. We are subject to income taxes in the U.S. and other foreign jurisdictions, including China and Taiwan. In addition,we are subject to various state taxes in states where we have nexus. We base our tax position on the anticipated nature andconduct of our business and our understanding of the tax laws of the countries and states in which we have assets or conductactivities. Our tax position may be reviewed or challenged by tax authorities. Moreover, the tax laws currently in effect maychange, and such changes may have retroactive effect, such as the U.S. tax reform legislation commonly referred to as the U.S.Tax Cuts and Jobs Act of 2017 (the “Tax Act”). We have inter-company arrangements in place providing for administrativeand financing services and transfer pricing, which involve a significant degree of judgment and are often subject to closereview by tax authorities. The tax authorities may challenge our positions related to these agreements. If the tax authoritiessuccessfully challenge our positions, our effective tax rate may increase, adversely affecting our results of operation and ourbusiness. The Tax Act significantly changes how the U.S. taxes corporations. The Tax Act requires complex computations tobe performed that were not previously required in U.S. tax law, significant judgments to be made in interpretation of theprovisions of the Tax Act and significant estimates in calculations, and the preparation and analysis of information notpreviously relevant or regularly produced. The U.S. Treasury Department, the IRS, and other standard-setting bodies couldinterpret or issue guidance on how provisions of the Tax Act will be applied or otherwise administered that is different fromour interpretation. As we interpret any additional guidance, we may make adjustments to amounts that we have recorded thatmay materially impact our provision for income taxes in the period in which the adjustments are made.24 Table of Contents Failure to manage our growth effectively may adversely affect our financial condition and results of operations. Successful implementation of our business plan in our target markets requires effective planning and management.Production volumes for some of our products are increasing and we have announced plans to increase our productioncapacity in response to demand for certain of our current and future products, including adding personnel in some of ourlocations as well as expanding our physical manufacturing facilities. We currently operate facilities in Sugar Land, Texas,Ningbo, China, Taipei, Taiwan, and Duluth, Georgia. We currently manufacture our lasers using a proprietary process andcustomized equipment located only in our Sugar Land, Texas facility, and it will be costly to duplicate that facility, to scaleour laser manufacturing capacity or to mitigate the risks associated with operating a single facility. The challenges ofmanaging our geographically dispersed operations have increased and will continue to increase the demand on ourmanagement systems and resources. Moreover, we are continuing to improve our financial and managerial controls, reportingsystems and procedures. Any failure to manage our expansion and the resulting demands on our management systems andresources effectively may adversely affect our financial condition and results of operations. Future acquisitions may adversely affect our financial condition and results of operations. As part of our business strategy, we may pursue acquisitions of companies that we believe could enhance orcomplement our current product portfolio, augment our technology roadmap or diversify our revenue base. Acquisitionsinvolve numerous risks, any of which could harm our business, including: ·difficulties integrating the acquired business; ·unanticipated costs, capital expenditures or liabilities or changes related to research in progress andproduct development; ·diversion of financial and management resources from our existing business; ·difficulties integrating the business relationships with suppliers and customers of the acquired businesswith our existing business relationships; ·risks associated with entering markets in which we have little or no prior experience; and ·potential loss of key employees, particularly those of the acquired organizations. Acquisitions may also result in the recording of goodwill and other intangible assets subject to potential impairmentin the future, adversely affecting our operating results. We may not achieve the anticipated benefits of an acquisition if wefail to evaluate it properly, and we may incur costs in excess of what we anticipate. A failure to evaluate and execute anacquisition appropriately or otherwise adequately address these risks may adversely affect our financial condition and resultsof operations. We may be subject to disruptions or failures in information technology systems and network infrastructures that could havea material adverse effect on our business and financial condition. We rely on the efficient and uninterrupted operation of complex information technology systems and networkinfrastructures to operate our business. A disruption, infiltration or failure of our information technology systems as a resultof software or hardware malfunctions, system implementations or upgrades, computer viruses, third-party security breaches,employee error, theft or misuse, malfeasance, power disruptions, natural disasters or accidents could cause a breach of datasecurity, loss of intellectual property and critical data and the release and misappropriation of sensitive competitiveinformation and partner, customer, and employee personal data. Any of these events could harm our competitive position,result in a loss of customer confidence, cause us to incur significant costs to remedy any damages and ultimately materiallyadversely affect our business and financial condition. 25 Table of ContentsOur future results of operations may be subject to volatility as a result of exposure to fluctuations in currency exchangerates. We have significant foreign currency exposure and are affected by fluctuations among the U.S. dollar, the ChineseRenminbi, or RMB, and the New Taiwan dollar, or NT dollar, because a substantial portion of our business is conducted inChina and Taiwan. Our sales, raw materials, components and capital expenditures are denominated in U.S. dollars, RMB andNT dollars in varying amounts. Foreign currency fluctuations may adversely affect our revenue and our costs and expenses, and hence our results ofoperations. The value of the NT dollar or the RMB against the U.S. dollar and other currencies may fluctuate and be affectedby, among other things, changes in political and economic conditions. The RMB currency is no longer being pegged solelyto the value of the U.S. dollar. In the long term, the RMB may appreciate or depreciate significantly in value against the U.S.dollar, depending upon the fluctuation of the basket of currencies against which it is currently valued, or it may be permittedto enter into a full float, which may also result in a significant appreciation or depreciation of the RMB against the U.S.dollar. In addition, our currency exchange variations may be magnified by Chinese exchange control regulations that restrictour ability to convert RMB into foreign currency. Our sales in Europe are denominated in U.S. dollars and fluctuations in the Euro or our customers’ other localcurrencies relative to the U.S. dollar may impact our customers and affect our financial performance. If our customers’ localcurrencies weaken against the U.S. dollar, we may need to lower our prices to remain competitive in our international marketswhich could have a material adverse effect on our margins. If our customers’ local currencies strengthen against the U.S.dollar and if the local sales prices cannot be raised due to competitive pressures, we will experience a deterioration of ourmargins. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currencyexchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness ofthese hedging transactions may be limited and we may not be able to successfully hedge our exposure. Natural disasters or other catastrophic events could harm our operations. Our operations in the U.S., China and Taiwan could be subject to significant risk of natural disasters, includingearthquakes, hurricanes, typhoons, flooding and tornadoes, as well as other catastrophic events, such as epidemics, terroristattacks or wars. For example, our corporate headquarters and wafer fabrication facility in Sugar Land, Texas is located nearthe Gulf of Mexico, an area that is susceptible to hurricanes. We use a proprietary MBE laser manufacturing process thatrequires customized equipment, and this process is currently conducted and located solely at our wafer fabrication facility inSugar Land, Texas, such that a natural disaster, terrorist attack or other catastrophic event that affects that facility wouldmaterially harm our operations. In addition, our manufacturing facility in Taipei, Taiwan, is susceptible to typhoons andearthquakes, and our manufacturing facility in Ningbo, China, has from time to time, suffered electrical outages. Anydisruption in our manufacturing facilities arising from these and other natural disasters or other catastrophic events couldcause significant delays in the production or shipment of our products until we are able to shift production to differentfacilities or arrange for third parties to manufacture our products. We may not be able to obtain alternate capacity onfavorable terms or at all. Our property insurance coverage with respect to natural disaster is limited and is subject todeductible and coverage limits. Such coverage may not be adequate or continue to be available at commercially reasonablerates and terms. The occurrence of any of these circumstances may adversely affect our financial condition and results ofoperation. Our business could be negatively impacted as a result of shareholder activism. In recent years, shareholder activists have become involved in numerous public companies. Shareholder activistsfrequently propose to involve themselves in the governance, strategic direction, and operations of the Company. We may inthe future become subject to such shareholder activity and demands. Such demands may disrupt our business and divert theattention of our management and employees, and any perceived uncertainties as to our future direction resulting from such asituation could result in the loss of potential business opportunities, be exploited by our competitors, cause concern to ourcurrent or potential customers, and make it more difficult to attract and retain qualified personnel and business partners, all ofwhich could adversely affect our business. In addition, actions of activist shareholders may cause significant fluctuations inour stock price based on temporary or speculative market perceptions or other factors that do not necessarily reflect theunderlying fundamentals and prospects of our business.26 Table of ContentsThe unfavorable outcome of any pending or future litigation or administrative action and expenses incurred in connectionwith litigation could result in financial losses or harm to our business.We are, and in the future may be, subject to legal actions in the ordinary course of our operations, both domesticallyand internationally. There can be no assurances as to the favorable outcome of any litigation. In addition it can be costly todefend litigation and these costs could negatively impact our financial results. As disclosed in “Item 3. Legal Proceedings,”on August 5, 2017, we and certain of our officers are currently subject to class action litigation related to allegations that wemade materially false and misleading statements or failed to disclose material facts. Such litigation includes requests fordamages and other relief. As further described in that section, subsequent derivative actions and securities class actions havesince been filed. This litigation and any other such litigation could result in substantial costs and divert our management’sattention from other business concerns, which could seriously harm our business.If we fail to protect, or incur significant costs in defending, our intellectual property and other proprietary rights, ourbusiness and results of operations could be materially harmed. Our success depends on our ability to protect our intellectual property and other proprietary rights. We rely on acombination of patent, trademark, copyright, trade secret and unfair competition laws, as well as license agreements and othercontractual provisions, to establish and protect our intellectual property and other proprietary rights. We have applied forpatents in the U.S. and in other foreign countries, some of which have been issued. In addition, we have registered certaintrademarks in the U.S. We cannot guarantee that our pending applications will be approved by the applicable governmentalauthorities. Moreover, our existing and future patents and trademarks may not be sufficiently broad to protect our proprietaryrights or may be held invalid or unenforceable in court. A failure to obtain patents or trademark registrations or a successfulchallenge to our patents and trademark registrations in the U.S. or other foreign countries may limit our ability to protect theintellectual property rights that these patent and trademark registrations intended to cover. Policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken willprevent the misappropriation, unauthorized use or other infringement of our intellectual property rights. Further, we may notbe able to effectively protect our intellectual property rights from misappropriation or other infringement in foreign countrieswhere we have not applied for patent protections and where effective patent, trademark, trade secret and other intellectualproperty laws may be unavailable, or may not protect our proprietary rights as fully as U.S. law. We may seek to securecomparable intellectual property protections in other countries. However, the level of protection afforded by patent and otherlaws in other countries may not be comparable to that afforded in the U.S. We also attempt to protect our intellectual property, including our trade secrets and know-how, through the use oftrade secret and other intellectual property laws, and contractual provisions. We enter into confidentiality and inventionassignment agreements with our employees and independent consultants. We also use non-disclosure agreements with otherthird parties who may have access to our proprietary technologies and information. Such measures, however, provide onlylimited protection, and there can be no assurance that our confidentiality and non-disclosure agreements will not bebreached, especially after our employees end their employment, and that our trade secrets will not otherwise become knownby competitors or that we will have adequate remedies in the event of unauthorized use or disclosure of proprietaryinformation. Unauthorized third parties may try to copy or reverse engineer our products or portions of our products,otherwise obtain and use our intellectual property, or may independently develop similar or equivalent trade secrets or know-how. If we fail to protect our intellectual property and other proprietary rights, or if such intellectual property and proprietaryrights are infringed, misappropriated or duplicated, our business, results of operations or financial condition could bematerially harmed. In the future, we may need to take legal actions to prevent third parties from infringing upon or misappropriating ourintellectual property or from otherwise gaining access to our technology. Protecting and enforcing our intellectual propertyrights and determining their validity and scope could result in significant litigation costs and require significant time andattention from our technical and management personnel, which could significantly harm our business. We may not prevail insuch proceedings, and an adverse outcome may adversely impact our competitive advantage or otherwise harm our financialcondition and our business. 27 Table of ContentsWe may be involved in intellectual property disputes in the future, which could divert management’s attention, cause us toincur significant costs and prevent us from selling or using the challenged technology. Participants in the markets in which we sell our products have experienced frequent litigation regarding patent andother intellectual property rights. While we have a policy in place that is designed to reduce the risk of infringement ofintellectual property rights of others and we have conducted a limited review of other companies’ relevant patents, there canbe no assurance that third parties will not assert infringement claims against us. We cannot be certain that our products wouldnot be found infringing on the intellectual property rights of others. Regardless of their merit, responding to such claims canbe time consuming, divert management’s attention and resources and may cause us to incur significant expenses. Intellectualproperty claims against us could force us to do one or more of the following: ·obtain from a third party claiming infringement a license to the relevant technology, which may not beavailable on reasonable terms, or at all; ·stop manufacturing, selling, incorporating or using our products that use the challenged intellectual property; ·pay substantial monetary damages; or ·expend significant resources to redesign the products that use the technology and to develop non-infringingtechnology. Any of these actions could result in a substantial reduction in our revenue and could result in losses over anextended period of time. In any potential intellectual property dispute, our customers could also become the target of litigation. Because weoften indemnify our customers for intellectual property claims made against them with respect to our products, any claimsagainst our customers could trigger indemnification claims against us. These obligations could result in substantial expensessuch as legal expenses, damages for past infringement or royalties for future use. Any indemnity claim could also adverselyaffect our relationships with our customers and result in substantial costs to us. If we fail to obtain the right to use the intellectual property rights of others that are necessary to operate our business, andto protect their intellectual property, our business and results of operations will be adversely affected. From time to time we may choose to or be required to license technology or intellectual property from third partiesin connection with the development of our products. We cannot assure you that third party licenses will be available to us oncommercially reasonable terms, if at all. Generally, a license, if granted, would include payments of up-front fees, ongoingroyalties or both. These payments or other terms could have a significant adverse impact on our results of operations. Ourinability to obtain a necessary third party license required for our product offerings or to develop new products and productenhancements could require us to substitute technology of lower quality or performance standards, or of greater cost, any ofwhich could adversely affect our business. If we are not able to obtain licenses from third parties, if necessary, then we mayalso be subject to litigation to defend against infringement claims from these third parties. Our competitors may be able toobtain licenses or cross-license their technology on better terms than we can, which could put us at a competitivedisadvantage. If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, the accuracyand timing of our financial reporting may be adversely affected. Preparing our consolidated financial statements involves a number of complex manual and automated processes,which are dependent upon individual data input or review and require significant management judgment. One or more ofthese elements may result in errors that may not be detected and could result in a material misstatement of our consolidatedfinancial statements. The Sarbanes-Oxley Act requires, among other things, that as a publicly-traded company we disclosewhether our internal control over financial reporting and disclosure controls and procedures are effective. We have implemented a system of disclosure and internal controls that we believe provide reasonable assurance thatwe will be able to timely report our financial results and avoid accounting errors or material weaknesses in future28 Table of Contentsperiods. However, our internal controls cannot guarantee that no accounting errors exist or that all accounting errors, nomatter how immaterial, will be detected because a control system, no matter how well designed and operated, can provideonly reasonable, but not absolute assurance that the control system’s objectives will be met. If we are unable to implementand maintain an effective system of disclosure controls and internal control over financial reporting, our ability to accuratelyand timely report our financial results could be adversely impacted. This could result in late filings of our annual andquarterly reports under the Exchange Act, restatements of our consolidated financial statements, a decline in our stock price,suspension or delisting of our common stock by NASDAQ, or other material adverse effects on our business, reputation,results of operations or financial condition. Our ability to use our net operating losses and certain other tax attributes may be limited. As of December 31, 2018, we had U.S. accumulated net operating losses, or NOLs, of approximately $47.4 million,federal and state research and development credits (“R&D credits”) of $6.6 million, interest expense of $1.0 million andforeign tax credits of $4.6 million for U.S. federal income tax purposes. Under Section 382 of the Internal Revenue Code of1986, as amended, if a corporation undergoes an “ownership change,” the corporation’s ability to use its pre-change NOLs,tax credits and other pre-change tax attributes to offset its post-change income may be limited. An ownership change isgenerally defined as a greater than 50% change in equity ownership by value over a 3-year period. Based upon an analysis ofour equity ownership, we believe that we have experienced ownership changes; however, we do not believe those limitationsresult in a material loss of tax benefits. Should we experience additional ownership changes, our NOL carry forwards and taxcredits may be further limited. Our manufacturing operations are subject to environmental regulation that could limit our growth or impose substantialcosts, adversely affecting our financial condition and results of operations. Our properties, operations and products are subject to the environmental laws and regulations of the jurisdictions inwhich we operate and sell products. These laws and regulations govern, among other things, air emissions, wastewaterdischarges, the management and disposal of hazardous materials and solid wastes, the contamination of soil andgroundwater, employee health and safety and the content, performance, packaging and disposal of products. Our failure tocomply with current and future environmental laws and regulations, or the identification of contamination for which we areliable, could subject us to substantial costs, including fines, clean-up costs, natural resource damages, third-party propertydamages or personal injury claims, administrative, civil or criminal penalties and could result in injunctive relief requiring usto make significant investments to upgrade our facilities, redesign or change our manufacturing processes, redesign ourproducts, or curtail our operations. Liability under environmental, health and safety laws can be joint and several andwithout regard to fault or negligence. For example, pursuant to environmental laws and regulations, including but notlimited to the Comprehensive Environmental Response Compensation and Liability Act, or CERCLA, we may be liable forthe full amount of any remediation-related costs at properties we currently own or formerly owned, such as our currentlyowned Sugar Land, Texas facility, or at properties at which we previously operated, as well as at properties we will own oroperate in the future, and properties to which we have sent hazardous substances, whether or not we caused thecontamination. Identification of presently unidentified environmental conditions, more vigorous enforcement by agovernmental authority, enactment of more stringent legal requirements or other unanticipated events could give rise toadverse publicity, restrict our operations, affect the design or marketability of our products or otherwise cause us to incurmaterial environmental costs, adversely affecting our financial condition and results of operations. We are exposed to increased expenses and business risk as a result of Restriction on Hazardous Substances, or RoHSdirectives. Following the lead of the European Union, or EU, various governmental agencies have either already put into placeor are planning to introduce regulations that regulate the permissible levels of hazardous substances in products sold invarious regions of the world. For example, the RoHS directive for EU took effect on July 1, 2006. The labeling provisions ofsimilar legislation in China went into effect on March 1, 2007. Consequently, many suppliers of products sold into the EUhave required their suppliers to be compliant with the new directive. Many of our customers have adopted this approach andhave required our full compliance. Though we have devoted a significant amount of resources and effort in planning andexecuting our RoHS program, it is possible that some of our products might be incompatible with such regulations. In suchevents, we could experience the following consequences: loss of revenue, damaged reputation, diversion of resources,monetary penalties, and legal action. 29 Table of ContentsFailure to comply with the U.S. Foreign Corrupt Practices Act could subject us to penalties and other adverseconsequences. We are subject to the U.S. Foreign Corrupt Practices Act which generally prohibits U.S. companies from engaging inbribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, weare required to maintain records that accurately and fairly represent our transactions and have an adequate system of internalaccounting controls. Foreign companies, including some that may compete with us, may not be subject to these prohibitions,and therefore may have a competitive advantage over us. If we are not successful in implementing and maintaining adequatepreventative measures, we may be responsible for acts of our employees or other agents engaging in such conduct. We couldsuffer severe penalties and other consequences that may have a material adverse effect on our financial condition and resultsof operations. We are subject to governmental export and import controls that could subject us to liability or impair our ability tocompete in international markets. We are subject to export and import control laws, trade regulations and other trade requirements that limit whichproducts we sell and where and to whom we sell our products. Specifically, the Bureau of Industry and Security of the U.S.Department of Commerce is responsible for regulating the export of most commercial items that are so called dual-use goodsthat may have both commercial and military applications. Our products are classified under Export Control ClassificationNumbers, or ECCNs, 5A991 and 6A995. Export Control Classification requirements are dependent upon an item’s technicalcharacteristics, the destination, the end-use, the end-user, and other activities of the end-user. Should the regulationsapplicable to our products change, or the restrictions applicable to countries to which we ship our products change, then theexport of our products to such countries could be restricted. As a result, our ability to export or sell our products to certaincountries could be restricted, which could adversely affect our business, financial condition and results of operations. Changes in our products or any change in export or import regulations or related legislation, shift in approach to theenforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by suchregulations, could result in delayed or decreased sales of our products to existing or potential customers. In such event, ourbusiness and results of operations could be adversely affected. For example, in April 2018, Zhongxing TelecommunicationsEquipment Corporation and ZTE Kangxun Communications Ltd. (collectively “ZTE”) were added to the U.S. Department ofCommerce’s Bureau of Industry and Security’s List of Denied Persons, which imposed a seven year denial of exportprivileges against ZTE. However, in July 2018, the denial of export privileged was suspended and ZTE was removed fromthe list of Denied Persons. Although ZTE is not currently one of our significant customers, such actions against customers orpotential customers could adversely affect our business and results of operations. Rapidly changing standards and regulations could make our products obsolete, which would cause our revenue and resultsof operations to suffer. We design our products to conform to regulations established by governments and to standards set by industrystandards bodies worldwide, such as the American National Standards Institute, the European Telecommunications StandardsInstitute, the International Telecommunications Union and the Institute of Electrical and Electronics Engineers, Inc. Variousindustry organizations are currently considering whether and to what extent to create standards applicable to our products.Because certain of our products are designed to conform to current specific industry standards, if competing or new standardsemerge that are preferred by our customers, we would have to make significant expenditures to develop new products. If ourcustomers adopt new or competing industry standards with which our products are not compatible, or the industry groupsadopt standards or governments issue regulations with which our products are not compatible, our existing products wouldbecome less desirable to our customers and our revenue and results of operations would suffer. Compliance with regulations related to conflict minerals could increase costs and affect the manufacturing and sale of ourproducts. Public companies are required to disclose the use of tin, tantalum, tungsten and gold (collectively, “conflictminerals”) mined from the Democratic Republic of the Congo and adjoining countries (the “covered countries”) if a conflictmineral(s) is necessary to the functionality of a product manufactured, or contracted to be manufactured, by the30 Table of ContentsCompany. We filed our latest conflict minerals report on Form SD on May 30, 2018. We have previously determined, as partof our compliance efforts, that certain products or components we obtain from our suppliers contain conflict minerals. Basedon our Reasonable Country of Origin Inquiry on the source of our conflict minerals for the year ended December 31, 2017,we had reason to believe that certain of such conflict minerals likely originated in covered countries. If we are unable toconclude in the future that all our products are free from conflict minerals originating from covered countries, this could havea negative impact on our business, reputation and/or results of operations. We may also encounter challenges to satisfycustomers who require that our products be certified as conflict free, which could place us at a competitive disadvantage if weare unable to substantiate such a claim. Compliance with these rules could also affect the sourcing and availability of someof the minerals used in the manufacture of products or components we obtain from our suppliers, including our ability toobtain products or components in sufficient quantities and/or at competitive prices. Certain of our customers are requiringadditional information from us regarding the origin of our raw materials, and complying with these customer requirementsmay cause us to incur additional costs, such as costs related to determining the origin of any minerals used in our products.Our supply chain is complex and we may be unable to verify the origins for all metals used in our products. We may alsoencounter challenges with our customers and stockholders if we are unable to certify that our products are conflict free. Some provisions of our named executive officers’ agreements regarding change of control or separation of service containobligations for us to make separation payments to them upon their termination. Certain provisions contained in our employment agreements with our named executive officers regarding change ofcontrol or separation of service may obligate us to make lump sum severance payments and related payments upon thetermination of their employment with us, other than such executive officer’s resignation without good reason or ourtermination of their employment as a result of their disability or for cause. In the event we are required to make theseseparation payments, it could have a material adverse effect on our results of operations for the fiscal period in which suchpayments are made. Risks Related to Our Operations in China Our business operations conducted in China are critical to our success. A total of $143.1 million, $122.3 million and$81.1 million or 53.6%, 32.0% and 31.1%, of our revenue in the years ended December 31, 2018, 2017 and 2016 wasattributable to our product manufactured at our plant in China, respectively. Additionally, a substantial portion of ourproperty, plant and equipment, 36.8%, 29.9% and 23.0% as of December 31, 2018, 2017 and 2016, was located in China,respectively. We expect to make further investments in China in the foreseeable future. Therefore, our business, financialcondition, results of operations and prospects are to a significant degree subject to economic, political, legal, and socialevents and developments in China. Adverse changes in economic and political policies in China, or Chinese laws or regulations could have a material adverseeffect on business conditions and the overall economic growth of China, which could adversely affect our business. The Chinese economy differs from the economies of most developed countries in many respects, including the levelof government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. TheChinese economy has been transitioning from a planned economy to a more market-oriented economy. Despite reforms, thegovernment continues to exercise significant control over China’s economic growth by way of the allocation of resources,control over foreign currency-denominated obligations and monetary policy and provision of preferential treatment toparticular industries or companies. In addition, the laws, regulations and legal requirements in China, including the laws that apply to foreign-investedenterprises, or FIEs, are subject to frequent changes. The interpretation and enforcement of such laws is uncertain. Protectionsof intellectual property rights and confidentiality in China may not be as effective as in the U.S. or other countries or regionswith more developed legal systems. Any litigation in China may be protracted and result in substantial costs and diversion ofresources and management attention. Any adverse changes to these laws, regulations and legal requirements or theirinterpretation or enforcement could have a material adverse effect on our business. Furthermore, while China’s economy has experienced rapid growth in the past 20 years, growth has been unevenacross different regions, among various economic sectors and over time. China has also in the past and may in31 Table of Contentsthe future experience economic downturns due to, for example, government austerity measures, changes in governmentpolicies relating to capital spending, limitations placed on the ability of commercial banks to make loans, reduced levels ofexports and international trade, inflation, lack of financial liquidity, stock market volatility and global economic conditions.Any of these developments could contribute to a decline in business and consumer spending in addition to other adversemarket conditions, which could adversely affect our business. The termination and expiration or unavailability of our preferential tax treatments in China may have a material adverseeffect on our operating results. Prior to January 1, 2008, entities established in China were generally subject to a 30% state and 3% local enterpriseincome tax rate. In accordance with the China Income Tax Law for Enterprises with Foreign Investment and ForeignEnterprises, effective through December 31, 2007, our China subsidiary enjoyed preferential income tax rates. EffectiveJanuary 1, 2008, the China Enterprise Income Tax Law, or the EIT law, imposes a single uniform income tax rate of 25% onall Chinese enterprises, including FIEs, and eliminates or modifies most of the tax exemptions, reductions and preferentialtreatment available under the previous tax laws and regulations. As a result, our China subsidiary may be subject to theuniform income tax rate of 25% unless we are able to qualify for preferential status. Since calendar year 2012, we havequalified for a preferential 15% tax rate that is available for state-encouraged new high technology enterprises. In order toretain this preferential tax rate, we must meet certain operating conditions, satisfy certain product requirements, meet certainheadcount requirements and maintain certain levels of research expenditures. In November 2017, we received approval fromthe Chinese government to extend this preferential tax treatment for an additional three years, ending November 2020. If wefail to continue to qualify for this preferential rate in the future, we may incur higher tax rates on our income in China. Anyfuture increase in the enterprise income tax rate applicable to us or the expiration or other limitation of preferential tax ratesavailable to us could increase our tax liabilities and reduce our net income. The turnover of direct labor in manufacturing industries in China is high, which could adversely affect our production,shipments and results of operations. Employee turnover of direct labor in the manufacturing sector in China is extremely high and retention of suchpersonnel is a challenge to companies located in or with operations in China. Although direct labor costs do not represent ahigh proportion of our overall manufacturing costs, direct labor is required for the manufacture of our products. If our directlabor turnover rates are higher than we expect, or we otherwise fail to adequately manage our direct labor turnover rates, thenour results of operations could be adversely affected. Chinese regulation of loans to and direct investment by offshore holding companies in China entities may delay or preventus from making loans or additional capital contributions to our China subsidiary. Any loans that we wish to make to our China subsidiary are subject to Chinese regulations and approvals. Forexample, any loans to our China subsidiary to finance their activities cannot exceed statutory limits, must be registered withState Administration of Foreign Exchange, or SAFE, or its local counterpart, and must be approved by the relevantgovernment authorities. Any capital contributions to our China subsidiary must be approved by the Ministry of Commerce orits local counterpart. In addition, under Circular 142, our China subsidiary, as a FIE, may not be able to convert our capitalcontributions to them into RMB for equity investments or acquisitions in China. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, ifat all, with respect to our future loans or capital contributions to our China subsidiary. If we fail to receive such registrationsor approvals, our ability to capitalize our China subsidiary may be negatively affected, which could materially and adverselyaffect our liquidity and ability to fund and expand our business. Our China subsidiary is subject to Chinese labor laws and regulations, and Chinese labor laws may increase our operatingcosts in China. Chinese labor laws and regulations provide certain protections for our employees located in China, and changes tothose labor laws and regulations may increase our costs and reduce our flexibility. The China Labor Contract Law, whichwent into effect in 2008, together with its implementing rules, provides increased rights to Chinese employees compared toprior employment laws in China. Under the rules under the China Labor Contract Law, the probation period varies dependingon contract terms and the employment contract can only be terminated during the probation period for32 Table of Contentscause upon three days’ notice. Additionally, an employer may not be able to terminate a contract during the probation periodon the grounds of a material change of circumstances or a mass layoff. The law also has specific provisions on conditionswhen an employer has to sign an employment contract with open-ended terms. If an employer fails to enter into an open-ended contract in certain circumstances, the employer must pay the employee twice their monthly wage beginning from thetime the employer should have executed an open-ended contract. Additionally, an employer must pay severance for nearlyall terminations, including when an employer decides not to renew a fixed-term contract. Any further changes to these lawsmay increase our costs and reduce our flexibility. An increase in our labor costs in China may adversely affect our business and our profitability. A significant portion of our workforce is located in China. Labor costs in China have been increasing recently dueto labor unrest, strikes and changes in employment laws. If labor costs in China continue to increase, our costs will increase.If we are not able to pass these increases on to our customers, our business, profitability and results of operations may beadversely affected. We may have difficulty establishing and maintaining adequate management and financial controls over our Chinaoperations. Businesses in China have historically not adopted a western style of management and financial reporting conceptsand practices, which includes strong corporate governance, internal controls and computer, financial and other controlsystems. Moreover, familiarity with U.S. GAAP principles and reporting procedures is less common in China. As aconsequence, we may have difficulty finding accounting personnel experienced with U.S. GAAP, and we may have difficultytraining and integrating our China-based accounting staff with our U.S.-based finance organization. As a result of thesefactors, we may experience difficulty in establishing and maintaining management and financial controls over our Chinaoperations. These difficulties include collecting financial data and preparing financial statements, books of account andcorporate records and instituting business practices that meet U.S. public-company reporting requirements. We may, in turn,experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of theSarbanes-Oxley Act. Risks Related to Our Common Stock Our stock price has been and is likely to be volatile. The market price of our common stock has been and is likely to be subject to wide fluctuations in response to,among other things, the risk factors described in this section of this Annual Report on Form 10-K, and other factors beyondour control, such as fluctuations in the valuation of companies perceived by investors to be comparable to us. For example,announcements made by competitors regarding factors influencing their business may cause fluctuations in the valuation ofcompanies throughout our industry, including fluctuations in the valuation of our stock. Furthermore, the stock markets have experienced price and volume fluctuations that have affected and continue toaffect the market prices of equity securities of many companies. These fluctuations often have been unrelated ordisproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well asgeneral economic, political and market conditions, such as recessions, interest rate changes or international currencyfluctuations, may negatively affect the market price of our common stock. In the past, many companies that have experienced volatility in the market price of their stock have been subject tosecurities class action litigation. We have been and may become the target of this type of litigation in the future. Forexample, on August 3, 2017 we provided guidance for the third quarter of 2017, and on August 4, 2017 the market price ofour stock decreased significantly. As disclosed in “Item 3. Legal Proceedings,” on August 5, 2017, a class action lawsuit wasfiled against us and two of our officers. The complaint in this matter alleges that we made materially false and misleadingstatements or failed to disclose material facts and requests damages and other relief. On August 7, 2018, a derivative classaction lawsuit was filed against our chief executive officer, chief financial officer and board of directors. The allegations aresubstantially similar to those under the August 5, 2017 lawsuit. On October 1, 2018, another class action lawsuit was filed inthe U.S. District Court for the Southern District of Texas against us and two of our officers. The complaint in this matteralleges that we made materially false and misleading statements or failed to disclose material facts and a related action wasfiled on October 10, 2018. These lawsuits and any other such litigation33 Table of Contentscould result in substantial costs and divert our management’s attention from other business concerns, which could seriouslyharm our business. We have incurred and will continue to incur significant increased expenses and administrative burdens as a publiccompany, which could have a material adverse effect on our operations and financial results. We face increased legal, accounting, administrative and other costs and expenses as a public company that we didnot incur as a private company, and greater expenditures may be necessary in the future with the advent of new laws,regulations and stock exchange listing requirements pertaining to public companies. These increased costs will require us todivert a significant amount of money that we could otherwise use to expand our business and achieve our strategicobjectives. The Sarbanes-Oxley Act, including the requirements of Section 404, as well as rules and regulations subsequentlyimplemented by the SEC, the Public Company Accounting Oversight Board and the NASDAQ Global Market, imposeadditional reporting and other obligations on public companies. Compliance with public company requirements hasincreased our costs and made some activities more time-consuming. For example, we have created board committees andadopted internal controls and disclosure controls and procedures. In addition, we have incurred and will continue to incuradditional expenses associated with our SEC reporting requirements. Furthermore, if we identify any issues in complyingwith those requirements (for example, if we or our auditors identify a material weakness or significant deficiency in ourinternal control over financial reporting), we could incur additional costs rectifying those issues, and the existence of thoseissues could adversely affect us, our reputation or investor perceptions of us. Advocacy efforts by stockholders and thirdparties may also prompt additional changes in governance and reporting requirements, which could further increase ourcosts. Legal, accounting, administrative and other costs and expenses may increase in the future as we continue to incur bothincreased external audit fees as well as additional spending to ensure continued regulatory compliance. We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve areturn on your investment is if the price of our common stock appreciates. We currently do not plan to declare or pay dividends on shares of our common stock in the foreseeable future.Consequently, your only opportunity to achieve a return on any shares of our common stock that you may acquire will be ifthe market price of our common stock appreciates and you sell your shares at a profit. There is no guarantee that the price ofour common stock in the market will ever exceed the price that you pay. Our charter documents, stock incentive plans and Delaware law could prevent a takeover that stockholders considerfavorable and could also reduce the market price of our stock. Our amended and restated certificate of incorporation and our amended and restated bylaws and our stock incentiveplans contain provisions that could delay or prevent a change in control of our company. These provisions could also makeit more difficult for stockholders to elect directors and take other corporate actions. These provisions include: ·providing for a classified board of directors with staggered, three-year terms; ·not providing for cumulative voting in the election of directors; ·authorizing our board of directors to issue, without stockholder approval, preferred stock rights senior to thoseof common stock; ·prohibiting stockholder action by written consent; ·limiting the persons who may call special meetings of stockholders; ·requiring advance notification of stockholder nominations and proposals; and ·change of control provisions in our stock incentive plans, and the individual stock option agreements, whichprovide that a change of control may accelerate the vesting of the stock options and equity awards issued undersuch plans. 34 Table of ContentsIn addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law. Theseprovisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding common stock, fromengaging in certain business combinations without the approval of substantially all of our stockholders for a certain periodof time. These and other provisions in our amended and restated certificate of incorporation, our amended and restatedbylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might bewilling to pay for shares of our common stock in the future and result in the market price being lower than it would bewithout these provisions. If research analysts do not publish research about our business or if they issue unfavorable commentary or downgrade ourcommon stock, our stock price and trading volume could decline. The trading market for our common stock depends on the research and reports that research analysts publish aboutus and our business. The price of our common stock could decline if one or more research analysts downgrade our commonstock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business. If one ormore of the research analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stockcould decrease, which could cause our stock price or trading volume to decline. Item 1B. Unresolved Staff Comments Not Applicable. Item 2. Properties We maintain manufacturing, research and development, sales and administrative offices in the U.S., China andTaiwan. Our corporate headquarters is located at our facility in Sugar Land, Texas. The table below provides informationregarding our facilities. Owned or Lease Approximate Location Expiration Date Square Footage Use Sugar Land, Texas Owned 139,450 Administration, sales, manufacturing, research and development Duluth, Georgia November 30, 2021 2,983 Research and development Ningbo, China Owned 458,849 Administration, sales, manufacturing, research and development Taipei, Taiwan May 31, 2029 268,797 Administration, sales, manufacturing, research and development (1)We manufacture laser chips (utilizing our MBE and MOCVD process), subassemblies and components in our SugarLand, Texas facility. (2)The lease covering the Georgia office commenced on December 1, 2015 and expires on November 30, 2021. (3)In our China facility, we manufacture certain more labor intensive components and optical equipment systems, such asoptical subassemblies and transceivers for the internet data center market, CATV transmitters (at the headend) andCATV outdoor equipment (at the node). Our China subsidiary acquired the land use rights to the real property on whichour current facility is located from the Chinese government. Such land use rights expire on October 7, 2054. Our Chinasubsidiary owns the facility located on such real property. Our China subsidiary also obtained from the Chinesegovernment the land use rights to a second real property located within a close proximity to our current facility. Wehave begun construction on a new manufacturing facility on the second real property. The land use rights for the secondreal property expire on December 28, 2067. (4)In our Taiwan location, we manufacture optical components, such as our butterfly lasers, which incorporate laser chips,subassemblies and components manufactured within our Sugar Land facility. In addition, in our Taiwan location, wemanufacture transceivers for the internet data center market, telecom, FTTH and other markets. Our Taiwan subsidiaryrelocated its entire operation to this facility in November 2014. The lease covering the new facility commenced on June1, 2014 and expires on May 31, 2029. 35 (1) (2)(3) (4)Table of Contents Item 3. Legal Proceedings From time to time, we 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.Except for the lawsuit described below, we believe that there are no claims or actions pending or threatened against us, theultimate disposition of which would have a material adverse effect on us. On August 5, 2017, a lawsuit was filed in the U.S. District Court for the Southern District of Texas against theCompany and two of our officers in Mona Abouzied v. Applied Optoelectronics, Inc., Chih-Hsiang (Thompson) Lin, andStefan J. Murry, et al., Case No. 4:17-cv-02399. The complaint in this matter seeks class action status on behalf of ourshareholders, alleging violations of Sections 10(b) and 20(a) of the Exchange Act against us, our chief executive officer, andour chief financial officer, arising out of our announcement on August 3, 2017 that “we see softer than expected demand forour 40G solutions with one of our large customers that will offset the sequential growth and increased demand we expect in100G.” The complaint requests unspecified damages and other relief. We dispute the allegations set forth in thecomplaint and are vigorously contesting the matter. The briefing on our motion to dismiss the complaint was completed onMay 21, 2018, and the motion is still pending. On August 7, 2018, a derivative lawsuit was filed in the United States District Court for the Southern District ofTexas styled Lei Jin, derivatively on behalf of Applied Optoelectronics, Inc. v. Chih-Hsiang (“Thompson”) Lin, Stefan J.Murry, William H. Yeh, Alex Ignatiev, Richard B. Black, Min-Chu Chen, Alan Moore, and Che-Wei Lin and AppliedOptoelectronics, Inc., No. 4:18-cv-02713 alleging breaches of fiduciary duties, unjust enrichment, and violations of Section14(a) of the Exchange Act based on similar factual allegations as in the Abouzied Securities Class Action. On December 18,2018, a second derivative complaint was filed styled Yiu Kwong Ng v. Chih-Hsiang (“Thompson”) Lin, Stefan J. Murry,William H. Yeh, Alex Ignatiev, Richard B. Black, Min-Chu Chen, Alan Moore, and Che-Wei Lin and Applied Optoelectronics,Inc., No. 4:18-cv-4751 alleging the same causes of actions as the Jin complaint and additional factual allegations regardingour announcement on September 28, 2018 that we had “identified an issue with a small percentage of 25G lasers within aspecific customer environment.” On January 11, 2019, the court consolidated these two derivative actions, and on January15, 2019, the court entered an order staying the actions pending the outcome of the motion to dismiss in the AbouziedSecurities Class action and the forthcoming motion to dismiss in the Taneja Securities Class Action, described in thefollowing paragraph. The complaint requests unspecified damages and other relief. We dispute the allegations and intend tovigorously contest the matter if and when the stay is lifted. On October 1, 2018, a securities class action was filed in the United States District Court for the Southern District ofTexas styled Gaurav Taneja v. Applied Optoelectronics, Inc., Thompson Lin, and Stefan Murry, Case No. 4:18-cv-3544. Thecomplaint in this matter seeks class action status on behalf of our shareholders, alleging violations of Sections 10(b) and20(a) of the Exchange Act against us, our chief executive officer, and our chief financial officer, arising out of ourannouncement on September 28, 2018 that we had “identified an issue with a small percentage of 25G lasers within a specificcustomer environment.” The original complaint requests unspecified damages and other relief. We dispute the allegationsset forth in the original complaint and intend to vigorously contest the matter. The case has been consolidated with twoidentical complaints that were subsequently filed on October 10, 2018 and October 18, 2018, styled Davin Pokoik v. AppliedOptoelectronics, Inc., Chih-Hsiang Lin, and Stefan J. Murry, Case No. 4:18-cv-3722 and Stephen McGrath v. AppliedOptoelectronics, Inc., Chih-Hsiang Lin, and Stefan J. Murry, respectively. The three cases were consolidated on January 4,2019, and Mark Naglich was appointed Lead Plaintiff on that same date. The original complaint requests unspecifieddamages and other relief. We dispute the allegations in the complaint and intend to vigorously contest the matter. Thedeadline for Lead Plaintiff to file a consolidated amended complaint is March 5, 2019, and the deadline for our motion todismiss is sixty days after the consolidated amended complaint is filed. Item 4. Mine Safety Disclosure Not Applicable.36 Table of Contents PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities On September 26, 2013, our common stock began to trade on the NASDAQ Global Market under the symbol“AAOI”. Prior to that time, there was no public market for our common stock. As of February 20, 2019 there were 37 holdersof record of our common stock (not including beneficial holders of our common stock holding in street name). The followingtable sets forth, for the periods indicated, the high and low sales prices of our common stock as reported by the NASDAQGlobal Market. Low High Fiscal Year 2017: First Quarter $21.88 $60.19 Second Quarter $40.28 $75.59 Third Quarter $55.13 $103.41 Fourth Quarter $36.70 $65.75 Fiscal Year 2018: First Quarter $23.65 $38.89 Second Quarter $24.00 $47.04 Third Quarter $24.66 $48.80 Fourth Quarter $13.84 $24.91 The graph below shows the cumulative total stockholder return of an investment of $100 (and the reinvestment ofany dividends thereafter) on September 26, 2013 (the first trading day of our common stock) in (i) our common stock, (ii) theNASDAQ Composite Index and (iii) the NASDAQ Telecommunications Index. Our stock price performance shown in thegraph below is not indicative of future stock price performance. The following graph and related information is being“furnished” and shall not be deemed “soliciting material” or be deemed to be “filed” with the SEC, nor shall suchinformation be incorporated by reference into any future filing, except to the extent that we specifically state that such graphand related information are incorporated by reference into such filing. 37 Table of ContentsPERCENT CHANGE NASDAQ NASDAQ Date AAOI Telecom Composite 9/26/2013 100.00% 100.00% 100.00%12/31/2013 150.70% 102.48% 110.28%12/31/2014 112.65% 111.61% 125.05%12/31/2015 172.29% 103.25% 132.21%12/31/2016 235.34% 118.59% 142.13%12/29/2017 379.72% 139.28% 182.27%12/31/2018 251.61% 146.03% 186.50% For equity compensation plan information refer to Item 12 of this Annual Report on Form 10-K. Dividend Policy We have never declared or paid any cash dividends on our capital stock, and we do not anticipate paying any cashdividends on our common stock for the foreseeable future. We currently intend to retain all available funds and futureearnings for use in the operation and expansion of our business. Any future determination to pay cash dividends will be atthe discretion of our board of directors and will depend upon our financial condition, results of operations, terms of financingarrangements, applicable Delaware law, capital requirements and such other factors as our board of directors deems relevant.In addition, the terms of our loan agreements governing our long-term debt obligations restricts us from paying dividends. Unregistered Sales of Equity Securities Not applicable. 38 Table of Contents Item 6. Selected Financial Data SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data in this section is not intended to replace our consolidated financialstatements and the related notes. You should read this summary consolidated financial data together with the sections titled“Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidatedfinancial statements and related notes, all included elsewhere in this Annual Report on Form 10-K. We derived theconsolidated statements of operations data for the years ended December 31, 2018, 2017 and 2016 and the consolidatedbalance sheet data as of December 31, 2018 and 2017 from our consolidated financial statements appearing elsewhere in thisAnnual Report on Form 10-K. The consolidated statement of operations data for the years ended December 31, 2015 and2014 and the consolidated balance sheet data as of December 31, 2016, 2015 and 2014 are derived from our auditedconsolidated financial statements that have previously been filed with the SEC. Our historical results are not necessarilyindicative of the results to be expected in the future and results of interim periods are not necessarily indicative of results forthe entire year. The following table sets forth our consolidated results of operations for the periods presented (in thousands, exceptshare and per share data): Years ended December 31, 2018 2017 2016 2015 2014 Consolidated Statements of OperationsData: Revenue $267,465 $382,329 $260,713 $189,903 $130,449 Cost of goods sold 179,692 216,049 173,759 129,450 86,203 Gross profit 87,773 166,280 86,954 60,453 44,246 Operating expenses: Research and development 49,903 35,365 31,780 20,852 15,970 Sales and marketing 9,141 8,702 6,627 6,381 6,043 General and administrative 39,497 35,262 25,527 19,771 17,095 Total operating expenses 98,541 79,329 63,934 47,004 39,108 Income (loss) from operations (10,768) 86,951 23,020 13,449 5,138 Interest and other income (expense), net: Interest income 282 221 247 328 369 Interest expense (1,106) (858) (1,717) (1,018) (326) Other income (expense), net 1,814 (1,788) (547) (1,591) (699) Total interest and other income(expense), net 990 (2,425) (2,017) (2,281) (656) Income (loss) before income taxes (9,778) 84,526 21,003 11,168 4,482 Income tax (expense) benefit 7,632 (10,575) 10,231 (375) (199) Net income (loss) attributable to commonstockholders $(2,146) $73,951 $31,234 $10,793 $4,283 Net income (loss) per share attributable tocommon stockholders: Basic $(0.11) $3.87 $1.82 $0.69 $0.30 Diluted $(0.11) $3.67 $1.76 $0.65 $0.28 Weighted average shares used to computenet income (loss) per share attributable tocommon stockholders: Basic 19,646,646 19,097,355 17,201,731 15,626,753 14,307,477 Diluted 19,646,646 20,139,105 17,712,928 16,532,850 15,186,961 (1)These expenses include share-based compensation expense. Share-based compensation expense is accounted for at fairvalue, using the Black-Scholes option-pricing model for stock options and at the fair market value based on quotedmarket prices of the Company’s stock as of the grant date for restricted stock units and restricted stock awards. Share-based compensation expense is recognized over the vesting period of the awards and was included in cost of goods soldand operating expenses as follows:39 (1)(1)(1) (1)Table of ContentsThe following table provides share-based compensation expense for the periods presented (in thousands): Years ended December 31, 2018 2017 2016 Cost of goods sold $795 $461 $190 Research and development 2,419 1,496 591 Sales and marketing 925 481 357 General and administrative 6,981 5,357 2,695 Total share-based compensation expense $11,120 $7,795 $3,833 The following table provides selected balance sheet data for the periods presented (in thousands): As of December 31, 2018 2017 2016 2015 2014 Consolidated balance sheet data: Total cash, restricted cash, cash equivalents and short-terminvestments $58,004 $83,984 $52,008 $40,679 $40,873 Working capital 116,857 158,953 97,579 79,848 64,638 Total assets 466,840 452,948 322,318 273,475 183,670 Short-term obligations 28,217 559 8,172 33,906 10,862 Long-term obligations 60,328 48,964 34,961 33,997 20,057 Common stock and additional paid-in-capital 292,500 285,395 265,282 233,353 192,127 Total retained earnings (deficit) $35,992 $38,138 $(37,013) $(68,247) $(79,040) (1)Working capital is defined as total current assets less total current liabilities.(2)Short-term obligations are defined as short-term loans, capital leases, notes payable and bank acceptance payable.(3)Long-term obligations are defined as long-term loans, capital leases and notes payable. 40 (1)(2)(3)Table of Contents Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations inconjunction with our consolidated financial statements and the accompanying notes appearing elsewhere in this AnnualReport on Form 10-K. This discussion and other parts of this Annual Report on Form 10-K contain forward-lookingstatements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Ouractual results could differ materially from those discussed in the forward-looking statements. Factors that could cause orcontribute to such differences include, but are not limited to, those discussed in “Risk Factors.” Overview We are a leading, vertically integrated provider of fiber-optic networking products. We target four networking end-markets: internet data centers, CATV, telecom and FTTH. We design and manufacture a range of optical communicationsproducts at varying levels of integration, from components, subassemblies and modules to complete turn-key equipment. Indesigning products for our customers, we begin with the fundamental building blocks of lasers and laser components. Fromthese foundational products, we design and manufacture a wide range of products to meet our customers’ needs andspecifications, and such products differ from each other by their end market, intended use and level of integration. We areprimarily focused on the higher-performance segments within the internet data center, CATV, telecom and FTTH marketswhich increasingly demand faster connectivity and innovation. Our vertically integrated manufacturing model provides usseveral advantages, including rapid product development, fast response times to customer requests and control over productquality and manufacturing costs. The four end markets we target are all driven by significant bandwidth demand fueled by the growth of network-connected devices, video traffic, cloud computing and online social networking. Within the internet data center market, webenefit from the increasing use of higher-capacity optical networking technology as a replacement for copper cables,particularly as speeds reach 10 Gbps and above, as well as the movement to open internet data center architectures and theincreasing use of in-house equipment design among leading internet companies. Within the CATV market, we benefit from anumber of ongoing trends including the global build-out of CATV infrastructure, the move to higher bandwidth networksamong CATV service providers and the outsourcing of system design among CATV networking equipment companies. In theFTTH market, we benefit from continuing PON deployments and system upgrades among telecommunication serviceproviders. In the telecom market, we benefit from deployment of new high-speed fiber-optic networks by telecom networkoperators. In 2018, 2017 and 2016, our revenue was $267.5 million, $382.3 million and $260.7 million and our gross marginwas 32.8%, 43.5% and 33.4%. We have grown our annual revenue at a compound annual growth rate, or CAGR, of 30.1%between 2009 and 2018. In the years ended December 31, 2018, 2017 and 2016, we had net income (loss) of $(2.1) million,$74.0 million and $31.2 million, respectively. At December 31, 2018 and 2017, our retained earnings was $36.0 million and$38.1 million, respectively. In 2018, we earned 74.9% of our total revenue from the internet data center market, and 19.3% ofour total revenue from the CATV market. We sell our products to leading OEMs in the CATV, telecom, and FTTH markets as well as internet data centeroperators. In 2018, revenue from the internet data center market, CATV market, telecom market and FTTH markets provided74.9%, 19.3%. 4.9%, and 0.3% of our revenue, respectively, compared to 80.2%, 15.9%. 3.4%, and 0.1% of our 2017revenue, respectively. In 2018, our key customers in the data center market included, Facebook, Inc. (Facebook), MicrosoftCorp (Microsoft) and Amazon.com (Amazon). In 2018, 2017, and 2016, Facebook accounted for 38.3%, 28.6% and 3.6% ofour revenue, Microsoft accounted for 22.1%, 13.8%, and 18.3% of our revenue and Amazon accounted for 12.1%, 35.4%,and 54.6% of our revenue, respectively. In 2018, our key customers in the CATV market included Cisco Systems, Inc.(Cisco); a large CATV equipment company in China; and Arris Group, Inc. (Arris). In 2018, 2017 and 2016, Cisco accountedfor 9.9%, 4.8%, and 5.4%, of our revenue, respectively; our large China-based customer accounted for 3.3%, 3.4%, and 1.2%of our revenue, respectively; and Arris accounted for 2.1%, 3.2% and 5.8%, of our revenue, respectively.41 Table of Contents In 2018, our revenue decrease of 30.0% over the prior-year was driven primarily by decreased demand for our 40Gbps and 100 Gbps transceivers as one of our customers reduced its demand for optical transceivers due to changes in theway it architects its network. Additionally, in the third quarter of 2018, we decreased shipments of our 100 Gbps transceiverproducts to one of our customers due to their concerns about failures of similar products shipped previously. We conductedextensive testing of our products with the goal of demonstrating that any potentially affected units could be nearlyeliminated in future shipments. During the time that this issue was being investigated, production activity was reduced asresources were redirected to efforts to identify the root cause of any failures observed, and in order to avoid manufacturingproducts that could not be proven to meet acceptable quality standards. These decreases were partially offset by an increasein demand for 100 Gbps transceivers from other customers. The decrease in revenue in the CATV market for the year was aresult of decreased available production capacity in our China factory associated with staff turnover related to the Lunar NewYear. The increase in revenue in our telecom market was primarily attributable to increased demand for telecom products byour customers as they supply new deployments of telecom infrastructure. The increase in revenue in our FTTH market wasdue to the fluctuation in demand for certain older legacy products and this demand is expected to continue to fluctuate. We expect continued sales of our 40 Gbps and 100 Gbps products in 2019, and we expect that sales of 100 Gbpsproducts will likely exceed sales of 40 Gbps products. However, quarter-to-quarter results may show considerable variabilityas is usual in a period of technology transition. Also, several of our customers have indicated more uncertainty in theirdemand levels in the near term, compared with previous years. This is attributed to uncertainty surrounding generaleconomic conditions and the effect of datacenter architecture changes on transceiver demand. Similar to revenue, our grossmargins can fluctuate materially depending on a variety of factors including average selling price changes, product mix, rawmaterial cost reduction or increase, manufacturing utilization rate and changes in manufacturing efficiency. Our sales model focuses on direct engagement and close coordination with our customers to determine productdesign, qualifications, performance and price. Our strategy is to use our direct sales force to sell to key accounts and toexpand our use of distributors for increased coverage in certain international markets and certain domestic market segments.We have direct sales personnel that cover the U.S., Taiwan and China focusing primarily on major OEM customers andinternet data center operators. Throughout our sales cycle, we work closely with our customers to qualify our products intotheir product lines. As a result, we strive to build strategic and long-lasting customer relationships and deliver products thatare customized to our customers’ requirements. Our business depends on winning competitive bid selection processes to develop components, systems andequipment for use in our customers’ products. These selection processes are typically lengthy, and as a result our sales cycleswill vary based on the level of customization required, market served, whether the design win is with an existing or newcustomer and whether our solution being designed in our customers’ product is our first generation or subsequent generationproduct. We do not have any long-term purchase commitments (in excess of one year) with any of our customers, most ofwhom purchase our products on a purchase order basis, however, once one of our solutions is incorporated into a customer’sdesign, we believe that our solution is likely to continue to be purchased for that design throughout that product’s life cyclebecause of the time and expense associated with redesigning the product or substituting an alternative solution. In 2018, 2017 and 2016, we had 26, 19, and 30 design wins, respectively. We define a design win as the successfulcompletion of the evaluation stage, where our customer has tested our product, verified that our product meets substantiallyall of their requirements and has informed us that they intend to purchase the product from us. Although we believe that ourability to obtain design wins is a key strength and can provide meaningful and recurring revenue, an increase or decrease inthe mere number of design wins does not necessarily correlate to a likely increase or decrease in revenue, particularly in theshort term. As such, the number of design wins we achieve on a quarterly or annual basis and any increase or decrease indesign wins will not necessarily result in a corresponding increase or decrease in revenue in the same or immediatelysucceeding quarter or year. For example, if our total number of design wins in an annual or quarterly period increases ordecreases compared to the total number of design wins in a prior period, this does not necessarily mean that our revenue insuch period will be higher or lower than our revenue in the prior period. In fact, our experience is that some design wins resultin significant revenue and some do not, and the timing of such revenue is difficult to predict as it depends on the success ofthe end customer’s product that uses our components. Thus, some design wins result in orders and significant revenue shortlyafter the design win is awarded and other design wins do not42 Table of Contentsresult in significant orders and revenue for several months or longer after the initial design win (if at all). We do believe thatover a period of years the collective impact of design wins correlates to our overall revenue growth. Factors Affecting Our Performance Increasing Consumer Demand for Bandwidth. Bandwidth demand in all of our target markets is driving serviceprovider investment in new equipment and in turn generating demand for our products. Increasingly, optical networkingtechnologies are being incorporated into networking equipment, replacing legacy copper-based networking technologies.This shift to optical networking solutions benefits us as a provider of those solutions. Pricing, Product Cost and Margins. Our products are sold in a highly competitive marketplace, and in many casesour products are only minimally differentiated from those of our competitors. In addition, our sales are heavily concentratedwith a small number of end customers. As a result, there is strong pricing pressure across many of our product lines. We haveaddressed this strong pressure in several ways: ·Lowering our material costs. In some cases, we are able to negotiate more favorable pricing from our rawmaterial suppliers. Also, where feasible, we are often able to develop internal production for certainmaterials that were previously purchased from other companies. This generally has resulted in lowermaterial costs for us. ·Enhancing the efficiency of our production process. We have been able to automate many of ourproduction processes, which often results in lower labor costs and reduced scrap or rework rates, both ofwhich lower our production cost. In some cases, we have been able to redesign our products to make themless complex to manufacture, and when possible during these redesigns we also incorporate lower cost rawmaterials. ·Introducing new products. In many cases, newly released products have more features and often higherprices compared with older products. By regularly introducing new products, we attempt to minimize theaverage price reduction we experience. However, we often initially experience lower gross margins on newproducts, as our pricing is based upon anticipated volume-driven cost reductions over the life of the designwin. Thus, if we are unable to realize our expected cost reductions, we may experience declining grossmargins on such products. Our product pricing is established when the product is initially introduced to the market, and thereafter throughperiodic negotiations with customers. We generally do not agree to periodic automatic price reductions. Furthermore, due tothe dynamics in the CATV market and the value of our outsourced design services to our customers, we believe we face lessdownward price pressure than many of our competitors in this market. We sell a wide variety of products among our fourtarget markets and our gross margin is heavily dependent in any quarter on the product mix achieved during that period aswell as any price changes that we have agreed upon with our customers. Customer Concentration within End Markets. Historically, our revenue has been significantly concentrated, firstwithin the CATV market and in 2016-2018 within the internet data center market. Moreover, within these markets, revenuetends to be concentrated among a small number of customers. In the last three years, we have taken several actions to increasethe diversity of our customer base. These actions include hiring additional sales staff to improve our ability to serve newcustomers and introduction of new products that we believe will appeal to new customers. Furthermore, we have developedadditional original design manufacturer, or ODM, relationships with customers in each of our target markets which shouldenable us to diversify our revenue base. In 2018 and 2017, we had three customers that each accounted for more than 10% ofour revenue. Product Development. We invest heavily to develop new and innovative products. The majority of our research anddevelopment expense is allocated to product development, usually with a specific customer and customer platform in mind.We believe our close coordination with our customers regarding their future product requirements enhances the efficiency ofour research and development expenditures. 43 Table of ContentsDiscussion of Financial Performance Revenue We generate revenue through the sale of our products to equipment providers for the internet data center, CATV,telecom, FTTH and other markets. We derive a significant portion of our revenue from our top ten customers, and weanticipate that we will continue to do so for the foreseeable future. The following chart provides the revenue contributionfrom each of the markets we serve for the years 2018, 2017 and 2016, as well as the corresponding percentage of our totalrevenue for each period (in thousands, except percentages): Years ended December 31, Market 2018 2017 2016 Data Center $200,236 $306,712 $201,314 CATV 51,699 60,756 43,567 Telecom 13,159 12,899 12,938 FTTH 818 490 1,567 Other 1,553 1,472 1,327 Total $267,465 $382,329 $260,713 Percentage of Revenue Data Center 74.9% 80.2% 77.2%CATV 19.3% 15.9% 16.7%Telecom 4.9% 3.4% 5.0%FTTH 0.3% 0.1% 0.6%Other 0.6% 0.4% 0.5%Total Revenue 100% 100% 100% In 2018, 2017 and 2016, our top ten customers represented 92.9%, 94.9% and 95.5% of our revenue, respectively. Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; generally thisoccurs with the transfer of control of products or services. Revenue is measured as the amount of consideration we expect toreceive in exchange for transferring products or providing services. A majority of our annual sales are denominated in U.S.dollars, but some sales from our Taiwan location and China-based subsidiary are denominated in NT dollars and RMB,respectively. For the year ended December 31, 2018, 53.6% of our total revenue was manufactured at our China-basedsubsidiary, with $10.1 million denominated in RMB and 42.5% of our total revenue was from products manufactured at ourTaiwan-based facility with no revenue denominated in NT dollars. We expect a similar portion of our sales to bedenominated in foreign currencies in 2019. Cost of goods sold and gross margin Our cost of goods sold is impacted by variances arising from changes in yields and production volume, as well asincreases or decreases in the cost of raw materials used in production. We typically experience lower yields and higherassociated costs on new products. For our mature products, we can experience lower yields and higher production costs ifcustomer requirements change or if we experience manufacturing difficulties or quality issues during our production process.Notwithstanding the foregoing, however, in general for our mature products our cost of goods sold for a particular productdeclines over time as a result of increasing efficiencies in the manufacturing processes, or supply cost declines, as well asyield improvements and testing enhancements. We manufacture products in three of our four facilities located in the U.S., Taiwan and China. Generally, laser chipsand optical components are manufactured in our Sugar Land facility, optical components and subassemblies aremanufactured in our Taiwan facility, and optical components and optical equipment are manufactured in our China facility.Because of our vertical integration model, we generally utilize our own optical component products in our semi-finished andfinished goods that we sell between and among our respective manufacturing operations. We base those internal sales uponestablished transfer pricing methodologies. However, we eliminate all of those internal sales, and cost of goods soldtransactions, to arrive at total revenue and cost of goods sold on a consolidated basis. 44 Table of ContentsWe have a global set of suppliers to help balance considerations related to product availability, quality and cost.Components of our cost of goods sold are denominated in U.S. or NT dollars or RMB, depending upon the manufacturinglocation. Gross profit as a percentage of total revenue, or gross margin, has been and is expected to continue to be affected bya variety of factors, including the introduction of new products, production volumes, the mix of products sold, thegeographic region in which products are sold, changes in the cost and volumes of materials purchased from our suppliers,changes in labor costs, changes in overhead costs, reserves for excess and obsolete inventories and changes in the averageselling prices of our products. Although our overall gross margins over the past three years have been between 32.8% and43.5%, our gross margins vary more broadly on a product-by-product basis. Our newer and more advanced products typicallyhave higher average selling prices and higher gross margins; however, until the product volumes scale, the gross margin fromnewer and advanced products may initially be lower. Within our markets, we may sell similar products to differentgeographic regions at different prices, and therefore realize different gross margins among those similar products. Ourstrategy is to improve our gross margins through vertical integration such as utilization of our own laser chips and opticalsub-components in our solutions. We expect that our gross margins are likely to continue to fluctuate from quarter to quarterbecause of the variety of products we sell and the relative product mix within a quarter. Operating expenses Our operating expenses consist of research and development, sales and marketing, and general and administrativeexpenses. Personnel costs are the most significant component of operating expenses and include salaries, benefits, bonusesand share-based compensation. With regard to sales and marketing expense, personnel costs also include sales commissions. Research and development. Research and development, or R&D, expense consists primarily of personnel costs,including share-based compensation for R&D personnel, and R&D work orders (that include material, direct labor andallocated overhead), as well as allocated development costs, such as engineering services, software and hardware tools,depreciation of capital equipment and facility costs. We record all research and development expense as incurred. Customersrely upon us to assist them with the development of new products and modification of existing products because of ourextensive optical design and manufacturing expertise. We work closely with our customers in the critical design phase ofproduct development and are occasionally reimbursed for some of these development efforts. As our product portfolio hasbecome broader and as we have placed increasing emphasis on diversifying our customer base, our R&D expenses have risenmore quickly than in the past. In the future, we expect research and development expense to increase on a dollar basis, andwill likely increase as a percentage of our revenue until revenue from the products developed as a result of this increasedR&D investment begin to be recognized, then thereafter we expect R&D expense to decrease as a percentage of our revenue. Sales and marketing. Sales and marketing expense consists primarily of personnel costs, including share-basedcompensation for our sales and marketing personnel, as well as travel and trade show expense, sales commissions and theallocation of overall corporate services and facility costs. We sell our products to customers who either incorporate ourproducts into their offering or resell our products to end customers. Because we sell to a limited number of well-establishedcustomers, we employ a limited number of sales professionals who are able to cover large markets. We compensate our salesstaff through base salary and commissions, with base salary being the largest component of overall compensation. Total salescommissions to employees amounted to less than one percent of our revenue in 2018, 2017 and 2016. Additionally, we paycommissions to third parties on certain product lines and identified customers, which also amounted to less than one percentof our revenue in 2018, 2017 and 2016. As such, our sales and marketing expense does not directly increase with revenue. Inthe future, we expect sales and marketing expense to increase on a dollar basis as we incrementally increase our overall salesactivities, but expect our sales and marketing expense to decline as a percentage of revenue, to the extent our revenueincreases over time. General and administrative. General and administrative expense consists primarily of personnel costs, includingshare-based compensation, primarily for our finance, human resources, legal and information technology personnel andcertain executive officers, as well as professional services costs related to accounting, tax, banking, legal and informationtechnology services, depreciation of capital equipment and facility costs. We expect general and administrative expense toincrease as we continue to grow in both size and complexity as a public company. We expect rising costs including increasedaudit and legal fees, costs to comply with the Sarbanes-Oxley Act and the rules and45 Table of Contentsregulations applicable to companies listed on a national stock exchange, as well as investor relations expense and higherinsurance premiums. In the future, we expect general and administrative expense to increase on a dollar basis but to declineas a percentage of revenue, to the extent that our revenue increases over time. Other income (expense) Interest income consists of income earned on our cash, cash equivalents and short-term investments. Interest expenseconsists of amounts paid for interest on our short-term and long-term debt borrowings. Other income (expense), net is primarily made up of foreign currency transaction gains and losses. The functionalcurrency of our China subsidiary is the RMB and the foreign currency transaction gains and losses of our China subsidiaryprimarily result from their transactions in U.S. dollars. The functional currency of our Taiwan location is the NT dollar andthe foreign currency transaction gains and losses of our Taiwan location primarily result from their transactions in U.S.dollars. Income taxes We are a U.S. registered company and are subject to income taxes in the U.S. We also operate in a number ofcountries throughout the world, including Taiwan and China. Consequently, our effective tax rate is impacted by thegeographic distribution of our earnings or losses and the tax laws and regulations in each geographical region. We expectthat our income taxes will vary in relation to our profitability and the geographic distribution of our profits. In 2018 oureffective tax rate was 78.1%. In 2017 and 2016, our effective tax rate was 12.5% and (48.7%), respectively. Our effective U.S.federal income tax rate was 0% prior to 2016 as we incurred operating losses and had recorded a full valuation allowanceagainst those losses, which was released in July 2016. Our wholly owned subsidiary, Global Technology, Inc., has received preferential tax concessions in China as anational high-tech enterprise. In March 2007, China’s parliament enacted the PRC Enterprise Income Tax Law, or the EITLaw, under which, effective January 1, 2008, China adopted a uniform income tax rate of 25% for all enterprises includingforeign invested enterprises. Global Technology, Inc. was recognized as a national high-tech enterprise in 2008 and wasentitled to a 15% tax rate for a three year period from November 2008 to November 2011. In 2011 and 2014 GlobalTechnology, Inc. renewed its national high-tech enterprise certificate and therefore extended its three year tax preferentialstatus through September 2017. In November 2017, Global Technology, Inc. again renewed its national high-tech enterprisecertificate and therefore extended its three year tax preferential status from November 2017 until November 2020. For the years ended December 31, 2018 and 2017, we had $0.2 million and $0.2 million, respectively, ofunrecognized tax benefits related to U.S. tax benefits recognized for which we do not meet the more likely than notthreshold. See additional information regarding income taxes in Note M. Seasonality We believe that the demand for our CATV products is seasonal. Historically, revenue derived from our CATVproducts has usually been highest in the second or third quarter and lowest in the first quarter of each year. The first quarter ofthe year has historically been negatively affected by reduced economic activity due to the Chinese New Year holiday and thelower level of deployment of outdoor CATV equipment in cold weather environments. We are uncertain whether the demand for our internet data center, telecom and FTTH products is seasonal, as oursales data does not indicate a significant trend with respect to these products. In 2017, we began to manufacture a meaningfulquantity of internet data center products in our Ningbo, China factory. This factory experiences a lengthy shut-downassociated with the Lunar New Year holiday which occurs in Q1 of each year. In addition to the factory shut-down, it is alsocommon for employees in the factory to fail to return to work following resumption of operations. In the years 2018, 2017,and 2016, the percentage of employees in our China factory who resigned or were terminated during Q1, relative to theaverage number of employees during the quarter was 90%, 42%, and 51%, respectively. As a result of this employee turnover,we must hire and train replacement employees. These replacement employees require a period46 Table of Contentsof training and improvement, and this impacts the quantity of products we can produce in the quarter. The combined effect ofthe factory shut-down and employee turnover in the quarter may also contribute to negative seasonality in Q1. Our gross margin varies quarter to quarter and varies primarily due to the product mix in a particular quarter, as wellas from the level of manufacturing efficiencies, production yields (particularly in the laser chip fabrication process) andoverall supply costs. Results of Operations The following table set forth our results of operations for the periods presented and as a percentage of our revenuefor those periods. The period-to-period comparison of our financial results is not necessarily indicative of our financialresults to be achieved in future periods. Years ended December 31, 2018 2017 2016 Revenue, net 100.0% 100.0% 100.0% Cost of goods sold 67.2% 56.5% 66.6% Gross profit 32.8% 43.5% 33.4% Operating expenses Research and development 18.6% 9.2% 12.2% Sales and marketing 3.4% 2.3% 2.5% General and administrative 14.8% 9.2% 9.8% Total operating expenses 36.8% 20.7% 24.5% Income (loss) from operations (4.0)% 22.7% 8.9% Interest and other income (expense), net 0.4% (0.6)% (0.8)% Income (loss) before income taxes (3.6)% 22.1% 8.1% Income tax benefit (expense) 2.8% (2.8)% 3.9% Net income (loss) (0.8)% 19.3% 12.0% Comparison of Years Ended December 31, 2018 and 2017 Revenue We generate revenue through the sale of our products to equipment providers and network operators for the internetdata center, CATV, telecom, FTTH and other markets. We derive a significant portion of our revenue from our top tencustomers, and we anticipate that we will continue to do so for the foreseeable future. The following charts provide therevenue contribution from each of the markets we served for the years ended December 31, 2018 and 2017 (in thousands,except percentages): Years ended December 31, Change 2018 % ofRevenue 2017 % ofRevenue Amount % Data Center $200,236 74.9% $306,712 80.2% $(106,476) (34.7)%CATV 51,699 19.3% 60,756 15.9% (9,057) (14.9)%Telecom 13,159 4.9% 12,899 3.4% 260 2.0%FTTH 818 0.3% 490 0.1% 328 66.9%Other 1,553 0.6% 1,472 0.4% 81 5.5%Total Revenue $267,465 100.0% $382,329 100.0% $(114,864) (30.0)% The decrease in revenue for the year was driven primarily by decreased demand for our 40 Gbps and 100 Gbpstransceivers as one of our customers reduced its demand for optical transceivers due to changes in the way they architect theirnetwork. Additionally, in the third and fourth quarters of 2018, we experienced decreased shipments of our 100 Gbpstransceiver products to one of our customers due to their concerns about failures of similar products shipped previously. Weconducted extensive testing of our products to demonstrate that any potentially affected units could be nearly eliminated infuture shipments. During the time that this issue was being investigated, production activity was reduced as resources wereredirected to efforts to identify the root cause of any failures observed, and in order to avoid manufacturing product thatcould not be proven to meet acceptable quality standards. These decreases were partially47 Table of Contentsoffset by an increase in demand for 100 Gbps transceivers from other customers. We expect continued sales in 2019 of 100Gbps and 40 Gbps products to the customer affected by the quality issue. The decrease in revenue in the CATV market for theyear was partially a result of decreased available production capacity in our China factory associated with staff turnoverrelated to the Lunar New Year, combined with reduced demand from one of our CATV customers in the second and thirdquarters associated with excess inventory the customer had previously purchased from us. The increase in revenue in ourtelecom market was primarily attributable to increased demand for telecom products by our customers as they supply newdeployments of telecom infrastructure. The increase in revenue in our FTTH market was due to the fluctuation in demand forcertain older legacy products and this demand is expected to continue to fluctuate. In the years ended December 31, 2018 and 2017, our top ten customers represented 92.9% and 94.9% of ourrevenue, respectively. Cost of goods sold and gross margin Years ended December 31, 2018 2017 Change % of % of Amount Revenue Amount Revenue Amount % (in thousands, except percentages) Cost of goods sold $179,692 67.2% $216,049 56.5% $(36,357) (16.8)%Gross margin 87,773 32.8% 166,280 43.5% Cost of goods sold decreased by $36.4 million, or 16.8%, from 2017 to 2018, primarily due to a 30.0% decrease insales over the prior year. The decrease in gross margin for the year ended December 31, 2018 compared to the same periodended December 31, 2017 was primarily the result of lower capacity utilization, resulting in higher fixed cost absorption for100 Gbps products produced and shipped in the period. In addition, additional costs were incurred for more extensivequality and reliability testing. As noted in the revenue discussion above, production was reduced while we investigatedcustomer reports of failures of similar products shipped previously. This decreased production quantity resulted in higherfixed-cost absorption, and eliminating potentially defective units from our production process temporarily reduced productyields in the third and fourth quarters of 2018. Operating expenses Years ended December 31, 2018 2017 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Research and development $49,903 18.7% $35,365 9.2% $14,538 41.1%Sales and marketing 9,141 3.4% 8,702 2.3% 439 5.0%General and administrative 39,497 14.8% 35,262 9.2% 4,235 12.0%Total operating expenses $98,541 36.8% $79,329 20.7% $19,212 24.2% Research and development expense Research and development expense increased by $14.5 million, or 41.1%, from 2017 to 2018. Research anddevelopment costs consist of R&D work orders, R&D material usage and other project related costs related to 40 Gbps, 100Gbps, and 200/400 Gbps data center products, DOCSIS 3.1 capable CATV products, including remote-PHY products, andother new product development, and depreciation expense resulting from R&D equipment investments. Research anddevelopment costs increased from 2017 to 2018 due mainly to increases in personnel-related costs, depreciation expensesassociated with new R&D equipment purchased or transferred during the year, materials and supplies used in R&D activitiesand an increase in costs from R&D work orders. As we continue to focus on broadening our product portfolio, especiallyincreasing our product offerings in the telecom, FTTH and other areas, we expect to continue to increase our R&Dinvestments. 48 Table of Contents Sales and marketing expense Sales and marketing expense increased by $0.4 million, or 5.0%, from 2017 to 2018. This increase was due toincreases in personnel costs, duties and freight and trade show expenses, offset by decreased commissions, customs taxes andprofessional fees. General and administrative expense General and administrative expense increased by $4.2 million, or 12.0%, from 2017 to 2018. These increases wereprimarily due to an increase in personnel-related costs, share-based compensation expenses, depreciation expenses, insuranceexpenses and professional service fees. Other income (expense), net Years ended December 31, 2018 2017 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Interest income $282 0.1% $221 0.1% $61 27.6%Interest expense (1,106) (0.4)% (858) (0.2)% (248) 28.9%Other income (expense), net 1,814 0.7% (1,788) (0.5)% 3,602 (201.5)%Total other expense, net $990 0.4% $(2,425) (0.6)% $3,415 (140.8)% Interest income increased over the same prior year periods due to larger cash balances. Interest expense increased by 28.9% from 2017 to 2018 due to higher debt balances along with higher interest ratesin the current year. Other income (expense) for 2018 was income of $1.8 million, a $3.6 million favorable increase as compared to 2017.These increases were due to a $2.7 million increase of foreign exchange gains resulting from the favorable fluctuation ofcertain Asian currencies against the U.S. dollar and $0.7 million higher subsidies during the current year from the U.S. andChinese governments related to our qualification as a high-tech enterprise. Benefit (provision) for income taxes Years ended December 31, 2018 2017 Change (in thousands, except percentages) Benefit (provision) for income taxes $7,632 $(10,575) 18,207 (172.2)% Our income tax expense (benefit) consists of U.S. income tax, state taxes, Taiwan and China income tax recordedduring the periods. Our effective tax rate is affected by recurring items, such as tax rates in state and foreign jurisdictions andthe relative amounts of income we earn in those jurisdictions. We recorded a tax benefit of $7.6 million for the year ended December 31, 2018 as compared to the tax expense of$10.6 million for the year ended December 31, 2017. The income tax benefit in the year ended December 31, 2018 wasprimarily related to the impact of changes to tax law, offset by the recognition of excess tax benefits attributable to share-based compensation as well as the recognition of research and development credits. The income tax expense recorded in theyear ended December 31, 2017 was primarily related to the impact of changes to tax law, offset by the recognition of excesstax benefits attributable to share-based compensation as well as the recognition of research and development credits. 49 Table of ContentsComparison of Years Ended December 31, 2017 and 2016 Revenue We generate revenue through the sale of our products to equipment providers and network operators for the internetdata center, CATV, FTTH, telecom and other markets. We derive a significant portion of our revenue from our top tencustomers, and we anticipate that we will continue to do so for the foreseeable future. The following charts provide therevenue contribution from each of the markets we served for the years ended December 31, 2017 and 2016 (in thousands,except percentages): Years ended December 31, Change 2017 % ofRevenue 2016 % ofRevenue Amount % Data Center $306,712 80.2% $201,314 77.2% $105,398 52.4% CATV 60,756 15.9% 43,567 16.7% 17,189 39.5% Telecom 12,899 3.4% 12,938 5.0% (39) (0.3)% FTTH 490 0.1% 1,567 0.6% (1,077) (68.7)% Other 1,472 0.4% 1,327 0.5% 145 10.9% Total Revenue $382,329 100.0% $260,713 100.0% $121,616 46.6% Revenues in the internet data center market were driven primarily by increasing demand for our 40 Gbps and 100Gbps transceivers as our customers continued to upgrade their technology infrastructure. We expect to continue to sell 40Gbps products to our customers in 2018, however we believe that revenue generated from our 40 Gbps products will likelydecline as customers continue their transition to 100 Gbps products. The decrease in revenue in our FTTH market is due to adecline in demand for certain older legacy products. The increase in revenue in the CATV market for the year was a result ofincreased demand from our customers who are supplying equipment for CATV network upgrades which began during theyear. The decrease in revenue in our telecom segment was primarily attributable to reduced orders from some of our telecomcustomers, particularly in China. In the years ended December 31, 2017 and 2016, our top ten customers represented 94.9% and 95.5% of ourrevenue, respectively. Cost of goods sold and gross margin Years ended December 31, 2017 2016 Change % of % of Amount Revenue Amount Revenue Amount % (in thousands, except percentages) Cost of goods sold $216,049 56.5% $173,759 66.6% $42,290 24.3% Gross margin 166,280 43.5% 86,954 33.4% Cost of goods sold increased by $42.3 million, or 24.3%, from 2016 to 2017, primarily due to a 46.6% increase insales over the prior year. The increase in gross margin for the year ended December 31, 2017 compared to the same periodended December 31, 2016 was primarily the result of lower production costs associated with certain 40 Gbps and 100 Gbpsproducts. Production costs were reduced due mainly to improved product yields, related to process improvements andautomation, as well as raw material cost reduction. Operating expenses Years ended December 31, 2017 2016 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Research and development $35,365 9.2% $31,780 12.2% $3,585 11.3% Sales and marketing 8,702 2.3% 6,627 2.5% 2,075 31.3% General and administrative 35,262 9.2% 25,527 9.8% 9,735 38.1% Total operating expenses $79,329 20.7% $63,934 24.5% $15,395 24.1% 50 Table of Contents Research and development expense Research and development expense increased by $3.6 million, or 11.3%, from 2016 to 2017. Research anddevelopment costs consist of R&D work orders, R&D material usage and other project related costs related to 40 Gbps, 100Gbps, and 200/400 Gbps data center products, DOCSIS 3.1-capable CATV products, including remote-PHY products, andother new product development, and depreciation expense resulting from R&D equipment investments. Research anddevelopment costs increased due mainly to an increase in personnel-related costs and increased overhead costs associatedwith our new building in Sugar Land, offset by a decrease in materials and supplies used in R&D activities and a decrease incosts from R&D work orders. Sales and marketing expense Sales and marketing expense increased by $2.1 million, or 31.3%, from 2016 to 2017. This was due to an increase inpersonnel costs, including sales commissions, an increase in customs taxes and duties, partially offset by decreasedcommissions to third parties. General and administrative expense General and administrative expense increased by $9.7 million, or 38.1%, from 2016 to 2017. These increases wereprimarily due to an increase in personnel-related costs, share-based compensation expenses, overhead costs due to our newbuilding in Sugar Land, and additional professional service fees. General and administrative expenses include costs to comply with Section 404 of the Sarbanes-Oxley Act, or SOX,and other regulations governing public companies, costs of directors' and officers' liability insurance and investor relationsactivities. As of June 30, 2017, the market value of our common stock held by non-affiliates exceeded $700 million. As ofDecember 31, 2017, we are a "large accelerated filer" and, accordingly no longer qualify as an emerging growth company andno longer are able to rely on certain exemptions that were available to us as an emerging growth company. We anticipate thatgeneral and administrative expenses will continue to increase in absolute dollars in the future as we continue to incur bothincreased external audit fees as well as additional spending to ensure continued SOX and other regulatory compliance. Other income (expense), net Years ended December 31, 2017 2016 Change % of % of Amount revenue Amount revenue Amount % (in thousands, except percentages) Interest income $221 0.1% $247 0.1% $(26) (10.5)% Interest expense (858) (0.2)% (1,717) (0.7)% 859 (50.0)% Other income (expense), net (1,788) (0.5)% (547) (0.2)% (1,241) 226.9% Total other expense, net $(2,425) (0.6)% $(2,017) (0.8)% $(408) 20.2% Interest income decreased over the same prior year periods due to lower investment balances. Interest expense decreased by 50.0% from 2016 to 2017 due to the repayment of debt that had been previouslyborrowed to fund expansion projects. Other income (expense) for 2017 was expense of $1.8 million, a $1.2 million unfavorable increase as compared to2016. These increases were due to the increase of foreign exchange losses resulting from the unfavorable fluctuation ofcertain Asian currencies against the U.S. dollar. We qualify as a high-tech enterprise in China, as determined by the Chinesegovernment, and are paid subsidies from time to time by the Chinese government to foster local high-tech manufacturing. Wereceived $0.2 million of government subsidies during 2017 and 2016, respectively.51 Table of Contents Benefit (provision) for income taxes Years ended December 31, 2017 2016 Change (in thousands, except percentages) Benefit (provision) for income taxes $(10,575) $10,231 (20,806) (203.4)% Our income tax expense consists of U.S. income tax, state taxes, Taiwan and China income tax recorded during theperiods. Our effective tax rate is affected by recurring items, such as tax rates in state and foreign jurisdictions and the relativeamounts of income we earn in those jurisdictions. We recorded a tax expense of $10.6 million for the year ended December 31, 2017 as compared to the tax benefit of$10.2 million for the year ended December 31, 2016. The income tax expense in the year ended December 31, 2017 wasprimarily related to the provisional impact of changes to tax law, offset by the recognition of excess tax benefits attributableto share-based compensation as well as the recognition of research and development credits. The income tax benefit recordedin the year ended December 31, 2016 was primarily related to the release of the valuation allowance previously recordedagainst U.S. and Taiwan deferred tax assets. On December 22, 2017, the Tax Act was signed into law making significant changes to the Internal Revenue Code.Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning afterDecember 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and aone-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. Weestimated the impact of the Tax Act in our year-end income tax provision in accordance with our understanding of the TaxAct and as a result recorded $7.8 million as additional income tax expense in 2017. The 2017 provisional amount related tothe remeasurement of certain deferred tax assets and liabilities, based on the rates at which they are expected to reverse in thefuture, was $2.8 million. The provisional amount related to the one-time transition tax on the mandatory deemed repatriationof foreign earnings was $5.0 million based on cumulative foreign earnings of $62.8 million. Liquidity and Capital Resources As of December 31, 2018, we had $69.4 million of unused borrowing capacity from all of our loan agreements. As ofDecember 31, 2018, our cash, cash equivalents, restricted cash and short-term investments totaled $58.0 million. Cash andcash equivalents are held for working capital purposes and are invested primarily in money market or time deposit funds. Wedo not enter into investments for trading or speculative purposes. On October 17, 2016, we filed a Registration Statement onForm S-3 with the Securities and Exchange Commission, which was declared effective on November 1, 2016, providing forthe public offer and sale of certain securities of the Company from time to time, at our discretion, up to an aggregate amountof $250 million. Between November 22, 2016 and March 2, 2017, the Company sold 1.6 million shares of common stock at aweighted average price of $31.55 per share, providing proceeds of $48.8 million, net of expenses and underwriting discountsand commissions. No shares of common stock were sold pursuant to this Registration Statement on Form S-3 in the yearended December 31, 2018 The table below sets forth selected cash flow data for the periods presented (in thousands): Years ended December 31, 2018 2017 2016 Net cash provided by operating activities $14,029 $84,284 $57,104 Net cash used in investing activities (76,514) (70,159) (41,535) Net cash provided by financing activities 34,803 18,244 1,655 Effect of exchange rates on cash and cash equivalents 1,738 (385) 1,947 Net increase (decrease) in cash $(25,944) $31,984 $19,171 Operating activities In 2018, net cash provided by operating activities was $14.0 million. Net cash provided by operating activitiesconsisted of our net loss of $2.1 million, after the exclusion of non-cash items of $38.5 million, an increase in accountsreceivable from our customers of $29.3 million and an increase in accrued liabilities of $0.6 million. These cash52 Table of Contentsincreases were offset by an increase in inventory of $28.4 million, a decrease in accounts payable to our vendors of $13.7million, a decrease in accrued income tax of $7.4 million and an increase in other current assets of $3.0 million In 2017, net cash provided by operating activities was $84.3 million. Net cash provided by operating activitiesconsisted of our net income of $74.0 million, after the exclusion of non-cash items of $30.4 million, increase in accountspayable to our vendors of $7.2 million, an increase in accrued liabilities of $4.1 million and an increase in accrued incometax of $6.2 million. These cash increases were offset by an increase in accounts receivable from our customers of $10.1million, an increase in inventory of $21.9 million and an increase in other current assets of $5.6 million. In 2016, net cash provided by operating activities was $57.1 million. Net cash provided by operating activitiesconsisted of our net income of $31.2 million, after the exclusion of non-cash items of $9.5 million as well as $10.2 millionfrom the reduction of inventories, increase in accounts payable to our vendors of $9.1 million, decrease in prepaid assets of$4.1 million and an increase in accrued liabilities and accrued income tax of $4.1 million. These cash increases were offsetby an increase in accounts receivable from our customers of $11.1 million in 2016. Investing activities Our investing activities consisted primarily of capital expenditures and purchases of intangible assets. In 2018, net cash used in investing activities was $76.5 million. The net cash used consisted of spending onproperty, plant and equipment and land use rights of $77.4 million offset by sales proceeds from equipment of $0.7 million. In 2017, net cash used in investing activities was $70.2 million. The net cash used consisted of spending onproperty, plant and equipment of $67.0 million and an increase of $2.9 million in deferred charges associated with thepurchase of new machinery and equipment. In 2016, net cash used in investing activities was $41.5 million. Spending on property, plant and equipment of$49.4 million was offset by the maturity of short-term investments of $7.7 million. Financing activities Our financing activities have historically consisted primarily of proceeds from the issuance of common stock andarrangements with various commercial lenders. In 2018, our financing activities provided $34.8 million in cash. We received $38.8 million in net borrowingsassociated with our bank loans and bank acceptance notes. These activities were offset by $4.1 million related to taxwithholding associated with employee share-based compensation. In 2017, our financing activities provided $18.2 million in cash. We received $21.6 million in net proceeds from thesale of our common stock pursuant to an at-the-market offering and $6.2 million in net borrowings associated with our bankloans. These activities were offset by $10.7 million related to tax withholding associated with employee share-basedcompensation. In 2016, our financing activities provided $1.7 million in cash. We repaid $22.9 million in net borrowingsassociated with our bank loans and $2.5 million in net repayments of acceptance payable. We also received $27.2 million innet proceeds from the sale of our common stock pursuant to an at-the-market offering. Loans and commitments We have lending arrangements with several financial institutions. In the US, we have revolving lines of credit andterm loans with Branch Banking and Trust (BB&T) Bank in the U.S. These term loans contain financial covenants that maylimit the amount and types of debt that we may incur. As of December 31, 2018, we were in compliance with thesecovenants. In Taiwan, we have a revolving credit facility with Taishin International Bank, a revolving credit facility withDevelopment Bank of Singapore (Taiwan) Ltd, a credit facility with CTBC Bank Co, Ltd. and a finance lease agreement53 Table of Contentswith Chailease Finance Co., Ltd. for Prime World’s Taiwan Branch. And in China, we have a revolving line of credit withChina Construction Bank with Global. As of December 31, 2018, we had $69.4 million of unused borrowing capacity. On September 28, 2017, we entered into a Loan Agreement, a Promissory Note, an Addendum to the Promissory Note,a BB&T Security Agreement, a Trademark Security Agreement, and a Patent Security Agreement (together the “CreditFacility”) with Branch Banking and Trust Company (“BB&T”). The Credit Facility provides us with a three year, $50million, revolving line of credit. Borrowings under the Credit Facility will be used for general corporate purposes. We makemonthly payments of accrued interest with the final monthly payment being for all principal and all accrued interest not yetpaid. Our obligations under the Credit Facility are secured by our accounts receivable, inventory, intellectual property, andall business assets with the exception of real estate and equipment. Borrowings under the Credit Facility bear interest at a rateequal to the one-month LIBOR plus 1.50%. The Credit Facility requires us to maintain certain financial covenants and alsocontains representations and warranties, and events of default applicable to us that are customary for agreements of this type. On March 30, 2018, we executed a First Amendment to Loan Agreement, a Note Modification Agreement andAddendum to Promissory Note for $60 million, a Promissory Note and Addendum to Promissory Note for $26 million, aPromissory Note and Addendum to Promissory Note for $21.5 million, a Texas Deed of Trust and Security Agreement, anAssignment of Lease and Rent, and an Environmental Certification and Indemnity Agreement, (collectively, the “AmendedCredit Facility”), with BB&T. The Amended Credit Facility amends our three-year $50 million line of credit with BB&T,originally executed on September 28, 2017 (the “Existing Loan”). The Amended Credit Facility (1) increases the principalamount of the three-year line of credit from $50 million to $60 million (the “Line of Credit”); (2) allows us to borrow anadditional $26 million from BB&T in the form of a five-year capital expenditure loan (the “CapEx Loan”) and (3) allows usto borrow an additional $21.5 million in the form of a seventy-month real estate term loan (the “Term Loan”) to refinance ourplant and facilities in Sugar Land, Texas. Borrowings under the Line of Credit bear interest at a rate equal to the one-monthLIBOR plus a Line of Credit margin ranging between 1.40% and 2.0%. Borrowings under the CapEx Loan bear interest at arate equal to the one-month LIBOR plus a CapEx Loan margin ranging between 1.30% and 2.0%. Borrowings under theTerm Loan bear interest at a rate equal to the one-month LIBOR plus a Term Loan margin ranging between 1.15% and 2.0%.We are required to make monthly payments of principal and accrued interest with the final monthly payments being for allprincipal and accrued interest not yet paid. Our obligations under the Amended Credit Facility are secured by our accountsreceivable, inventory, equipment, intellectual property, real property, and virtually all business assets. As of December 31,2018, we were in compliance with all covenants under the Amended Credit Facility. As of December 31, 2018, $23.1 millionwas outstanding under the Line of Credit, $20.1 million was outstanding under the Term Loan and $19.2 million wasoutstanding under the CapEx Loan. On February 1, 2019, we executed a Second Amendment to Loan Agreement with BB&T. The original loanagreement with BB&T, executed on September 28, 2017, and a first amendment to the original loan agreement, executed onMarch 30, 2018, provided us with a three-year $60 million line of credit; a $26 million five-year capital expenditure loan(the “CapEx Loan”) and a $21.5 million seventy-month real estate term loan for our plant and facilities in Sugar Land, Texas.The Second Amendment to Loan Agreement extends the CapEx Loan draw-down date from March 30, 2019 to September 30,2019, requires us to provide BB&T monthly financial statements and revises certain financial covenants which are deemedeffective as of September 30, 2018. On May 27, 2015, our Taiwan branch entered into a Purchase and Sale Contract and a Finance Lease Agreementwith Chailease Finance Co, Ltd. (“Chailease”) in connection with certain equipment, structured as a sale lease-backtransaction. Pursuant to the Purchase and Sale contract, our Taiwan branch sold certain equipment to Chailease for a purchaseprice of 180,148,532 New Taiwan dollars, approximately $6.0 million, and simultaneously leased the equipment back fromChailease pursuant to the Finance Lease Agreement. The monthly lease payments range from 3,784,000 New Taiwan dollars,approximately $0.1 million, to 3,322,413 New Taiwan dollars, approximately $0.1 million, during the term of the FinanceLease Agreement, including an initial payment in an amount of 60,148,532 New Taiwan dollars, approximately $2.0 million.The Finance Lease Agreement had a three-year term, with monthly payments, that matured on May 27, 2018. The title to theequipment was transferred to our Taiwan branch upon the expiration of the Finance Lease Agreement. On June 19, 2018, Prime World entered into a one year revolving credit facility totaling 300 million New Taiwandollars (“NT$”), or approximately $9.8 million, (the “Taiwan Credit Facility”) with Taishin International Bank54 Table of Contentsin Taiwan (the “Bank”). Borrowing under the Taiwan Credit Facility will be used for short-term working capital. Prime Worldmay draw upon the Taiwan Credit Facility from June 19, 2018 until May 31, 2019. The term of each draw shall be either 90or 120 days. Borrowings under the Taiwan Credit Facility bear interest at a rate of 2.00% for 90 day draws and 1.95% for 120day draws. At the end of the draw term, Prime World is required to make payment for all principal and accrued interest. Theagreements for the Taiwan Credit Facility contain representations and warranties and events of default applicable to PrimeWorld that are customary for agreements of this type. As of December 31, 2018, $3.3 million was outstanding under theTaiwan Credit Facility. On October 3, 2018, Prime World entered into a revolving credit facility for up to $7 million, (the “RevolvingCredit Facility”) with the Development Bank of Singapore (Taiwan) Ltd. (“DBS”). Borrowing under the Revolving CreditFacility will be used for short-term working capital. Prime World may draw upon the Revolving Credit Facility from October3, 2018 until July 26, 2019. The term of each draw shall be either 60 or 90 days depending on the purpose of thedraw. Borrowings under the Revolving Credit Facility bear interest at a rate equal to DBS’s cost of funds rate plus 1.25% fordraws in U.S. Dollars and 1.35% plus the Bank’s cost of funds rate for draws in New Taiwan Dollars. As of the execution ofthe Revolving Credit Facility, DBS’s cost of fund’s rate is 0.77% for loans made in New Taiwan Dollars and 2.54% for loansmade in U.S. Dollars. DBS’s cost of fund’s rate is adjusted daily. Prime World is required to make monthly payments ofaccrued interest with the final monthly payment being for all principal and all accrued interest not yet paid. Prime World’sobligations under the Revolving Credit Facility are secured by promissory notes executed between Prime World and DBS atthe time of each draw. The agreements for the Revolving Credit Facility contain representations and warranties and events ofdefault applicable to the Prime World that are customary for agreements of this type. As of December 31, 2018, $3.6 millionwas outstanding under the Revolving Credit Facility. On November 29, 2018, Prime World entered into a Purchase and Sale Contract (the “Sale Contract”) and a FinanceLease Agreement with Chailease Finance Co., Ltd. (“Chailease”) in connection with certain equipment, structured as a salelease-back transaction. Pursuant to the Sale Contract, Prime World sold certain equipment to Chailease for a purchase price ofNT$267,340,468, or approximately $8.7 million. Simultaneously, Prime World leased the equipment back from Chailease fora term of three-years, pursuant to the Finance Lease Agreement. Prime World is obligated to pay an initial payment ofNT$67,340,468, or approximately $2.2 million, thereafter the monthly lease payments range from NT$5,571,229, or $0.2million, to NT$6,139,188, or approximately $0.2 million. Based on the lease payments made under the Finance LeaseAgreement, the annual interest rate is calculated to be 3.5%. Upon an event of default under the Finance Lease Agreement,Prime World’s payment obligation is secured by a promissory note to Chailease in the amount of NT$210,601,605, orapproximately $6.8 million, subject to certain terms and conditions. The title of the equipment will be transferred to PrimeWorld upon expiration of the Finance Lease Agreement. As of December 31, 2018, $6.3 million was outstanding under theFinance Lease Agreement. On December 11, 2018, Prime World entered into a one-year credit facility totaling New Taiwan Dollars 150million (the “Credit Facility”) with CTBC Bank Co., Ltd. (“CTBC”). Borrowing under the Credit Facility will be used forshort-term working capital. Prime World may draw upon the Credit Facility from December 11, 2018 until October 31, 2019.The term of each draw shall be up to 120 days. Under the Credit Facility borrowing in New Taiwan Dollars bear interest at arate equal to CTBC’s Enterprise Swap Index Rate plus 1.2%; for all foreign currency borrowing interest will bear at a rateequal to CTBC’s Cost of Fund lending rate plus 1.2%. As of the execution of the Credit Facility, CTBC’s Enterprise SwapIndex Rate and Cost of Funds lending rate is 0.69% and 3.40% respectively. At the end of the draw term, Prime World isrequired to make payment for all principal and accrued interest. The agreements for the Credit Facility containrepresentations and warranties, and events of default applicable to Prime World that are customary for agreements of thistype. As of December 31, 2018, there was no outstanding balance under the Credit Facility. On September 21, 2018, our China subsidiary, Global Technology, Inc., entered into a five-year revolving creditline agreement, totaling 129,000,000 Chinese Renminbi, or RMB, or approximately $18.6 million, (the “Credit Line”) and aSecurity Agreement with China Construction Bank Co., Ltd., in Ningbo, China (“CCB”). Borrowing under the Credit Linewill be used for general corporate and capital investment purposes, including the issuance of bank acceptance notes toGlobal’s vendors. Global may draw upon the Credit Line between September 21, 2018 and September 17, 2023; however, theamount of available credit under the Credit Line may be reduced by CCB without notice to Global and may be decreasedsubject to changes of Chinese government regulations. Each draw bears interest equal to CCB’s commercial banking interestrate effective on the day of the applicable draw. Global’s obligations under the Credit Line will be secured by real propertyowned by Global in China and mortgaged to CCB under the terms of the55 Table of ContentsSecurity Agreement. As of December 31, 2018, $8.7 million was outstanding under the Credit Line and the outstandingbalance of bank acceptance notes issued to vendors was $4.6 million. On January 21, 2019, Prime World entered into a second Purchase and Sale Contract (the “Second Sales Contract”),Promissory Note, and a second Finance Lease Agreement, (collectively, the “Second Financing Agreements”) with Chaileasein connection with certain equipment, structured as a sale lease-back transaction. Pursuant to the Second Sales Contract,Prime World sold certain equipment to Chailease for a purchase price of NT$267,333,186, or approximately $8.7 million.Simultaneously, Prime World leased the equipment back from Chailease for a term of three-years, pursuant to the SecondFinance Lease Agreement. Prime World is obligated to pay an initial monthly payment of NT$67,333,186, or approximately$2.2 million, thereafter the monthly lease payments range from NT$5,570,167, or approximately $0.2 million toNT$6,082,131, or approximately $0.2 million. Based on the lease payments made under the Second Finance LeaseAgreement, the annual interest rate is calculated to be 3.5%. Upon an event of default under the Second Finance LeaseAgreement, Prime World’s payment obligation will be secured by a promissory note to Chailease at the amount ofNT$209,555,736 or approximately $6.8 million, subject to certain terms and conditions. The title of the equipment will betransferred to Prime World upon expiration of the Second Finance Lease Agreement. One-month LIBOR rates were 2.50% and 1.56% at December 31, 2018 and 2017, respectively. As of December 31, 2018 and 2017, there was $2.4 million and $1.0 million of restricted cash, investments orsecurity deposit associated mainly with the loan facilities, respectively China factory construction On February 8, 2018, we entered into a construction contract with Zhejiang Xinyu Construction Group Co., Ltd. forthe construction of a new factory and other facilities at our Ningbo, China location. Construction costs for these facilitiesunder this contract are estimated to total approximately $27.5 million. As of December 31, 2018, approximately $8.2 millionof this total cost has been incurred, with the remaining portion due as the construction progresses. Construction under thiscontract is expected to be completed in early 2020. Future liquidity needs We believe that our existing cash and cash equivalents, cash flows from our operating activities, and available creditwill be sufficient to meet our anticipated cash needs for the next 12 months. Our future capital requirements will depend onmany 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, changes in ourmanufacturing capacity and the continuing market acceptance of our products. In the event we need additional liquidity, wewill explore additional sources of liquidity. These additional sources of liquidity could include one, or a combination, of thefollowing: (i) issuing equity or debt securities, (ii) incurring indebtedness secured by our assets and (iii) selling product lines,other assets and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on termsacceptable to us, or at all. Contractual Obligations and Commitments The following summarizes our contractual obligations as of December 31, 2018 (in thousands): Payments due by period Less than 1 More than Total Year 1-3 Years 3-5 Years 5 Years Notes payable and long-term debt $93,141 $29,644 $41,427 $12,669 $9,401 Operating leases 11,166 1,233 2,175 2,010 5,748 Total commitments $104,307 $30,877 $43,602 $14,679 $15,149 1)We have several loan and security agreements in China, Taiwan and the U.S. that provide various credit facilities,including lines of credit, bank acceptance payable and term loans. The amount presented in the table represents theprincipal portion and estimated interest expense for the obligations.2)We have entered into various non-cancellable operating lease agreements for our offices in Taiwan and the U.S. 56 (1)(2)Table of ContentsInflation We believe that the relatively low rate of inflation in the U.S. over the past few years has not had a significantimpact on our sales or operating results or on the prices of raw materials. To the extent we expand our operations in Chinaand Taiwan, such actions may result in inflation having a more significant impact on our operating results in the future. Off-Balance Sheet Arrangements During 2018, 2017 and 2016, we did not have any off-balance sheet arrangements that we believe have or arereasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues orexpenses, results of operations, liquidity, capital expenditures or capital resources that would be material to investors. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidatedfinancial statements, which have been prepared in accordance with U.S. GAAP. These principles require us to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenue, expenses and cash flows, and related disclosureof contingent assets and liabilities. Our estimates include those related to revenue recognition, share-based compensationexpense, impairment analysis of goodwill and long-lived assets, valuation of inventory, warranty liabilities and accountingfor income taxes. We base our estimates on historical experience and on various other assumptions that we believe to bereasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are materialdifferences between these estimates and our actual results, our future financial statements will be affected. We believe that of our significant accounting policies, which are described in Note B to our consolidated financialstatements appearing elsewhere in this Annual Report on Form 10-K, the following accounting policies involve a greaterdegree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate ourfinancial condition and results of operations. Revenue recognition We generally employ a direct sales model in North America, and in the rest of the world we use both direct andindirect channels. Our revenue recognition policy is to recognize gross revenue whether our products are sold on a direct orindirect basis, because our reseller customers (indirect channel) honor the same terms and conditions as do our direct salescustomers. Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; generallythis occurs with the transfer of control of products or services. Contracts or customer purchase orders are used to determinethe existence of an obligation. Shipping documents are used to verify delivery. Revenue is measured as the amount ofconsideration we expect to receive in exchange for transferring products or providing services. Certain customers mayreceive cash and/or non-cash incentives, which are accounted for as variable consideration. We assess collectability basedprimarily on the creditworthiness of the customer as determined by credit checks and the customer’s payment history.Customers are generally extended net 30 credit terms from the date of shipment, with some extensions for more creditworthycustomers. Shipping and handling costs are included in operating expenses as fulfillment costs unless we bill our customers forshipping and handling charges, which are included in net sales for the applicable period, and the corresponding shipping andhandling expense is reported in cost of sales. We present revenue net of sales returns and allowances, sales taxes and anysimilar assessments. We provide a limited warranty as part of our standard terms and conditions of sale. This warrantyprovides for the repair or replacement of our products, at our discretion, that we determine (i) are defective in workmanship,material, or not in compliance with the mutually agreed written applicable specification and (ii) has in fact failed undernormal use on or before one year from the date of original shipment of the products. Some of our customers are providedlimited warranties between three to five years, on certain limited and identified products. Warranty costs associated withreturned goods that are repaired or replaced are charged to cost of goods sold. During our ordinary course of business, we may enter into new product development agreements to design,customize and develop new products for our customers. Such new product development agreements often involve materialcost and engineering hours and therefore non-recurring engineering service (NRE) charges are agreed upon for57 Table of Contentsthe customer to reimburse our related costs. We adopt the milestone method in revenue recognition for NRE revenues byusing cost-input measurement. We capitalize cost input up to the contractual agreement amount and recognize NRE revenuesbased upon the agreement schedule. Contracts or customer purchase orders are often used to determine the existence ofservice agreement. Share-Based Compensation We account for share-based compensation in accordance with the provisions of ASC 718, Compensation—StockCompensation. Share-based compensation expense is recognized based on the estimated grant date fair value in order torecognize compensation cost for those shares expected to vest. Compensation cost is recognized on a straight-line basis overthe vesting period of the options and adjusted as forfeitures occur. Long-lived assets Depreciation and amortization of the intangible assets and other long-lived assets is provided using the straight-linemethod over their respective estimated useful lives, reflecting the pattern of economic benefits associated with these assets.Changes in circumstances such as technological advances, changes to our business model, or changes in our capital strategycould cause the actual useful lives of intangible assets or other long-lived assets to differ from initial estimates. When webecome aware of such changes, we review the anticipated useful life of the affected assets and make any necessaryrevisions. In those cases where we determine that the useful life of an asset should be revised, we depreciate the remainingnet book value over the new estimated useful life. In December, 2018, our production management undertook a review of theestimated useful life of many of our production-related assets. Based on the results of this review, we believe that it isreasonably likely that estimated asset useful lives may be changed in the near term. If useful lives are revised, we generallyexpect these revisions to result in longer than current useful lives, and thus lower annual depreciation expense for thisequipment. We evaluate the carrying value of long-lived assets for potential impairment when we determine a triggering eventhas occurred, or whenever events or changes in circumstances indicate that the carrying amount of such assets may not berecoverable. When indicators exist, recoverability of assets is measured by a comparison of the carrying value of the assetgroup to the estimated undiscounted future net cash flows expected to be generated by the asset. Examples of such triggeringevents include a significant disposal of a portion of such assets, an adverse change in the market involving the businessemploying the related asset, a significant decrease in the benefits realized from an acquired business, difficulties or delays inintegrating the business, and a significant change in the operations of an acquired business. If such assets are determined notto be recoverable we perform an analysis of the fair value of the asset group and will recognize an impairment loss when thefair value is less than the carrying amount of such assets. The fair value, based on reasonable and supportable assumptionsand projections, require subjective judgments. Depending on the assumptions and estimates used, the fair value projected inthe evaluation of long-lived assets can vary within a range of outcomes. We consider the likelihood of possible outcomes indetermining the best estimate for the fair value of the assets. We did not record any asset impairment charges in 2018 or 2017. Valuation of inventories Inventories are stated at the lower of cost (average-cost method) or market. Work in process and finished goodsincludes materials, labor and allocated overhead. We assess the valuation of our inventory on a periodic basis and provide anallowance for the value of estimated excess and obsolete inventory based on estimates of future demand. During the yearsended December 31, 2018, 2017 and 2016, we recorded excess and obsolete inventory charges of $7.2 million, $1.9 million,and $3.7 million, respectively. For the years December 21, 2018, 2017 and 2016, the direct inventory write-offs related toscrap and damaged inventories were $3.5 million, $6.8 million and $5.0 million, respectively. We have an accounting policy to write down the value of obsolete inventory. We considered the following factorsin our determination of the appropriate reserve level: how often we buy material in bulk; the overall market value of rawmaterial, semi-finished goods and finished goods across our varied product lines and within markets; changes in expecteddemand for our products; the change in valuations historically; the determined safety stock for key customers; and thelikelihood of postponement in delivery schedules for materials already placed in finished goods inventory.58 Table of Contents Accounting for income taxes We account for income taxes in accordance with the provisions of ASC 740, Income Taxes. The liability method isused to account for deferred income taxes. Under the liability method, deferred tax assets and liabilities are measured usingthe enacted tax rates and laws that will be in effect when the differences are expected to reverse. The ability to realizedeferred tax assets is evaluated annually and a valuation allowance is provided if it is unlikely that the deferred tax assetswill not give rise to future benefits in our tax returns. We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) wedetermine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of theposition and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largestamount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related taxauthority. We recognize interest and penalties related to unrecognized tax benefits on the income tax expense line in theaccompanying consolidated statement of operations. Accrued interest and penalties are included on the related tax liabilityline in the consolidated balance sheet. Tax Cuts and Jobs Act On December 22, 2017, the U.S. government enacted the Tax Act. The Tax Act makes broad and complex changesto the U.S. tax code, including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21percent; (2) requiring companies to pay a one-time transition tax (“Transition Tax”) on certain unrepatriated earnings offoreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) a newprovision designed to tax global intangible low-taxed income (“GILTI”); (5) eliminating the corporate alternative minimumtax (“AMT”) and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax (“BEAT”),a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses andlimitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. Shortly after enactment of the Tax Act, the SEC staff issued SAB 118, which provides guidance on accounting forthe tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the TaxAct enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company mustreflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To theextent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine areasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine aprovisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of theprovisions of the tax laws that were in effect immediately before the enactment of the Tax Act. The Transition Tax is a tax on certain previously untaxed accumulated and current earnings and profits (E&P) of ourforeign subsidiaries. We were able to reasonably estimate the Transition Tax and recorded a provisional Transition Taxobligation of $5.0 million, with a corresponding adjustment of $5.0 million to income tax expense for the year endedDecember 31, 2017. On the basis of revised E&P computations that were completed during the reporting period, werecognized an additional measurement-period adjustment of ($1.8) million to the Transition Tax obligation, with acorresponding adjustment of ($1.8) million to income tax benefit during year ended December 31, 2018, net of foreign taxcredit considerations. The effect of the measurement-period adjustment on the 2018 effective tax rate was approximately 18.8percent. The Transition Tax, which has now been determined to be complete, resulted in recording a total Transition Taxobligation of $3.2 million, with a corresponding adjustment of $3.2 million to income tax expense. See additional information regarding income taxes in Note M of our Consolidated Financial Statements. Recent Accounting Pronouncements See Note B of our Consolidated Financial Statements for a description of recent accounting pronouncements. 59 Table of Contents Item 7A. Quantitative and Qualitative Disclosures about Market Risk Market Risks Market risk represents the risk of loss that may impact our financial statements through adverse changes in financialmarket prices and rates and inflation. Our market risk exposure results primarily from fluctuations in foreign exchange andinterest rates. We manage our exposure to these market risks through our regular operating and financing activities. We havenot historically attempted to reduce our market risks through hedging instruments; we may, however, do so in the future. Interest Rate Fluctuation Risk Our cash equivalents consisted primarily of money market funds, and interest and non-interest bearing bankdeposits. Our primary objective is to maintain the security of our principal balances and ensure liquidity. We attempt tomaximize the return on these balances without significantly increasing risk, but have little opportunity to do so given theshort-term nature of our investments and current interest rate environments. We do not anticipate any material effect on ourcash balances or investment portfolio due to fluctuations in interest rates. We are exposed to market risk due to the possibility of changing interest rates associated with certain debtinstruments. As of December 31, 2018, our U.S. debt bears a variable rate of interest that is based on LIBOR. The debt subjectto variable rates is subject to fluctuation in the LIBOR. As of December 31, 2018, we had not hedged our interest rate risk. With respect to our interest expense for the three months ended December 31, 2018, an increase of 1.0% in each ofour interest rates would have resulted in an increase of $0.8 million in our interest expense for such period. Foreign Exchange Rates We operate on an international basis with a large portion of our business conducted in our Taiwan branch and Chinasubsidiary. We use the U.S. dollar as our reporting currency for our consolidated financial statements. The financial records ofour China subsidiary and our Taiwan branch are maintained in their respective local currencies, the RMB and the NT dollar,which are the functional currencies for our China subsidiary and our Taiwan branch, respectively. Assets and liabilities aretranslated at prevailing exchange rates at the balance sheet date, equity accounts are translated at historical exchange ratesand revenues, expenses, gains and losses are translated using the average rate for the then current period using a monthlyaverage. Translation adjustments are reported as cumulative translation adjustments and are shown as a separate componentof accumulated other comprehensive income in our statement of stockholders’ equity and comprehensive income. All transactions in currencies other than their functional currencies during the year are subject to foreign exchangerisk when the exchange rate fluctuates on the respective relevant dates of such transactions. Transaction gains and losses arerecognized in our statements of operations in other income (expense). Monetary assets and liabilities existing at the balancesheet date denominated in currencies other than the functional currencies are re-measured at the exchange rates prevailing onthe Balance Sheet date and unrealized exchange differences are recorded in our consolidated income statement. In October2015, we determined that certain intercompany loans are long-term investments. Therefore, exchange gain (loss) arising fromre-measurement of intercompany loans were recorded in the Cumulative Translation Adjustment accounts. During the year ended December 31, 2018, we recognized $0.7 million of exchange gains arising from foreigncurrency transactions and re-measurement of monetary assets and liabilities dominated in non-functional currency onbalance sheet date. During the year ended December 31, 2018, 3.8% of our revenue was denominated in RMB and none of our revenuewas denominated in NT dollars. In the year ended December 31, 2018, 21.4% of our operating expenses were denominated inRMB and 32.7% of our operating expenses were denominated in NT dollars. Accordingly, fluctuations in exchange ratesdirectly affect our cost of goods sold and net income, and have a significant impact on our operating60 Table of Contentsmargins. If exchange rates of RMB and NT dollars for U.S. dollars were 1% higher during the year ended December 31, 2018,our operating expenses would have had been higher by $0.5 million. As of December 31, 2018, we held the U.S. dollar denominated liabilities net of assets of approximately$15.3 million in our China subsidiary and $13.8 million in our Taiwan branch. With respect to these U.S. Dollardenominated net liabilities as of December 31, 2018, if exchange rates of RMB and NT dollars for U.S. dollars were 1%higher during the year ended December 31, 2018, our other operating expenses would have been reduced by $0.3 million.Any significant revaluation of the RMB and NT dollars may materially and adversely affect the cash flows, revenues, and netincome as reported in U.S. Dollars. We currently do not use derivative financial instruments to mitigate this exposure. We continue to review this issueand may consider hedging certain foreign exchange risks through the use of currency forwards or options in future years. Item 8. Financial Statements and Supplementary Data The information required by this item is incorporated by reference to the consolidated financial statements andaccompanying notes set forth on pages F-1 through F-30 of this Annual Report on Form 10-K Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. Item 9A. Controls and Procedures a.Evaluation of Disclosure Controls and Procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the ExchangeAct, means controls and other procedures of a company that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported,within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicated to the company’s management, includingits principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of our disclosure controls and procedures as of December 31, 2018. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that, as of the end of the period covered in this report, our disclosurecontrols and procedures were effective. b.Management’s Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting(as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). Internal control over financial reporting is a processdesigned by, or under the supervision of, the issuer’s principal executive and principal financial officers, or personsperforming similar functions, and effected by our board of directors, management and other personnel, to provide reasonableassurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposesin accordance with generally accepted accounting principles. Internal control over financial reporting includes those policiesand procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and thatreceipts and expenditures of the Company are being made only in accordance with authorizations of management anddirectors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Becauseof its inherent limitations, internal control61 Table of Contentsover financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequate because of changes in conditions, or that ourdegree of compliance with the policies or procedures may deteriorate. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting as ofthe end of the period covered by this Annual Report on Form 10-K based on the framework in Internal Control—IntegratedFramework (2013) issued by the Committee of Sponsoring Organization of the Treadway Commission. Based on thisevaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2018. Grant Thornton LLP, the independent registered public accounting firm that audited the consolidated financialstatements included in this Annual Report on Form 10-K, has issued a report, included below, on the effectiveness of ourinternal control over financial reporting as of December 31, 2018. c.Changes in Internal Control over Financial Reporting There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under theExchange Act) identified in connection with management’s evaluation required by the Rules 13a-15(d) and 15d-15(d) underthe Exchange Act that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.62 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and ShareholdersApplied Optoelectronics, Inc.Opinion on internal control over financial reportingWe have audited the internal control over financial reporting of Applied Optoelectronics, Inc. (a Delaware corporation) andsubsidiaries (the “Company”) as of December 31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In ouropinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)(“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2018, and ourreport dated February 26, 2019 expressed an unqualified opinion on those financial statements.Basis for opinionThe Company’s management is responsible for maintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’sAnnual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’sinternal control over financial reporting based on our audit.We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Companyin accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and ExchangeCommission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained inall material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing therisk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control basedon the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe thatour audit provides a reasonable basis for our opinion.Definition and limitations of internal control over financial reportingA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and thatreceipts and expenditures of the company are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ GRANT THORNTON LLPHouston, TexasFebruary 26, 2019 63 Table of Contents Item 9B. Other Information Not applicable. 64 Table of Contents PART III Item 10. Directors, Executive Officers and Corporate Governance The information required regarding our directors is incorporated herein by reference from the information containedin our definitive Proxy Statement for the 2019 Annual Meeting of Stockholders (our “Proxy Statement”), a copy of whichwill be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year ended December31, 2018. The information required regarding our executive officers is incorporated herein by reference from the informationcontained in the section entitled “Management” in our Proxy Statement. The information required regarding Section 16(a) beneficial ownership reporting compliance is incorporated byreference from the information contained in our Proxy Statement. The information required with respect to procedures by which security holders may recommend nominees to ourboard of directors, the composition of our Audit Committee, and whether the Company has an “audit committee financialexpert”, is incorporated by reference from the information contained in our Proxy Statement. Adoption of Code of Ethics The Company has adopted a Code of Business Conduct and Ethics (the “Code”) applicable to all of our board ofdirector members, employees and executive officers, including our Chief Executive Officer (Principal Executive Officer), andChief Financial Officer (Principal Financial Officer and Principal Accounting Officer). The Company has made the Codeavailable on our website at http://www.ao-inc.com. The Company intends to satisfy the public disclosure requirements regarding (1) any amendments to the Code, or(2) any waivers under the Code given to our Principal Executive Officer, Principal Financial Officer and PrincipalAccounting Officer by posting such information on our website at www.ao-inc.com. There were no amendments to the Codeor waivers granted thereunder relating to the Principal Executive Officer, Principal Financial Officer or Principal AccountingOfficer during 2018. Item 11. Executive Compensation The information required regarding the compensation of our directors and executive officers is incorporated hereinby reference from the information contained in the sections entitled “Executive Compensation,” and “DirectorCompensation,” “Compensation Committee Report” in our Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required regarding security ownership of our 5% or greater stockholders and of our directors andmanagement is incorporated herein by reference from the information contained in the section entitled “Security Ownershipof Certain Beneficial Owners and Management” in our Proxy Statement. The information required regarding securities authorized for issuance our equity compensation plans is incorporatedherein by reference from the information contained in the section entitled “Employee Benefit Plans” in our Proxy Statement. Item 13. Certain Relationships and Related Transactions, and Director Independence The information required regarding related transactions is incorporated herein by reference from the informationcontained in our Proxy Statement. Item 14. Principal Accounting Fees and Services The information required by Part III, Item 14, regarding principal accounting fees and services is incorporated byreference from the information contained in our Proxy Statement, a copy of which will be filed with the Securities andExchange Commission within 120 days after the end of our fiscal year ended December 31, 2018.65 Table of Contents PART IV Item 15. Exhibits, Financial Statements Schedules a) (1) The consolidated financial statements are listed on the Index to Consolidated Financial Statements to thisreport beginning on page F‑1. (a)(2) Financial Statement Schedules. Financial statement schedules have been omitted, as the information requiredto be set forth therein is included in the Consolidated Financial Statements or Notes thereto appearing in this Annual Reporton Form 10-K. (a)(3) Exhibits. See the Exhibit immediately following Item 16. Form 10-K Summary of this Form 10-K.. Item 16. Form 10-K Summary None.66 Table of Contents EXHIBIT INDEX Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date3.1 Amended and Restated Certificate of Incorporation ofthe registrant, as currently in effect 10-Q 001-36083 3.1 November 14, 2013 3.2 Amended and Restated Bylaws of the registrant, ascurrently in effect 10-Q 001-36083 3.2 November 14, 2013 4.1 Common Stock Specimen 8-K 001-36083 4.1 November 14, 2016 10.1 Form of Indemnification Agreement between theregistrant each of its Directors and certain of itsExecutive Officers S-1 333-190591 10.1 August 13, 2013 10.2†2004 Incentive Share Plan S-1 333-190591 10.4 August 13, 2013 10.2.1†Form of Stock Option Agreement under 2004 IncentiveShare Plan S-1 333-190591 10.4.1 August 13, 2013 10.3†2006 Incentive Share Plan S-1 333-190591 10.5 August 13, 2013 10.3.1†First Amendment to 2006 Incentive Share Plan S-1/A 333-190591 10.5.1 August 27, 2013 10.3.2†Form of Stock Option Agreement under 2006 IncentiveShare Plan S-1 333-190591 10.5.2 August 13, 2013 10.4†Amended and Restated 2013 Equity Incentive Plan 10-K 001-36083 10.6 March 9, 2017 10.4.1†Form of Restricted Stock Award Agreement under2013 Equity Incentive Plan S-1 333-190591 10.6.1 August 13, 2013 10.4.2†Form of Restricted Stock Unit Award Agreement under2013 Equity Incentive Plan S-1 333-190591 10.6.2 August 13, 2013 10.4.3†Form of Stock Appreciation Right Award Agreementunder 2013 Equity Incentive Plan S-1 333-190591 10.6.3 August 13, 2013 10.4.4†Form of Notice of Stock Option Award and StockOption Award Agreement under 2013 Equity IncentivePlan S-1 333-190591 10.6.4 August 13, 2013 10.5†Employment Agreement regarding Change of Controlor Separation of Service between the registrant andChih-Hsiang (Thompson) Lin, dated January 28, 2007 S-1 333-190591 10.12 August 13, 2013 10.5.1†Amended and Restated Employment Agreementregarding Change of Control or Separation of Servicebetween the registrant and Chih-Hsiang (Thompson)Lin, dated April 16, 2013 S-1 333-190591 10.12.1 August 13, 2013 10. 6†Employment Agreement, dated August 5, 2016,between Applied Optoelectronics, Inc. and Stefan J.Murry 10-Q/A 001-36083 10.20 August 9, 2016 10.7†Employment Agreement, dated August 5, 2016,between Applied Optoelectronics, Inc. and Mr. JoshuaYeh 10-Q/A 001-36083 10.21 August 9, 2016 10.8†Employment Agreement, dated August 5, 2016,between Applied Optoelectronics, Inc. and Dr. FredChang 10-Q/A 001-36083 10.22 August 9, 2016 10.9†Employment Agreement, dated August 5, 2016,between Applied Optoelectronics, Inc. and David C.Kuo 10-K 001-36083 10.9 February 28, 201867 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.10 Translation of Chinese form of RMB Working CapitalLoan Agreement between the Global Technology Inc.and China Construction Bank 10-K 001-36083 10.11.13 March 6, 2014 10.11 Translation of Chinese form of USD Trust ReceiptLoan Agreement between Global Technology Inc. andChina Construction Bank 10-K 001-36083 10.12 March 6, 2014 10.12 Translation of Lease Agreement dated April 1, 2014between the Company and Taiwan Asset ManagementCorporation for office and manufacturing space at No.18, Gong 4th Rd., Gong’er Industrial Park, LinkouDistrict, New Taipei City 244, Taiwan (R.O.C.) 8-K 001-36083 1.01 April 7, 2014 10.13 Construction Loan Agreement, dated January 26, 2015,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.1 January 30, 2015 10.13.1 Commercial Security Agreement, dated January 26,2015, between Applied Optoelectronics, Inc. and EastWest Bank 8-K 001-36083 10.2 January 30, 2015 10.13.2 Promissory Note, dated January 26, 2015, betweenApplied Optoelectronics, Inc. and East West Bank 8-K 001-36083 10.3 January 30, 2015 10.14 Translation of Comprehensive Credit Line Contract andGeneral Agreement, dated April 1, 2015, betweenApplied Optoelectronics, Inc., Taiwan Branch, andChina Construction Bank, Taipei Branch 8-K 001-36083 10.1 April 7, 2015 10.14.1 Translation of Approval Notice of China ConstructionBank, Taipei Branch 8-K 001-36083 10.2 April 7, 2015 10.15 Translation of Purchase and Sale Contract betweenApplied Optoelectronics, Inc., Taiwan Branch, andChailease Finance Co., Ltd. 8-K 001-36083 10.1 June 2, 2015 10.15.1 Translation of Finance Lease Agreement betweenApplied Optoelectronics, Inc., Taiwan Branch, andChailease Finance Co., Ltd. 8-K 001-36083 10.2 June 2, 2015 10.16 Credit Agreement, dated June 30, 2015, among AppliedOptoelectronics, Inc., East West Bank and ComericaBank 8-K 001-36083 10.1 July 7, 2015 10.16.1 Security Agreement, dated June 30, 2015, amongApplied Optoelectronics, Inc., East West Bank andComerica Bank 8-K 001-36083 10.2 July 7, 2015 10.16.2 Patent Security Agreement, dated June 30, 2015,among Applied Optoelectronics, Inc., East West Bankand Comerica Bank 8-K 001-36083 10.3 July 7, 2015 10.16.3 Trademark Security Agreement, dated June 30, 2015,among Applied Optoelectronics, Inc., East West Bankand Comerica Bank 8-K 001-36083 10.4 July 7, 2015 10.16.4 East West Bank Promissory Note, dated June 30, 2015,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.5 July 7, 2015 10.16.5 Comerica Bank Promissory Note, dated June 30, 2015,between Applied Optoelectronics, Inc. and ComericaBank 8-K 001-36083 10.6 July 7, 201568 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.16.6 2 Lien Construction Deed of Trust, dated June 30,2015, among Applied Optoelectronics, Inc., East WestBank and Comerica Bank 8-K 001-36083 10.7 July 7, 2015 10.17 Translation of Purchase and Sale Contract betweenApplied Optoelectronics, Inc., Taiwan Branch, andChailease Finance Co., Ltd. 8-K 001-36083 10.1 July 7, 2015 10.17.1 Translation of Finance Lease Agreement andPromissory Note between Applied Optoelectronics,Inc., Taiwan Branch, and Chailease Finance Co., Ltd. 8-K 001-36083 10.2 July 7, 2015 10.18 Office Lease Agreement between AppliedOptoelectronics, Inc. and GIG VAOI Breckinridge,LLC dated November 5, 2015 10-Q 001-36083 10.1 November 9, 2015 10.19 Translation of Purchase and Sale Contract, FinanceLease Agreement and Promissory Note betweenApplied Optoelectronics, Inc., Taiwan Branch, andChailease Finance Co., Ltd. 8-K 001-36083 10.1 April 6, 2016 10.20 Translation of the General Crediting Agreement, datedApril 8, 2016, between Applied Optoelectronics, Inc.and E. Sun Commercial Bank Co., Ltd. 8-K 001-36083 10.1 April 14, 2016 10.20.1 Translation of the Promissory Note, dated April 8,2016, between Applied Optoelectronics, Inc. and E.Sun Commercial Bank Co., Ltd. 8-K 001-36083 10.2 April 14, 2016 10.20.2 Translation of Loan Approval Notice by E. SunCommercial Bank Co., Ltd. 8-K 001-36083 10.3 April 14, 2016 10.21 Translation of Comprehensive Credit Line Contract andGeneral Agreement, dated April 22, 2016, betweenApplied Optoelectronics, Inc., Taiwan Branch, andChina Construction Bank, Taipei Branch 8-K 001-36083 10.1 April 28, 2016 10.21.1 Translation of Approval Notice of China ConstructionBank, Taipei Branch, dated March 29, 2016 8-K 001-36083 10.2 April 28, 2016 10.21.2 Translation of the Promissory Note, dated April 22,2016 between China Construction Bank – TaipeiBranch and Applied Optoelectronics, Inc., TaiwanBranch 8-K 001-36083 10.3 April 28, 2016 10.22 Change in Terms Agreement, dated June 14, 2016,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.1 June 17, 2016 10.22.1 Notice of Final Agreement, dated June 14, 2016,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.2 June 17, 2016 10.22.2 Modification to the Construction Loan Agreement,dated June 14, 2016, between Applied Optoelectronics,Inc. and East West Bank 8-K 001-36083 10.3 June 17, 2016 10.23 First Amendment to Credit Agreement and LimitedConsent, dated June 24, 2016, between AppliedOptoelectronics, Inc., East West Bank and ComericaBank 8-K 001-36083 10.1 June 30, 201669 ndTable of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.23.1 $17,500,000 Amended and Restated Revolving CreditNote, dated June 24, 2016, between AppliedOptoelectronics, Inc. and Comerica Bank 8-K 001-36083 10.2 June 30, 2016 10.23.2 $2,500,000 Amended and Restated Revolving CreditNote, dated June 24, 2016, between AppliedOptoelectronics, Inc. and Comerica Bank 8-K 001-36083 10.3 June 30, 2016 10.23.3 $5,000,000 Amended and Restated Term Note, datedJune 24, 2016, between Applied Optoelectronics, Inc.and Comerica Bank 8-K 001-36083 10.4 June 30, 2016 10.23.4 $5,000,000 Term Note, dated June 24, 2016, betweenApplied Optoelectronics, Inc. and Comerica Bank 8-K 001-36083 10.5 June 30, 2016 10.23.5 $17,500,000 Amended and Restated Revolving CreditNote, dated June 24, 2016, between AppliedOptoelectronics, Inc. and East West Bank 8-K 001-36083 10.6 June 30, 2016 10.23.6 $2,500,000 Amended and Restated Revolving CreditNote, dated June 24, 2016, between AppliedOptoelectronics, Inc. and East West Bank 8-K 001-36083 10.7 June 30, 2016 10.23.7 $5,000,000 Amended and Restated Term Note, datedJune 24, 2016, between Applied Optoelectronics, Inc.and East West Bank 8-K 001-36083 10.8 June 30, 2016 10.23.8 $5,000,000 Term Note, dated June 24, 2016, betweenApplied Optoelectronics, Inc. and East West Bank 8-K 001-36083 10.9 June 30, 2016 10.23.9 First Modification to Promissory Note, dated June 24,2016, between Applied Optoelectronics, Inc. and EastWest Bank 8-K 001-36083 10.10 June 30, 2016 10.24 Change in Terms Agreement, dated October 5, 2016,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.1 October 7, 2016 10.24.1 Notice of Final Agreement, dated October 5, 2016,between Applied Optoelectronics, Inc. and East WestBank 8-K 001-36083 10.2 October 7, 2016 10.24.2 Second Modification to the Construction LoanAgreement, dated October 5, 2016, between AppliedOptoelectronics, Inc. and East West Bank 8-K 001-36083 10.3 October 7, 2016 10.25 Translation of Early Termination Agreement, datedJanuary 25, 2017, between Applied Optoelectronics,Inc. and Chailease Finance Company, Ltd. 8-K 001-36083 10.1 January 30, 2017 10.26 Loan Agreement, dated September 28, 2017, betweenApplied Optoelectronics, Inc. and Branch Banking andTrust Company 8-K 001-36083 10.1 October 4, 2017 10.26.1 Promissory Note, dated September 28, 2017, betweenApplied Optoelectronics, Inc. and Branch Banking andTrust Company 8-K 001-36-83 10.2 October 4, 2017 10.26.2 Addendum to the Promissory Note, dated September28, 2017, between Applied Optoelectronics, Inc. andBranch Banking and Trust Company 8-K 001-36-83 10.3 October 4, 201770 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.26.3 BB&T Security Agreement, dated September 28, 2017,between Applied Optoelectronics, Inc. and BranchBanking and Trust Company 8-K 001-36083 10.4 October 4, 2017 10.26.4 Trademark Security Agreement, dated September 28,2017, between Applied Optoelectronics, Inc. andBranch Banking and Trust Company 8-K 001-36083 10.5 October 4, 2017 10.26.5 Patent Security Agreement, dated September 28, 2017,between Applied Optoelectronics, Inc. and BranchBanking and Trust Company 8-K 001-36083 10.6 October 4, 2017 10.27 Translation of Early Termination Agreement, datedOctober 5, 2017, between Prime World InternationalHoldings Ltd., and Chailease Finance Co., Ltd. 8-K 001-36083 10.1 October 11, 2017 10.28 Supply Agreement, effective November 8, 2017,between Applied Optoelectronics, Inc. and Facebook,Inc. 8-K 001-36083 10.1 February 24, 2018 10.29 Master Purchase Agreement, effective January 2, 2018,between Applied Optoelectronics, Inc. and Facebook,Inc. 8-K 001-36083 10.2 February 21, 2018 10.30 Translation of Lease Agreement between GlobalTechnology, Inc. and the People’s Republic of China inZhejiang Province, Ningbo City, Land ResourcesBureau 10-K 001-36083 10.30 February 28, 2018 10.30.1 Translation of Investment and Construction Agreementbetween Global Technology, Inc. and the People’sRepublic of China in Zhejiang Province, Ningbo City,Land Resources Bureau 10-K 001-36083 10.30.1 February 28, 2018 10.31 Translation of Construction Agreement between GlobalTechnology, Inc. and Zhejiang Xinyu ConstructionGroup Co., Ltd. dated February 8, 2018 10-Q 001-36083 10.5 May 8, 2018 10.32 First Amendment to Loan Agreement, dated March 30,2018, between Applied Optoelectronics, Inc. andBranch Banking and Trust Company 8-K 001-36083 10.1 April 5, 2018 10.32.1 Addendum to the Promissory Note ($60 million), datedMarch 30, 2018, between Applied Optoelectronics, Inc.and Branch Banking and Trust Company 8-K 001-36083 10.2 April 5, 2018 10.32.2 Promissory Note ($26 million), dated March 30, 2018,between Applied Optoelectronics, Inc. and BranchBanking and Trust Company 8-K 001-36083 10.3 April 5, 2018 10.32.3 Addendum to the Promissory Note ($26 million), datedMarch 30, 2018, between Applied Optoelectronics, Inc.and Branch Banking and Trust Company 8-K 001-36083 10.4 April 5, 2018 10.32.4 Promissory Note ($21.5 million), dated March 30,2018, between Applied Optoelectronics, Inc. andBranch Banking and Trust Company 8-K 001-36083 10.5 April 5, 201871 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.32.5 Addendum to the Promissory Note ($21.5 million),dated March 30, 2018, between AppliedOptoelectronics, Inc. and Branch Banking and TrustCompany 8-K 001-36083 10.6 April 5, 2018 10.32.6 Note Modification Agreement, dated March 30, 2018,between Applied Optoelectronics, Inc. and BranchBanking and Trust Company 8-K 001-36083 10.7 April 5, 2018 10.32.7 Assignment of Lease and Rent, dated March 30, 2018,between Applied Optoelectronics, Inc. and BranchBanking and Trust Company 8-K 001-36083 10.8 April 5, 2018 10.32.8 Texas Deed of Trust and Security Agreement, datedMarch 30, 2018, between Applied Optoelectronics, Inc.and Branch Banking and Trust Company 8-K 001-36083 10.9 April 5, 2018 10.32.9 Environmental Certification and Indemnity Agreement,dated March 30, 2018, between AppliedOptoelectronics, Inc. and Branch Banking and TrustCompany 8-K 001-36083 10.10 April 5, 2018 10.33 Translation of the Approval Notice of Credit Line,dated June 12, 2018 8-K 001-36083 10.1 June 25, 2018 10.33.1 Translation of the Credit Facility Agreement, dated June19, 2018, between Prime World International HoldingsLtd. and Taishin International Bank (filed as Exhibit10.2 to the Registrant’s Current Report on Form 8-Kfiled with the Securities and Exchange Commission onJune 25, 2018) 8-K 001-36083 10.2 June 25, 2018 10.33.2 Translation of the Agreement on Providing Collateral,dated June 19, 2018, between Prime WorldInternational Holdings Ltd., and Taishin InternationalBank (filed as Exhibit 10.3 to the Registrant’s CurrentReport on Form 8-K filed with the Securities andExchange Commission on June 25, 2018) 8-K 001-36083 10.3 June 25, 2018 10.33.3 Translation of the NT$300 Million Promissory Note,dated June 19, 2018, between Prime WorldInternational Holdings Ltd. and Taishin InternationalBank (filed as Exhibit 10.4 to the Registrant’s CurrentReport on Form 8-K filed with the Securities andExchange Commission on June 25, 2018) 8-K 001-36083 10.4 June 25, 2018 10.33.4 Translation of the Maximum Loan (Credit Line)Agreement, dated September 21, 2018, between GlobalTechnology, Inc. and China Construction Bank Co.,Ltd. 8-K 001-36083 10.1 September 27, 2018 10.33.5 Translation of the Security Agreement, dated September21, 2018, between Global Technology, Inc. and ChinaConstruction Bank Co., Ltd. 8-K 001-36083 10.2 September 27, 2018 10.34 Letter of Offer, dated July 26, 2018, between PrimeWorld International Holdings, Ltd. and theDevelopment Bank of Singapore (Taiwan) Ltd. 8-K 001-36083 10.1 October 9, 201872 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 10.34.1 Conditions Governing Facilities Granted by andTransactions Entered into with DBS Bank (Taiwan)Ltd., dated October 3, 2018, between Prime WorldInternational Holdings Ltd. and the Development Bankof Singapore (Taiwan) Ltd. 8-K 001-36083 10.2 October 9, 2018 10.35 First Amendment to Lease, dated October 8, 2018,between Applied Optoelectronics, Inc. and GIG VAOIBreckinridge, LLC. 8-K 001-36083 10.1 October 12, 2018 10.36 Translation of Purchase and Sale Contract, FinanceLease Agreement and Promissory Note between, PrimeWorld International Holdings, Ltd., and ChaileaseFinance Co., Ltd. 8-K 001-36083 10.1 December 6, 2018 10.37 Translation of Agreement for Individually NegotiatedTerms and Conditions between, Prime WorldInternational Holdings, Ltd., and CTBC Bank, Ltd. 8-K 001-36083 10.1 December 17, 2018 10.37.1 Translation of Approval Notice between, Prime WorldInternational Holdings, Ltd., and CTBC Bank, Ltd. 8-K 001-36083 10.2 December 17, 2018 10.37.2 Translation of General Agreement for Omnibus CreditLines between, Prime World International Holdings,Ltd., and CTBC Bank, Ltd. 8-K 001-36083 10.3 December 17, 2018 10.37.3 Translation of Promissory Note between, Prime WorldInternational Holdings, Ltd., and CTBC Bank, Ltd. 8-K 001-36083 10.4 December 17, 2018 10.38 Translation of Purchase and Sale Contract, FinanceLease Agreement and Promissory Note between, PrimeWorld International Holdings, Ltd. and ChaileaseFinance Co., Ltd. 8-K 001-36083 10.1 January 25, 2019 10.39 Second Amendment to Loan Agreement, datedFebruary 1, 2019, between Applied Optoelectronics,Inc. and Branch Banking and Trust Company 8-K 001-36083 10.1 February 7, 2019 23.1*Consent of Grant Thornton LLP 24.1 Power of Attorney (see the signature page in thisAnnual Report on Form 10-K). 31.1*Certification of Principal Executive Officer RequiredUnder Rule 13a-14(a) and 15d-14(a) of the SecuritiesExchange Act of 1934, as amended, as adoptedpursuant to Section 302 of The Sarbanes-Oxley Act of2002. 31.2*Certification of Principal Financial Officer RequiredUnder Rule 13a-14(a) and 15d-14(a) of the SecuritiesExchange Act of 1934, as amended, as adoptedpursuant to Section 302 of The Sarbanes-Oxley Act of2002. 73 Table of Contents Incorporated By ReferenceNumber Exhibit Description Form File No. Exhibit Filing Date 32.1*Certification of Principal Executive Officer andPrincipal Financial Officer Required Under Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of1934, as amended, and 18 U.S.C. §1350 as adoptedpursuant to Section 906 of The Sarbanes-Oxley Act of2002. 101.INS XBRL Instance Document 101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Extension Calculation LinkbaseDocument 101.DEF XBRL Taxonomy Extension Definition LinkbaseDocument 101.LAB XBRL Taxonomy Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation LinkbaseDocument * Filed herewith.† Management contract, compensatory plan or arrangement. 74 Table of Contents SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this Form 10-K to be signed on itsbehalf by the undersigned, thereunto duly authorized, on February 26, 2019. APPLIED OPTOELECTRONICS, INC. By:/s/ CHIH-HSIANG (THOMPSON) LIN Chih-Hsiang (Thompson) Lin, President and Chief Executive Officer and Chairman of the Board of DirectorsFebruary 26, 2019 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Chih-Hsiang(Thompson) Lin and Stefan J. Murry, and each of them, jointly and severally, his attorneys-in-fact, each with the power of substitution, for himin any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto andother documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of saidattorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities and Exchange Act of 1934, this Form 10-K has been signed by the following persons on behalf ofthe registrant and in the capacities and on the dates indicated. SignatureDate /s/ CHIH-HSIANG (THOMPSON) LIN CHIH-HSIANG (THOMPSON) LIN, President, Chief Executive Officer andFebruary 26, 2019Chairman of the Board of Directors (principal executive officer) /s/ STEFAN J. MURRY STEFAN J. MURRY,Chief Financial OfficerFebruary 26, 2019(principal financial officer and principal accounting officer) SignatureDate /s/ WILLIAM H. YEH WILLIAM H. YEH,February 26, 2019Director /s/ RICHARD B. BLACK RICHARD B. BLACK,February 26, 2019Director /s/ CHE-WEI LIN CHE-WEI LIN,February 26, 2019Director /s/ ALEX IGNATIEV ALEX IGNATIEV,February 26, 2019Director /s/ ALAN MOORE ALAN MOORE,February 26, 2019Director /s/ MIN-CHU (MIKE) CHEN MIN-CHU (MIKE) CHEN,February 26, 2019Director 75 Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Pages Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Comprehensive Income (Loss) F-5 Consolidated Statements of Stockholders’ Equity F-6 Consolidated Statements of Cash Flows F-7 Notes to Consolidated Financial Statements F-8 F - 1 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and ShareholdersApplied Optoelectronics, Inc.Opinion on the financial statementsWe have audited the accompanying consolidated balance sheets of Applied Optoelectronics, Inc. (a Delaware corporation)and subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of operations,comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period endedDecember 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financialstatements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017,and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, inconformity with accounting principles generally accepted in the United States of America.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)(“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria establishedin the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”), and our report dated February 26, 2019 expressed an unqualified opinion.Basis for opinionThese financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinionon the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB andare required to be independent with respect to the Company in accordance with the U.S. federal securities laws and theapplicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether dueto error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financialstatements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures includedexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits alsoincluded evaluating the accounting principles used and significant estimates made by management, as well as evaluating theoverall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion./s/ GRANT THORNTON LLPWe have served as the Company’s auditor since 2008. Houston, TexasFebruary 26, 2019 F - 2 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesCONSOLIDATED BALANCE SHEETS(in thousands, except per share data) December 31, 2018 2017 ASSETS Current Assets Cash and cash equivalents $55,646 $82,936 Restricted cash 2,358 1,012 Short-term investments — 36 Accounts receivable - trade, net of allowance of $32 and $33, respectively 30,534 59,850 Inventories 93,256 75,768 Prepaid income tax 1,188 1,394 Prepaid expenses and other current assets 11,293 8,665 Total current assets 194,275 229,661 Property, plant and equipment, net 234,211 197,943 Land use rights, net 5,814 804 Intangible assets, net 3,977 4,007 Deferred income tax assets 21,714 12,801 Other assets, net 6,849 7,732 TOTAL ASSETS $466,840 $452,948 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portion of notes payable and long-term debt $23,589 $559 Accounts payable 29,910 43,624 Bank acceptance payable 4,628 — Accrued income taxes — 7,422 Accrued liabilities 19,291 19,103 Total current liabilities 77,418 70,708 Notes payable and long-term debt, less current portion 60,328 48,964 TOTAL LIABILITIES 137,746 119,672 Stockholders' equity: Preferred Stock; 5,000 shares authorized at $0.001 par value; no shares issued andoutstanding at December 31, 2018 and December 31, 2017, respectively — — Common Stock; 45,000 shares authorized at $0.001 par value; 19,810 and 19,451 sharesissued and outstanding at December 31, 2018 and December 31, 2017, respectively 20 19 Additional paid-in capital 292,480 285,376 Accumulated other comprehensive income 602 9,743 Retained earnings 35,992 38,138 TOTAL STOCKHOLDERS' EQUITY 329,094 333,276 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $466,840 $452,948 The accompanying notes are an integral part of these consolidated financial statements.F - 3 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except share and per share data) Year ended December 31, 2018 2017 2016 Revenue, net $267,465 $382,329 $260,713 Cost of goods sold 179,692 216,049 173,759 Gross profit 87,773 166,280 86,954 Operating expenses Research and development 49,903 35,365 31,780 Sales and marketing 9,141 8,702 6,627 General and administrative 39,497 35,262 25,527 Total operating expenses 98,541 79,329 63,934 Income (loss) from operations (10,768) 86,951 23,020 Other income (expense) Interest income 282 221 247 Interest expense (1,106) (858) (1,717) Other income (expense), net 1,814 (1,788) (547) Total other income (expense), net 990 (2,425) (2,017) Income (loss) before income taxes (9,778) 84,526 21,003 Income tax (expense) benefit 7,632 (10,575) 10,231 Net income (loss) $(2,146) $73,951 $31,234 Net income (loss) per share Basic $(0.11) $3.87 $1.82 Diluted $(0.11) $3.67 $1.76 Weighted average shares used to compute net income (loss) pershare: Basic 19,646,646 19,097,355 17,201,731 Diluted 19,646,646 20,139,105 17,712,928 The accompanying notes are an integral part of these consolidated financial statements.F - 4 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)(in thousands) Year ended December 31, 2018 2017 2016 Net income (loss) $(2,146) $73,951 $31,234 Gain (loss) on foreign currency translation adjustment (9,141) 10,628 (1,177) Comprehensive income (loss) $(11,287) $84,579 $30,057 The accompanying notes are an integral part of these consolidated financial statements. F - 5 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYYears ended December 2016, 2017 and 2018(in thousands) Accumulated Retained Preferred Stock Common Stock Additional other earnings/ Number Number paid-in comprehensive (Accumulated Stockholders' of shares Amount of shares Amount capital gain (loss) deficit) equity January 1, 2016 — $ — 16,839 $17 $233,336 $292 $(68,247) $165,398 Public offering of common stock, net — — 1,126 1 27,236 — — 27,237 Issuance of shares under equity plans — — 276 — — — — — Stock options exercised — — 159 — 859 — — 859 Share-based compensation — — — — 3,833 — — 3,833 Net income — — — — — — 31,234 31,234 Loss on foreign currency translation adjustment — — — — — (1,177) — (1,177) Other — — — — — — — — December 31, 2016 — $ — 18,400 $18 $265,264 $(885) $(37,013) $227,384 Public offering of common stock, net — — 459 1 21,571 — — 21,572 Stock options exercised, net of shares withheld for employee tax — — 418 — (6,630) — — (6,630) Issuance of restricted stock, net of shares withheld for employee tax — — 174 — (2,631) — — (2,631) Share-based compensation — — — — 7,795 — — 7,795 Cumulative effect of previously unrecognized tax benefits — — — — — — 1,207 1,207 Net income — — — — — — 73,951 73,951 Foreign currency translation adjustment — — — — — 10,628 — 10,628 December 31, 2017 — $ — 19,451 $19 $285,376 $9,743 $38,138 $333,276 Stock options exercised, net of shares withheld for employee tax — — 121 — (2,073) — — (2,073) Issuance of restricted stock, net of shares withheld for employee tax — — 238 1 (1,943) — — (1,942) Share-based compensation — — — — 11,120 — — 11,120 Foreign currency translation adjustment — — — — — (9,141) — (9,141) Net loss — — — — — — (2,146) (2,146) December 31, 2018 — $ — 19,810 $20 $292,480 $602 $35,992 $329,094 The accompanying notes are an integral part of these consolidated financial statements. F - 6 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Year ended December 31, 2018 2017 2016 Operating activities: Net income (loss) $(2,146) $73,951 $31,234 Adjustments to reconcile net income to net cash provided by operating activities: Lower of cost or market reserve adjustment to inventory 7,166 1,866 3,707 Depreciation and amortization 29,698 20,381 14,188 Amortization of debt issuance costs 42 81 — Deferred income taxes, net (8,964) (114) (11,426) Loss (gain) on disposal of assets 7 97 126 Share-based compensation 11,120 7,795 3,833 Unrealized foreign exchange gain (548) 330 (937) Changes in operating assets and liabilities: Accounts receivable, trade 29,316 (10,080) (11,147) Prepaid income tax 230 (1,386) — Inventories (28,403) (21,876) 10,207 Other current assets (2,939) (4,266) 4,119 Accounts payable (13,714) 7,249 9,105 Accrued income taxes (7,390) 6,204 988 Accrued liabilities 554 4,052 3,107 Net cash provided by operating activities 14,029 84,284 57,104 Investing activities: Maturities of short-term investments 36 8 7,752 Purchase of property, plant and equipment (71,854) (66,968) (49,442) Purchase of land use rights (5,591) — — Proceeds from disposal of equipment 697 171 14 Deposits and prepaid for equipment 674 (2,871) 688 Purchase of intangible assets (476) (499) (547) Net cash used in investing activities (76,514) (70,159) (41,535) Financing activities: Proceeds from issuance of notes payable and long-term debt, net of debt issuance costs 47,849 — 28,858 Principal payments of long-term debt and notes payable (3,133) (42,758) (5,855) Proceeds from line of credit borrowings 155,078 88,003 117,172 Repayments of line of credit borrowings (165,569) (39,003) (163,068) Proceeds from bank acceptance payable 4,595 — 5,850 Repayments of bank acceptance payable — (309) (8,398) Repayments of note payable — — (1,000) Exercise of stock options 120 1,460 859 Payments of tax withholding on behalf of employees related to share-based compensation (4,137) (10,721) — Proceeds from common stock offering, net — 21,572 27,237 Net cash provided by financing activities 34,803 18,244 1,655 Effect of exchange rate changes on cash 1,738 (385) 1,947 Net increase (decrease) in cash, cash equivalents and restricted cash (25,944) 31,984 19,171 Cash, cash equivalents and restricted cash at beginning of period 83,948 51,964 32,793 Cash, cash equivalents and restricted cash at end of period $58,004 $83,948 $51,964 Supplemental disclosure of cash flow information: Cash paid for: Interest $848 $872 $1,689 Income taxes 8,470 5,835 (12) Non-cash investing and financing activities: Net change in accounts payable related to property and equipment additions $(1,151) $4,582 $– The accompanying notes are an integral part of these consolidated financial statements.F - 7 Table of ContentsApplied Optoelectronics, Inc. and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A—ORGANIZATION AND OPERATIONS Applied Optoelectronics, Inc. (“AOI” or the “Company”) was incorporated in the State of Texas on February 28,1997. In March 2013, the Company converted into a Delaware corporation. The Company is a leading, vertically integratedprovider of fiber-optic networking products, primarily for four networking end-markets: internet data center, cable television,telecommunications and fiber-to-the-home. The Company designs and manufactures a wide range of optical communicationsproducts 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. Atits corporate headquarters and manufacturing facilities in Sugar Land, Texas, the Company primarily manufactures lasers andlaser components and performs research and development activities for laser component and optical module products. TheCompany operates in Taipei, Taiwan and Ningbo, China through its wholly-owned subsidiary Prime World InternationalHoldings, Ltd. (“Prime World”, incorporated in the British Virgin Islands). Prime World is the parent of Global Technology,Inc. (“Global”, incorporated in the People’s Republic of China). Through Global, the Company primarily manufacturescertain of its data center transceiver products, including subassemblies and transceivers, as well as Cable TV Broadband(“CATV”) systems and equipment, and performs research and development activities for the CATV products. Prime Worldalso operates a branch in Taiwan, which primarily manufactures transceivers. The Company also has a research anddevelopment center in Duluth, Georgia. NOTE B—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. Basis of Presentation The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiariesand are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Allintercompany balances and transactions have been eliminated in consolidation. 2. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates andassumptions that affect the amounts reported. Actual results could differ from those estimates in the consolidated financialstatements and accompanying notes. Significant estimates and assumptions that impact these financial statements relate to,among other things, allowance for doubtful accounts, inventory reserve, product warranty costs, share-based compensationexpense, estimated useful lives of property and equipment, and taxes. 3. Foreign Currency Translation The functional currency for the Company’s foreign operations is the local currency. The assets and liabilities ofthese operations are translated at the rate of exchange in effect on the balance sheet date and sales and expenses are translatedat monthly average rates. The resulting gains or losses from translation are included in a separate component of othercomprehensive income. There is no tax effect on the foreign currency translation because it is management’s intent toreinvest the undistributed earnings of its foreign subsidiaries indefinitely. Transaction gains and losses resulting from re-measuring monetary asset and liability accounts that are denominated in a currency other than a subsidiary’s functionalcurrency are included in net foreign exchange gain and loss and are included in net income except for those intercompanybalances that are long-term investments in nature. The translation gain or losses from the long-term investment nature ofintercompany balances are treated as translation adjustments and included in comprehensive income. 4. Fair Value The carrying value of cash, cash equivalents and short-term investments, accounts receivable, accounts payable, andnote receivable approximate their historical fair values due to their short-term maturities. The carrying value of the debtapproximates its fair value due to the short-term nature of the debt since it renews frequently at current interestF - 8 Table of Contentsrates. Management believes that the interest rates in effect at each year end represent the current market rates for similarborrowings. The fair value measurement standard defines fair value as the price that would be received to sell an asset or paid totransfer a liability in an orderly transaction between market participants at the measurement date. The standard characterizesinputs used in determining fair value according to a hierarchy that prioritized inputs based on the degree to which they areobservable. The three levels of the fair value hierarchy are as follows: Level 1—Inputs represent quoted prices in active markets for identical assets or liabilities. Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset orliability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active marketsand quoted prices for identical or similar assets or liabilities in markets that are not active. Level 3—Inputs that are not observable from objective sources, such as management’s internallydeveloped assumptions used in pricing an asset or liability. Assets and liabilities that are required to be fair valued on a recurring basis include money market funds, marketablesecurities, equity instruments and contingent consideration. Money market funds are valued with Level 1 inputs, using quoted market prices, and are included in cash and cashequivalents on the Company’s consolidated balance sheets. 5. Cash and Cash Equivalents The Company considers all highly liquid securities with an original maturity of ninety days or less from the date ofpurchase to be cash equivalents. Cash in foreign accounts was approximately $8.0 million and $21.0 million at December 31,2018 and 2017, respectively. The Company maintains cash and cash equivalents at U.S. financial institutions for which the combined accountbalances in individual institutions may exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage and, as aresult, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. As ofDecember 31, 2018, approximately $46.1 million of U.S. deposits were not covered by FDIC insurance. The Company hasnot experienced any losses and believes it is not exposed to any significant risk with such accounts. 6. Restricted Cash/Compensating Balances The Company is required to maintain a compensation deposit equal to 30% of its bank acceptance notes to vendors.The Company’s Taiwan and China subsidiaries also use time deposits for customs guarantees. As of December 31, 2018 and2017, the amount of restricted cash was $2.4 million and $1.0 million, respectively. 7. Accounts Receivable/Allowance for Doubtful Accounts The Company carries its accounts receivable at the net amount that it estimates to be collectible. An allowance foruncollectable accounts is maintained through a charge against operations. The allowance is determined by managementreview of outstanding amounts per customer, historical payments and the aging of accounts. 8. Concentration of Credit Risk and Significant Customers Financial instruments which potentially subject the Company to concentrations of credit risk include cash, cashequivalents and accounts receivable. The Company places all cash and cash equivalents with high-credit quality financialinstitutions. The Company performs ongoing credit valuations of its customers’ financial condition whenever deemed necessaryand generally does not require deposits or collateral to support customer receivables. The historical amount of losses onuncollectible accounts has been within the Company’s estimates. The Company generates much of its revenueF - 9 Table of Contentsfrom a limited number of customers. In 2018, 2017 and 2016, its top five customers represented 85.7%, 86.1% and 87.8% ofits revenue, respectively. In 2018, Facebook, Microsoft and Amazon represented 38.3%, 22.1% and 12.1% of its revenue,respectively. In 2017, Amazon, Facebook and Microsoft represented 35.4%, 28.6% and 13.8% of its revenue, respectively. In2016, Amazon, Microsoft and Arris represented 54.6%, 18.3% and 5.8% of its revenue, respectively. The five largestreceivable balances for customers represented an aggregate of 70.2%, and 82.6% of total accounts receivable at December 31,2018 and 2017, respectively. As of December 31, 2018, Microsoft, Amazon and Facebook represented 23.2%, 18.7% and12.6% of total accounts receivable, respectively. As of December 31, 2017, Amazon and Microsoft represented 36.1% and19.5% of total accounts receivable, respectively. No other customer represented greater than ten percent of revenue in 2018,2017 or 2016 or greater than ten percent of total accounts receivable at December 31, 2018 or 2017. 9. Inventories Inventories are stated at the lower of cost (average-cost method) or market. Work in process and finished goodsincludes materials, labor and allocated overhead. The Company assesses the valuation of its inventory on a periodic basisand provides write-offs for the value of estimated excess and obsolete inventory based on estimates of future demand. 10. Property, Plant and Equipment Property, plant and equipment are stated at cost, net of accumulated depreciation and amortization. The Companycalculates depreciation using the straight-line method over the following estimated useful lives: Useful lives Buildings 20 - 42 years Land improvements 10 years Machinery and equipment 2 - 20 years Furniture and fixtures 3 - 7 years Computer equipment and software 3 - 10 years Leasehold improvements The shorter of the life of the applicable lease or the useful life ofthe improvement Transportation equipment 5 years Major improvements are capitalized and expenditures for maintenance and repairs are expensed as incurred.Construction in progress represents property, plant and equipment under construction or being installed. Costs includeoriginal cost, installation, construction and other direct costs which include interest on borrowings used to finance the asset.Construction in progress is transferred to the appropriate fixed asset account and depreciation commences when the asset hasbeen substantially completed and placed in service. Land use rights allow the Company rights for 50 years to certain land in Ningbo, China on which the Company builta facility that included office space, manufacturing operations and employee dormitories. The land use rights are recorded atcost and are amortized on the straight-line basis over the useful life of the related contract. The land use rights expire onOctober 7, 2054 and December 28, 2067. 11. Intangible Assets Intangible assets consist of intellectual property that is stated at cost less accumulated amortization. As ofDecember 31, 2018, the Company had 265 total patents issued. The costs incurred to obtain such patents have beencapitalized and are being amortized over an estimated life of 20 years. The Company periodically evaluates its intangibleassets to determine whether events or changes in circumstances indicate that a patent or trademark may not be applicable tothe Company’s current products or is no longer in use. If such a determination is made, the intangible asset is impaired andthe remaining value of the patent or trademark will be expensed at that time. F - 10 Table of Contents12. Impairment of Long-Lived Assets The Company accounts for impairment of long-lived assets in accordance with Accounting Standards Codification(“ASC”) 360, Property, Plant and Equipment, (“ASC 360”). Long-lived assets consist primarily of property, plant andequipment. In accordance with ASC 360, the Company evaluates the carrying value of long-lived assets when it determines atriggering event has occurred, or whenever events or changes in circumstances indicate that the carrying amount of an assetmay not be recoverable. When indicators exist, recoverability of assets is measured by a comparison of the carrying value ofthe asset group to the estimated undiscounted future net cash flows expected to be generated by the asset. Examples of suchtriggering events include a significant disposal of a portion of such assets, an adverse change in the market involving thebusiness employing the related asset, a significant decrease in the benefits realized from an acquired business, difficulties ordelays in integrating the business, and a significant change in the operations of an acquired business. If such assets aredetermined not to be recoverable, the Company perform an analysis of the fair value of the asset group and will recognize animpairment loss when the fair value is less than the carrying amounts of such assets. The fair value, based on reasonable andsupportable assumptions and projections, require subjective judgments. Depending on the assumptions and estimates used,the appraised fair value projected in the evaluation of long-lived assets can vary within a range of outcomes. The Companyconsiders the likelihood of possible outcomes in determining the best estimate for the fair value of the assets. The Companydid not record any asset impairment charges in 2018 or 2017. 13. Comprehensive Income (Loss) ASC 220, Comprehensive Income, (“ASC 220”) establishes rules for reporting and display of comprehensive incomeand its components. ASC 220 requires that unrealized gains and losses on the Company’s foreign currency translationadjustments be included in comprehensive income (loss). 14. Share-based Compensation The Company accounts for share-based compensation in accordance with the provisions of ASC 718, Compensation—Stock Compensation. Share-based compensation expense is recognized based on the estimated grant date fair value inorder to recognize compensation cost for those shares expected to vest. Compensation cost is recognized on a straight-linebasis over the vesting period of the options and adjusted as forfeitures occur. 15. Revenue Recognition The Company derives revenue from the manufacture and sale of fiber optic networking products. Revenuerecognition follows the criteria of ASC 606, Revenue from Contracts with Customers. Specifically, the Company recognizesrevenue when obligations under the terms of a contract with its customer are satisfied; generally this occurs with the transferof control of products or services. 16. Product Warranty The Company generally offers a one-year limited warranty for its products but it can extend for longer periods ofthree to five years for certain products sold to certain customers. The Company estimates the costs that may be incurred underits basic limited warranty and records a liability for the amount of such costs at the time when product defects occur. Factorsthat affect the Company’s warranty liability include the historical and anticipated rates of warranty claims and cost to repair.While the Company believes that its warranty accrual is adequate, the actual warranty costs may exceed the accrual, cost ofsales will increase in the future. As of December 31, 2018 and 2017, the amount of accrued warranty was $1.0 million and$1.1 million, respectively. 17. Advertising Costs Advertising costs are charged to operations as incurred and amounted to approximately $0.5 million, $0.3 millionand $0.2 million for the years ended December 31, 2018, 2017 and 2016, respectively. F - 11 Table of Contents18. Research and Development Research and development costs are charged to operations as incurred. The Company receives reimbursement forcertain development costs, which are capitalized when incurred, up to the reimbursable amount. 19. Income Taxes The Company accounts for income taxes in accordance with the provisions of ASC 740, Income Taxes. The liabilitymethod is used to account for deferred income taxes. Under the liability method, deferred tax assets and liabilities aremeasured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The abilityto realize deferred tax assets is evaluated annually and a valuation allowance is provided if it is unlikely that the deferred taxassets will not give rise to future benefits in the Company’s tax returns. The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process inwhich (1) it determines whether it is more likely than not that the tax positions will be sustained on the basis of the technicalmerits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, it recognizesthe largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the relatedtax authority. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense linein the accompanying consolidated statement of operations. Accrued interest and penalties are included on the related taxliability line in the consolidated balance sheet. 20. Recent Accounting Pronouncements Recent Accounting Pronouncements Adopted in 2018 In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of AssetsOther Than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset,other than inventory, when the transfer occurs. The Company adopted the guidance on January 1, 2018, with no impact onthe financial statements. In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts withCustomers (Topic 606). The new revenue recognition guidance establishes a new control-based revenue recognition model,changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailedguidance on specific topics and expands and improves disclosures about revenue. The Company evaluated its revenues andthe new guidance had immaterial impact to recognition practices upon adoption on January 1, 2018. As part of the adoption,the Company elected to apply the new guidance on a modified retrospective basis. The Company did not record acumulative effect adjustment to retained earnings for initially applying the new guidance as no revenue recognitiondifferences were identified in the timing or amount of revenue. See Note C, "Revenue Recognition" for additionalinformation on the required disclosures related to the impact of adopting this standard. The FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition andMeasurement of Financial Assets and Financial Liabilities with further clarifications made in February 2018 with theissuance of ASU No. 2018-03. The amended guidance requires certain equity investments that are not consolidated and notaccounted for under the equity method to be measured at fair value with changes in fair value recognized in net incomerather than as a component of accumulated other comprehensive income (loss). It further states that an entity may choose tomeasure equity investments that do not have readily determinable fair values using a quantitative approach, or measurementalternative, which is equal to its cost minus impairment, if any, plus or minus changes resulting from observable pricechanges in orderly transactions for the identical or a similar investment of the same issuer. The Company adopted thisamended guidance on January 1, 2018, with no impact on its financial statements. In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC ParagraphsPursuant to SEC Staff Accounting Bulletin No. 118. ASU No. 2018-05, effective 2018, expands income tax accounting anddisclosure guidance to include SAB 118 issued by the SEC in December 2017. SAB 118 provides guidance on accountingfor the income tax effects of the U.S. Tax Cuts and Jobs Act of 2017 (the “Tax Act”) and among other things allows for ameasurement period not to exceed one year for companies to finalize the provisional amountsF - 12 Table of Contentsrecorded as of December 31, 2017. See Note M, “Income Taxes” for additional information on the Company’s accounting forthe Tax Act. In January 2018, the FASB released guidance on the accounting for tax on the global intangible low-taxed income("GILTI") provisions of the Tax Cuts and Jobs Act (the "Tax Act"). The GILTI provisions impose a tax on foreign income inexcess of a deemed return on tangible assets of foreign corporations. The guidance indicates that either accounting fordeferred taxes related to GILTI inclusions or to treat any taxes on GILTI inclusions as period cost are both acceptablemethods subject to an accounting policy election. Effective the first quarter of 2018, the Company elected to treat anypotential GILTI inclusions as a period cost as there was no material impact from GILTI inclusions. See Note M, “IncomeTaxes” for additional information on the Company’s accounting for the Tax Act Recent Accounting Pronouncements Yet to be Adopted On February 25, 2016, the FASB released ASU No. 2016-02, Leases, to complete its project to overhaul leaseaccounting. The ASU codifies ASC 842, Leases, which will replace the guidance in ASC 840. The new standard establishes aright-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leaseswith a term longer than 12 months. The guidance is effective for public business entities in fiscal years beginning afterDecember 15, 2018. The Company expects to adopt the new standard on January 1, 2019 and has elected to recognize acumulative effect adjustment to the beginning balance sheet of retained earnings in the period of adoption pursuant to ASU2018-11. The Company expects to use the package of practical expedients that allows it not reassess under the new standardits prior conclusion about lease identification, lease classifications and initial indirect costs. The Company will adopt thisASU on January 1, 2019 with a cumulative adjustment to retained earnings. The Company believes the most significanteffects relate to the recognition of new ROU assets and lease liabilities on its balance sheet for its Taiwan branch. Uponadoption, the Company expects to recognize additional operating liabilities in approximately $10.3 million, withcorresponding ROU assets of approximately $9.3 million based on the present value of the remaining minimum rentalpayments under the current leasing standards for existing operating leases. The Company has additionally assessed theimpact of Topic 842 on its internal controls over financial reporting. In June 2016, the FASB issued ASU 2016-13 Financial Instruments - Credit Losses, Measurement of Credit Losseson Financial Instruments, which changes the way entities measure credit losses for most financial assets and certain otherinstruments that are not measured at fair value through net earnings. The new standard is effective for annual periodsbeginning after December 15, 2019, including interim periods within those annual periods. The Company is evaluating theimpact the adoption of the new standard will have on its consolidated financial statements and related disclosures. NOTE C—REVENUE RECOGNITION Revenue from Contracts with Customers On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method. Under the modifiedretrospective method, the Company did not record a cumulative effect adjustment to retained earnings for initially applyingthe new guidance as no revenue recognition differences were identified in the timing or amount of revenue. Results forreporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjustedand continue to be reported in accordance with its historic accounting under Revenue Recognition ("Topic 605"). The adoption of Topic 606 represents a change in accounting principle that will provide financial statement readerswith enhanced revenue recognition disclosures. In accordance with Topic 606, revenue is recognized when obligations underthe terms of a contract with its customer are satisfied; generally this occurs with the transfer of control of products or services.Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products orproviding services. Certain customers may receive cash and/or non-cash incentives, which are accounted for as variableconsideration. To achieve this core principle, the Company applies the following five steps:F - 13 Table of Contents 1. Identify the contract with a customer A contract with a customer exists when (i) the Company enters into an agreement with a customer that defines eachparty's rights regarding the products or services to be transferred and identifies the payment terms related to these products orservices, (ii) both parties to the contract are committed to perform their respective obligations, (iii) the contract hascommercial substance, and (iv) the Company determines that collection of substantially all consideration for products orservices that are transferred is probable based on the customer's intent and ability to pay the promised consideration. TheCompany applies judgment in determining the customer's ability and intention to pay, which is based on a variety of factorsincluding the customer's payment history or, in the case of a new customer, published credit and financial informationpertaining to the customer. 2. Identify the performance obligations in the contract Performance obligations promised in a contract are identified based on the products or services that will betransferred to the customer that are both capable of being distinct, whereby the customer can benefit from the product orservice either on its own or together with other resources that are readily available from third parties or from the Company,and are distinct in the context of the contract, whereby the transfer of the products or services is separately identifiable fromother promises in the contract. To the extent a contract includes multiple promised products or services, the Company mustapply judgment to determine whether promised products or services are capable of being distinct and distinct in the contextof the contract. If these criteria are not met, the promised products or services are accounted for as a combined performanceobligation. The Company has elected to account for shipping and handling activities as a fulfillment cost as permitted by thestandard. 3. Determine the transaction price The transaction price is determined based on the consideration to which the Company will be entitled in exchangefor transferring products or services to the customer. To the extent the transaction price is variable, revenue is recognized atan amount equal to the consideration to which the Company expects to be entitled. This estimate includes customer salesincentives which are accounted for as a reduction to revenue and estimated using either the expected value method or themost likely amount method, depending on the nature of the program. The Company will adjust its consideration for anyrebates if it is more likely than not that the rebate conditions will be met. 4. Allocate the transaction price to performance obligations in the contract If the contract contains a single performance obligation, the entire transaction price is allocated to the singleperformance obligation. Contracts that contain multiple performance obligations require an allocation of the transactionprice to each performance obligation based on a relative standalone selling price basis unless a portion of the variableconsideration related to the contract is allocated entirely to a performance obligation. The Company determines standaloneselling price based on the price at which the performance obligation is sold separately. 5. Recognize revenue when or as the Company satisfies a performance obligation The Company generally satisfies performance obligations at a point in time. Revenue is recognized based on thetransaction price at the time the related performance obligation is satisfied by transferring a promised product or service to acustomer. Disaggregation of Revenue Revenue is classified based on the location of where the product is manufactured. For additional information on thedisaggregated revenues by geographical region, see Note P, "Segments and Geographic Information.” F - 14 Table of ContentsRevenue is also classified by major product category and is presented below (in thousands): Years ended December 31, 2018 % ofRevenue 2017 % ofRevenue 2016 % ofRevenueData Center $200,236 74.9% $306,712 80.2% $201,314 77.2%CATV 51,699 19.3% 60,756 15.9% 43,567 16.7%Telecom 13,159 4.9% 12,899 3.4% 12,938 5.0%FTTH 818 0.3% 490 0.1% 1,567 0.6%Other 1,553 0.6% 1,472 0.4% 1,327 0.5%Total Revenue $267,465 100.0% $382,329 100.0% $260,713 100.0% NOTE D—CASH, CASH EQUIVALENTS AND RESTRICTED CASH The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within thestatement of financial position that sum to the total of the same such amounts in the statement of cash flows (in thousands): As of December 31, 2018 2017Cash and cash equivalents $55,646$82,936Restricted cash 2,358 1,012Total cash, cash equivalents and restricted cash shown in the statement of cashflows $58,004$83,948 Restricted cash includes guarantee deposits for customs duties and compensating balances required for certain creditfacilities. NOTE E—EARNINGS PER SHARE Basic net income (loss) per share has been computed using the weighted-average number of shares of common stockoutstanding during the period. Diluted net income (loss) per share has been computed using the weighted-average number ofshares of common stock and dilutive potential common shares from options and restricted stock units outstanding during theperiod. In periods with net losses, normally dilutive shares become anti-dilutive. Therefore, basic and dilutive earnings pershare are the same. The following table presents the computation of the basic and diluted net income (loss) per share for the periodsindicated (in thousands, except per share amounts): Year ended December 31, 2018 2017 2016 Numerator: Net income (loss) $(2,146) $73,951 $31,234 Denominator: Weighted average shares used to compute net income (loss) per share Basic 19,647 19,097 17,202 Effect of dilutive options and restricted stock units — 1,042 511 Diluted 19,647 20,139 17,713 Net income (loss) per share Basic $(0.11) $3.87 $1.82 Diluted $(0.11) $3.67 $1.76 F - 15 Table of Contents The following potentially dilutive securities were excluded from diluted net income (loss) per share as their effectwould have been antidilutive during periods of net loss: As of December 31, 2018 2017 2016Employee stock options 263 — —Restricted stock units 117 — —Total antidilutive shares 380 — — NOTE F—INVENTORIES At December 31, 2018 and 2017, inventories consisted of the following (in thousands): As of December 31, 2018 2017 Raw materials $30,214 $26,648 Work in process and sub-assemblies 49,192 31,060 Finished goods 13,850 18,060 Total inventory $93,256 $75,768 For the years ended December 31, 2018, 2017 and 2016, the lower of cost or market reserve adjustment expensed forinventory was $7.2 million, $1.9 million and $3.7 million, respectively. For the years December 21, 2018, 2017 and 2016,the direct inventory write-offs related to scrap and damaged inventories were $3.5 million, $6.8 million and $5.0 million,respectively. NOTE G—PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following for the periods indicated (in thousands): As of December 31, 2018 2017Land improvements $806 $806Building and improvements 80,960 78,785Machinery and equipment 214,718 168,993Furniture and fixtures 5,043 4,663Computer equipment and software 9,709 8,248Transportation equipment 658 718 311,894 262,213Less accumulated depreciation and amortization (95,233) (70,194) 216,661 192,019Construction in progress 16,449 4,823Land 1,101 1,101Total property, plant and equipment, net $234,211 $197,943 For the years ended December 31, 2018, 2017 and 2016, depreciation expense of property, plant and equipment was$29.2 million $19.9 million and $13.7 million, respectively. F - 16 Table of ContentsNOTE H—INTANGIBLE ASSETS Intangible assets consisted of the following for the periods indicated (in thousands): 2018 Gross Accumulated Intangible Amount amortization assets, netPatents $6,983 $(3,008) $3,975Trademarks 15 (13) 2Total intangible assets $6,998 $(3,021) $3,977 2017 Gross Accumulated Intangible Amount amortization assets, netPatents $6,524 $(2,519) $4,005Trademarks 14 (12) 2Total intangible assets $6,538 $(2,531) $4,007 For the years ended December 31, 2018, 2017 and 2016, amortization expense for intangible assets, included ingeneral and administrative expenses on the income statement, was $0.5 million each year. The remaining weighted averageamortization period for intangible assets is approximately 8 years. At December 31, 2018, future amortization expense for intangible assets is estimated to be (in thousands): 2019 $5052020 5062021 5062022 5062023 506thereafter 1,448 $3,977 NOTE I—FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents a summary of the Company’s financial instruments measured at fair value on arecurring basis as of December 31, 2018 (in thousands): Quoted prices Significant in active other markets for observable Significant identical remaining unobservable assets (Level 1) inputs (Level 2) inputs (Level 3) Total Assets: Cash and cash equivalents $55,646 $ — $ — $55,646 Restricted cash 2,358 — — 2,358 Total assets $58,004 $ — $ — $58,004 Liabilities: Bank acceptance payable — $4,628 — $4,628 Total liabilities $ — $4,628 $ — $4,628 F - 17 Table of ContentsThe following table presents a summary of the Company’s financial instruments measured at fair value on arecurring basis as of December 31, 2017 (in thousands): Quoted prices Significant in active other markets for observable Significant identical remaining unobservable assets (Level 1) inputs (Level 2) inputs (Level 3) Total Assets: Cash and cash equivalents $82,936 $ — $ — $82,936 Restricted cash 1,012 — — 1,012 Short term investments 36 — — 36 Total assets $83,984 $ — $ — $83,984 Liabilities: Bank acceptance payable — $ — — $ — Total liabilities $ — $ — $ — $ — NOTE J—NOTES PAYABLE AND LONG-TERM DEBT Notes payable and long-term debt consisted of the following for the periods indicated (in thousands): December 31, 2018 2017 Revolving line of credit with a U.S. bank up to $60,000 with interest at LIBOR plus1.4%, maturing September 28, 2020 $23,104 $49,000 Term loan with a U.S. bank with monthly payments of principal and interest at LIBOR plus1.15%, maturing April 1, 2024 20,067 — Term loan with a U.S. bank with monthly payments of principal and interest at LIBOR plus1.3%, maturing between April 1, 2023 and December 18, 2023 19,164 — Revolving line of credit with a Taiwan bank up to $9,767 with interest at 2%, maturing May31, 2019 3,256 — Revolving line of credit with a Taiwan bank up to $7,000 with interest at 1.5%, maturing July26, 2019 3,550 — Notes payable to a finance company due in monthly installments with 4.5% interest, whichmatured May 27, 2018 — 559 Notes payable to a finance company due in monthly installments with 3.4% interest, maturingNovember 30, 2021 6,331 — Revolving line of credit with a China bank up to $18,599 with interest ranging from 3.7% to4.6% 8,652 — Sub-total 84,124 49,559 Less debt issuance costs, net (207) (36) Grand total 83,917 49,523 Less current portion (23,589) (559) Non-current portion $60,328 $48,964 Bank Acceptance Notes Payable Bank acceptance notes issued to vendors with a zero percent interest rate $4,628 $ — The current portion of long-term debt is the amount payable within one year of the balance sheet date ofDecember 31, 2018. F - 18 Table of ContentsMaturities of notes payable and long-term debt are as follows for the future years ending December 31 (inthousands): 2019 $23,589 2020 31,375 2021 8,160 2022 6,242 2023 5,369 2024 and thereafter 9,182 Total outstanding $83,917 On September 28, 2017, the Company entered into a Loan Agreement, a Promissory Note, an Addendum to thePromissory Note, a BB&T Security Agreement, a Trademark Security Agreement, and a Patent Security Agreement (togetherthe “Credit Facility”) with Branch Banking and Trust Company (“BB&T”). The Credit Facility provides the Company with athree year, $50 million, revolving line of credit. Borrowings under the Credit Facility will be used for general corporatepurposes. The Company makes monthly payments of accrued interest with the final monthly payment being for all principaland all accrued interest not yet paid. The Company’s obligations under the Credit Facility are secured by the Company’saccounts receivable, inventory, intellectual property, and all business assets with the exception of real estate and equipment.Borrowings under the Credit Facility bear interest at a rate equal to the one-month LIBOR plus 1.50%. The Credit Facilityrequires the Company to maintain certain financial covenants and also contains representations and warranties, and events ofdefault applicable to the Company that are customary for agreements of this type. On March 30, 2018, the Company executed a First Amendment to Loan Agreement, a Note Modification Agreementand Addendum to Promissory Note for $60 million, a Promissory Note and Addendum to Promissory Note for $26 million, aPromissory Note and Addendum to Promissory Note for $21.5 million, a Texas Deed of Trust and Security Agreement, anAssignment of Lease and Rent, and an Environmental Certification and Indemnity Agreement, (collectively, the “AmendedCredit Facility”), with BB&T. The Amended Credit Facility amends the Company’s three-year $50 million line of credit withBB&T, originally executed on September 28, 2017 (the “Existing Loan”). The Amended Credit Facility (1) increases theprincipal amount of the three-year line of credit from $50 million to $60 million (the “Line of Credit”); (2) allows theCompany to borrow an additional $26 million from BB&T in the form of a five-year capital expenditure loan (the “CapExLoan”) and (3) allows the Company to borrow an additional $21.5 million in the form of a seventy-month real estate termloan (the “Term Loan”) to refinance the Company’s plant and facilities in Sugar Land, Texas. Borrowings under the Line ofCredit bear interest at a rate equal to the one-month LIBOR plus a Line of Credit margin ranging between 1.40% and 2.0%.Borrowings under the CapEx Loan bear interest at a rate equal to the one-month LIBOR plus a CapEx Loan margin rangingbetween 1.30% and 2.0%. Borrowings under the Term Loan bear interest at a rate equal to the one-month LIBOR plus a TermLoan margin ranging between 1.15% and 2.0%. The Company is required to make monthly payments of principal andaccrued interest with the final monthly payments being for all principal and accrued interest not yet paid. The Company’sobligations under the Amended Credit Facility are secured by the Company’s accounts receivable, inventory, equipment,intellectual property, real property, and virtually all business assets. As of December 31, 2018, the Company was incompliance with all covenants under the Amended Credit Facility. As of December 31, 2018, $23.1 million was outstandingunder the Line of Credit, $20.1 million was outstanding under the Term Loan and $19.2 million was outstanding under theCapEx Loan. On May 27, 2015, the Company’s Taiwan branch entered into a Purchase and Sale Contract and a Finance LeaseAgreement with Chailease Finance Co, Ltd. (“Chailease”) in connection with certain equipment, structured as a sale lease-back transaction. Pursuant to the Purchase and Sale contract, the Company’s Taiwan branch sold certain equipment toChailease for a purchase price of 180,148,532 New Taiwan dollars, approximately $6.0 million, and simultaneously leasedthe equipment back from Chailease pursuant to the Finance Lease Agreement. The monthly lease payments range from3,784,000 New Taiwan dollars, approximately $0.1 million, to 3,322,413 New Taiwan dollars, approximately $0.1 million,during the term of the Finance Lease Agreement, including an initial payment in an amount of 60,148,532 New Taiwandollars, approximately $2.0 million. The Finance Lease Agreement had a three-year term, with monthly payments, thatmatured on May 27, 2018. The title to the equipment was transferred to the Company’s Taiwan branch upon the expiration ofthe Finance Lease Agreement. On June 19, 2018, Prime World entered into a one year revolving credit facility totaling 300 million New Taiwandollars (“NT$”), or approximately $9.8 million, (the “Taiwan Credit Facility”) with Taishin International BankF - 19 Table of Contentsin Taiwan (the “Bank”). Borrowing under the Taiwan Credit Facility will be used for short-term working capital. Prime Worldmay draw upon the Taiwan Credit Facility from June 19, 2018 until May 31, 2019. The term of each draw shall be either 90or 120 days. Borrowings under the Taiwan Credit Facility bear interest at a rate of 2.00% for 90 day draws and 1.95% for 120day draws. At the end of the draw term, Prime World is required to make payments for all principal and accrued interest. Theagreements for the Taiwan Credit Facility contain representations and warranties and events of default applicable to PrimeWorld that are customary for agreements of this type. As of December 31, 2018, $3.3 million was outstanding under theTaiwan Credit Facility. On October 3, 2018, Prime World entered into a revolving credit facility for up to $7 million, (the “RevolvingCredit Facility”) with the Development Bank of Singapore (Taiwan) Ltd. (“DBS”). Borrowing under the Revolving CreditFacility will be used for short-term working capital. Prime World may draw upon the Revolving Credit Facility from October3, 2018 until July 26, 2019. The term of each draw shall be either 60 or 90 days depending on the purpose of thedraw. Borrowings under the Revolving Credit Facility bear interest at a rate equal to DBS’s cost of funds rate plus 1.25% fordraws in U.S. Dollars and 1.35% plus the Bank’s cost of funds rate for draws in New Taiwan Dollars. As of the execution ofthe Revolving Credit Facility, DBS’s cost of fund’s rate is 0.77% for loans made in New Taiwan Dollars and 2.54% for loansmade in U.S. Dollars. DBS’s cost of fund’s rate is adjusted daily. Prime World is required to make monthly payments ofaccrued interest with the final monthly payment being for all principal and all accrued interest not yet paid. Prime World’sobligations under the Revolving Credit Facility is secured by promissory notes executed between Prime World and DBS atthe time of each draw. The agreements for the Revolving Credit Facility contain representations and warranties and events ofdefault applicable to the Prime World that are customary for agreements of this type. As of December 31, 2018, $3.6 millionwas outstanding under the Revolving Credit Facility. On November 29, 2018, Prime World entered into a Purchase and Sale Contract (the “Sale Contract”) and a FinanceLease Agreement with Chailease Finance Co., Ltd. (“Chailease”) in connection with certain equipment, structured as a salelease-back transaction. Pursuant to the Sale Contract, Prime World sold certain equipment to Chailease for a purchase priceof NT$267,340,468, or approximately $8.7 million. Simultaneously, Prime World leased the equipment back from Chaileasefor a term of three-years, pursuant to the Finance Lease Agreement. Prime World is obligated to pay an initial payment ofNT$67,340,468, or approximately $2.2 million, thereafter the monthly lease payments range from NT$5,571,229, or $0.2million, to NT$6,139,188, or approximately $0.2 million. Based on the lease payments made under the Finance LeaseAgreement, the annual interest rate is calculated to be 3.5%. Upon an event of default under the Finance Lease Agreement,Prime World’s payment obligation will be secured by a promissory note to Chailease in the amount of NT$210,601,605, orapproximately $6.8 million, subject to certain terms and conditions. The title of the equipment will be transferred to PrimeWorld upon expiration of the Finance Lease Agreement. As of December 31, 2018, $6.3 million was outstanding under theFinance Lease Agreement. On December 11, 2018, Prime World entered into a one-year credit facility totaling New Taiwan Dollars 150million (the “Credit Facility”) with CTBC Bank Co., Ltd. (“CTBC”). Borrowing under the Credit Facility will be used forshort-term working capital. Prime World may draw upon the Credit Facility from December 11, 2018 until October 31, 2019.The term of each draw shall be up to 120 days. Under the Credit Facility borrowing in New Taiwan Dollars will bear interestat a rate equal to CTBC’s Enterprise Swap Index Rate plus 1.2%; for all foreign currency borrowing interest bear at a rateequal to CTBC’s Cost of Fund lending rate plus 1.2%. As of the execution of the Credit Facility, CTBC’s Enterprise SwapIndex Rate and Cost of Funds lending rate is 0.69% and 3.40% respectively. At the end of the draw term, Prime World isrequired to make payments for all principal and accrued interest. The agreements for the Credit Facility containrepresentations and warranties, and events of default applicable to Prime World that are customary for agreements of thistype. As of December 31, 2018, there was no outstanding balance under the Credit Facility. On September 21, 2018, the Company’s China subsidiary, Global Technology, Inc., entered into a five-yearrevolving credit line agreement, totaling 129,000,000 Chinese Renminbi, or RMB, or approximately $18.6 million, (the“Credit Line”) and a Security Agreement with China Construction Bank Co., Ltd., in Ningbo, China (“CCB”). Borrowingunder the Credit Line will be used for general corporate and capital investment purposes, including the issuance of bankacceptance notes to Global’s vendors. Global may draw upon the Credit Line between September 21, 2018 and September17, 2023; however, the amount of available credit under the Credit Line may be reduced by CCB without notice to Globaland may be decreased subject to changes of Chinese government regulations. Each draw bears interest equal to CCB’scommercial banking interest rate effective on the day of the applicable draw. Global’s obligations under the Credit Line issecured by real property owned by Global in China and mortgaged to CCB under theF - 20 Table of Contentsterms of the Security Agreement. As of December 31, 2018, $8.7 million was outstanding under the Credit Line and theoutstanding balance of bank acceptance notes issued to vendors was $4.6 million. As of December 31, 2018 and 2017, the Company had $69.4 million and $1.0 million of unused borrowingcapacity, respectively. One-month LIBOR rates were 2.50% and 1.56% at December 31, 2018 and 2017, respectively. As of December 31, 2018 and 2017, there was $2.4 million and $1.0 million of restricted cash, investments orsecurity deposit associated mainly with the loan facilities, respectively. NOTE K—ACCRUED LIABILITIES Accrued liabilities consisted of the following for the periods indicated (in thousands): As of December 31, 2018 2017 Accrued payroll $10,772 $11,693 Accrued rent 1,200 1,180 Accrued employee benefits 2,862 2,035 Accrued state and local taxes 1,088 951 Advance payments 426 441 Accrued product warranty 995 1,118 Accrued commission expenses 398 425 Accrued professional fees 315 181 Accrued capital expenditures 371 — Accrued other 864 1,079 Total accrued liabilities $19,291 $19,103 NOTE L—OTHER INCOME AND EXPENSE Other income and expense consisted of the following for the periods indicated (in thousands): Year ended December 31, 2018 2017 2016 Foreign exchange transaction gain (loss) $663 $(2,012) $(617) Government subsidy income 934 211 164 Other non-operating gain 224 110 32 Loss on disposal of assets (7) (97) (126) Total other income (expense), net $1,814 $(1,788) $(547) NOTE M—INCOME TAXES The sources of the Company’s income (loss) from operations before income taxes were as follows (in thousands): Year ended December 31, 2018 2017 2016 Domestic $(11,444) $17,497 10,047 Foreign 1,666 67,029 10,956 Total income (loss) before income taxes $(9,778) $84,526 21,003 F - 21 Table of ContentsThe provision for income tax expense (benefit) for the years ended December 31, was as follows (in thousands): Current: 2018 2017 2016 Federal $ — $ — $(15) State 80 (292) 256 Foreign 1,349 10,965 962 Total $1,429 $10,673 $1,203 Deferred: Federal $(6,391) $2,015 $(10,794) State 61 (1,669) (130) Foreign (2,731) (444) (510) Total $(9,061) $(98) $(11,434) Income tax (benefit) expense $(7,632) $10,575 $(10,231) Deferred income tax assets and liabilities result principally from net operating losses, different methods ofrecognizing depreciation, reserves for doubtful accounts and inventory, research and development credits and foreign taxcredits. At December 31, the net deferred tax assets and liabilities are comprised of the following approximate amounts (inthousands): 2018 2017 NOL carryforward $12,049 $7,739 Inventory reserves 1,490 837 AMT credit 172 345 Unrealized gains and losses 69 92 Share-based compensation 510 732 Foreign tax credit 4,599 2,018 Research and development credits 6,648 4,626 Interest 208 — Other 718 573 Deferred tax assets 26,463 16,962 Depreciation and amortization (4,749) (4,161) Deferred tax liabilities (4,749) (4,161) Deferred tax assets, net $21,714 $12,801 The Company has a U.S. net operating loss carry forward of approximately $47.4 million, $32.8 million of which, ifunused, expires between 2025 and 2032 and $14.6 million of which, can be carryforward indefinitely. The Company has U.S.and state research and development tax credits of $6.6 million, which, if unused, expire between 2028 and 2038. In addition,the Company has foreign tax credits of $4.6 million, which, if unused, will expire in 2027. Utilization of U.S. net operatinglosses and tax credit carry forwards are subject to an annual limitation due to the ownership change limitations set forth inInternal Revenue Code Section 382. During 2016, the Company updated its Section 382 analysis resulting in the recognitionof additional utilizable net operating losses. Additional ownership changes could result in the expiration of the net operatingloss and tax credit carryforwards before utilization. On October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of AssetsOther Than Inventory (“ASU 2016-16”), which requires the recognition of the income tax consequences of an intra-entitytransfer of as asset, other than inventory, when the transfer occurs. The Company adopted guidance on January 1, 2018, withno impact on its financial statements. F - 22 Table of ContentsA reconciliation of the U.S. federal income tax rate of 21%, 35% and 35% for the years ended December 31, 2018,2017 and 2016, respectively, to the Company’s effective income tax rate follows (in thousands): 2018 2017 2016 Expected taxes at statutory rate $(2,053) $29,584 $7,351 Non-deductible/non-taxable items 1,020 1,212 565 Foreign rate differences (1,043) (11,656) (654) Foreign permanent differences (1,067) 416 (1,005) Increase (decrease) in valuation allowance — (1,700) (13,063) Share-based compensation (1,325) (10,348) — Section 382 limitation — — (3,065) Changes in tax rates (103) 2,768 (361) Transition tax adjustment, net of foreign tax credits (1,777) 5,067 — Research and development credits (2,022) (2,821) — Uncertain tax positions — (1,616) — Foreign other 514 — — Other, net 224 (331) 1 Tax (benefit) expense $(7,632) $10,575 $(10,231) The Company’s provision for income taxes in 2018 was lower than in 2017 primarily due to a decrease in pre-taxincome and the impact of the 2017 Tax Act, partially offset by excess tax benefits from stock-based compensation, recordingresearch and development credits, and the U.S. return-to-accrual adjustment as a result of the 2017 Tax Act as discussedbelow. The Company’s provision for income taxes in 2017 was higher than in 2016 primarily due to an increase in pre-taxincome and the provisional effect of the 2017 Tax Act, partially offset by excess tax benefits from stock-based compensationand recording research and development credits, including a portion of which were previously uncertain. The Company’s wholly owned subsidiary, Prime World is a tax-exempt entity under the Income Tax Code of theBritish Virgin Islands. The Company’s wholly owned subsidiary, Global Technology, Inc., has enjoyed preferential tax concessions inChina as a national high-tech enterprise. In March 2007, China’s parliament enacted the PRC Enterprise Income Tax Law, orthe EIT Law, under which, effective January 1, 2008, China adopted a uniform income tax rate of 25% for all enterprisesincluding foreign invested enterprises. Global Technology, Inc. was recognized as a National high-tech enterprise in 2008and was entitled to a 15% tax rate for a three year period from November 2008 to November 2017. Global Technology, Inc.renewed its National high-tech enterprise certificate and was therefore extended its three-year tax preferential status fromNovember 2017 to November 2020. This tax holiday reduced its 2018 and 2017 income tax provision by approximately$0.5 and $1.4 million respectively, but had no overall effect on the 2016 income tax provision due to a full valuationallowance. This tax holiday increased its fiscal 2018 and 2017 diluted earnings per share by approximately $0.03 and $0.07respectively, but had no effect on its 2016 diluted earnings per share due to the full valuation allowance. Effective January 1,2016, China expanded the scope of the National high-tech enterprise to include additional deductions for qualifyingresearch and development. As of December 31, 2018, 2017 and 2016, the total amount of unrecognized tax benefit was $0.2 million, $0.2million, and $1.8 million, respectively. The following is a tabular reconciliation of the total amounts of unrecognized taxbenefits (in thousands): 2018 2017 2016 Unrecognized tax benefits — January 1 $181 $1,797 $1,797 Gross increases — tax positions in prior period — — — Gross decreases — tax positions in prior period — (1,616) — Unrecognized tax benefits — December 31 $181 $181 $1,797 As of December 31, 2018 and 2017, the Company had $0.2 million of unrecognized tax benefits related to U.S. taxbenefits recognized for prior branch losses, respectively. As of December 31, 2016, the Company had $1.8 million ofunrecognized tax benefits related to U.S. tax benefits recognized for prior year branch losses and research andF - 23 Table of Contentsdevelopment credits. If recognized, none of the amounts would have an impact on the Company’s effective tax rate, butrather would result in adjustments to other tax accounts, primarily deferred taxes. The Company recognizes interest accrued related to unrecognized tax benefits and penalties as income tax expense.Related to the unrecognized tax benefits noted above, it has not accrued penalties or interest during 2018 as a result of netoperating losses. During 2017 or 2016, the Company also accrued no penalties or interest. The Company is subject to taxation in the United States and various states and foreign jurisdictions. TheCompany’s open tax years subject to examination in the U.S. federal and state jurisdictions are 2015 through 2017. To theextent allowed by law, the taxing authorities may have the right to examine prior periods where net operating losses or taxcredits were generated and carried forward, and make adjustments up to the amount of the net operating loss or tax creditcarryforward. The Company is subject to examination for tax years 2010 forward for various foreign jurisdictions. Effects of the Tax Cuts and Jobs Act On December 22, 2017, the President of the United States signed Public Law No. 115-97, commonly referred to asthe Tax Cut and Jobs Act of 2017 (the “Tax Act”). The Tax Act made significant changes to the U.S. tax code, whichincluded, but were not limited to: a U.S. federal corporate tax rate decrease from 35% to 21%, effective January 1, 2018; ashift to a modified territorial tax regime, which requires companies to pay a one-time transition tax on the mandatory deemedrepatriation of the cumulative earnings of certain foreign subsidiaries as of December 31, 2017; a new provision designed totax global intangible low-taxed income (“GILTI”) of foreign subsidiaries; a limitation of the deduction for net operatinglosses; elimination of net operating loss carrybacks; immediate deductions for depreciation expense for certain qualifiedproperty; additional limitations on the deductibility of executive compensation and limitations on the deductibility ofinterest. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications ofthe Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not toextend beyond one year of the enactment data. As a result, we previously provided a provisional estimate of the effect of theTax Act in our financial statements. In third quarter of 2018, we completed our analysis to determine the effect of the TaxAct and the material impact of the Tax Act is described below. The deemed repatriation transition tax (the “Transition Tax”) is a tax on certain previously untaxed accumulatedand current earnings and profits (“E&P”) of our foreign subsidiaries. The company was able to reasonably estimate theTransition Tax and recorded a provisional Transition Tax obligation of $5.0 million, with a corresponding adjustment of$5.0 million to income tax expense for the year ended December 31, 2017. On the basis of revised E&P computations thatwere completed during the reporting period, the Company recognized an additional measurement-period adjustment of($1.8) million to the Transition Tax obligation, with a corresponding adjustment of ($1.8) million to income tax expenseduring the reporting period, net of foreign tax credit considerations. The effect of the measurement-period adjustment on the2018 effective tax rate was approximately 18.8%. The Transition Tax, which has now been determined to be complete,resulted in recording a total Transition Tax obligation of $3.2 million, with a corresponding adjustment of $3.2 million toincome tax expense. As of December 31, 2018, the Company has accumulated undistributed earnings generated by its foreignsubsidiaries of approximately $44 million. Because $44 million of such earnings have previously been subject to the one-time transition tax on foreign earnings required by the 2017 Tax Act, any additional taxes due with respect to such earningsor the excess of the amount for financial reporting over the tax basis of our foreign investments would generally be limited toforeign and state taxes. The Company intends, however, to indefinitely reinvest these earnings and expects future U.S. cashgeneration to be sufficient to meet future U.S. cash needs. NOTE N—SHARE-BASED COMPENSATION Equity Plans The Company’s board of directors and stockholders approved the following equity plans: ·the 1998 Share Incentive Plan F - 24 Table of Contents·the 2000 Share Incentive Plan ·the 2004 Share Incentive Plan ·the 2006 Share Incentive Plan ·the Amended and Restated 2013 Equity Incentive Plan (“2013 Plan”) The Company issued stock options, restricted stock awards (“RSAs”) and restricted stock units (“RSUs”) toemployees, consultants and non-employee directors. Stock option awards generally vest over a four year period and have amaximum term of ten years. Stock options under these plans have been granted with an exercise price equal to the fair marketvalue 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 beenhistorically 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 five incentive plans and generally becomeexercisable as to 25% of the shares on the first anniversary date following the date of grant and semi-annually thereafter. Alloptions 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 SharePrice 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, January 1, 2016 1,310 9.07 $4.59 $10,598Exercised (159) 6.91 $19.90 2.56 2,071Forfeited (21) 7.96 3.29 273Outstanding, December 31, 2016 1,130 9.40 4.90 15,872Exercised (418) 8.56 $59.31 4.51 21,224Forfeited (176) 9.42 4.97 4,998Outstanding, December 31, 2017 536 10.04 5.19 14,888Exercised (122) 9.79 $36.18 5.00 3,223Forfeited (127) 9.92 5.10 697Outstanding, December 31, 2018 287 $10.19 $5.31 4.60 1,503Exercisable, December 31, 2018 287 $10.19 4.60 1,503Vested and expected to vest 287 $10.19 4.60 $1,503 As of December 31, 2018, there was no unrecognized stock option expense. F - 25 Table of ContentsRestricted Stock Unit/Awards The following is a summary of RSU/RSA activity (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, 2016 152 $11.20 $2,611Granted 497 $13.50 15.73 7,815Released (122) 14.09 1,644Cancelled/Forfeited (10) 15.38 180Outstanding, December 31, 2016 517 14.79 12,128Granted 510 38.87 19,803Released (289) $60.87 20.92 17,579Cancelled/Forfeited (31) 24.23 1,181Outstanding, December 31, 2017 707 29.23 26,732Granted 526 33.74 17,768Released (363) $33.86 28.87 12,306Cancelled/Forfeited (44) 32.91 680Outstanding, December 31, 2018 826 32.07 12,744Vested and expected to vest 826 $32.07 $12,744 The aggregate intrinsic value of RSUs and RSAs outstanding at December 31, 2018 was $12.7 million.Unrecognized compensation expense related to these RSUs and RSAs at December 31, 2018 was $24.0 million. This expenseis expected to be recognized over 2.49 years. Share-Based Compensation The Company recognizes compensation expense on a straight-line basis over the applicable vesting term of theaward and expense is adjusted as forfeitures occur. In 2014, the Company ceased issuing stock options and began issuing RSUs and RSAs as share-based compensationto employees. The Company estimates the fair value of RSUs and RSAs at the fair market value on the grant date. Employee share-based compensation expenses recognized for the years ended December 31, were as follows (inthousands): Share-Based compensation - by expense type: 2018 2017 2016 Cost of goods sold $795 $461 $190 Research and development 2,419 1,496 591 Sales and marketing 925 481 357 General and administrative 6,981 5,357 2,695 Total share-based compensation expense $11,120 $7,795 $3,833 Share-Based compensation - by award type: 2018 2017 2016 Employee stock options $12 $853 $1,460 Restricted stock units 11,108 6,942 2,373 Total share-based compensation expense $11,120 $7,795 $3,833 F - 26 Table of ContentsNOTE O—STOCKHOLDERS’ EQUITY Common Stock The Company’s Amended and Restated Certificate of Incorporation authorizes the issuance of up to45,000,000 shares of common stock, all of which have been designated voting common stock. Preferred Stock The Company’s Amended and Restated Certificate of Incorporation authorizes the issuance of up to5,000,000 shares of preferred stock. Public Offerings of Common Stock On October 17, 2016, the Company filed a Registration Statement on Form S-3 with the Securities and ExchangeCommission effective November 1, 2016, providing for the public offer and sale of certain securities of the Company fromtime to time, at its discretion, up to an aggregate amount of $250 million. In connection with such Form S-3, the Companyentered into an Equity Distribution Agreement with Raymond James & Associates, Inc. pursuant to which the Company mayissue and sell shares of the Company’s stock having an aggregate offering price of up to $50.0 million (the “Second ATMOffering”) from time to time through Raymond James & Associates, Inc. On November 22, 2016, the Company commencedsales of common stock through the Second ATM Offering. The Company completed its Second ATM Offering in March 2017and sold 1.6 million shares of common stock at a weighted average price of $31.55 per share, providing proceeds of $48.8million, net of expenses and underwriting discounts and commissions. NOTE P—SEGMENT AND GEOGRAPHIC INFORMATION The Company operates in one reportable segment. The Company’s Chief Executive Officer, who is considered to bethe chief operating decision maker, manages the Company’s operations as a whole and reviews financial informationpresented on a consolidated basis, accompanied by information about product revenue, for purposes of evaluating financialperformance and allocating resources. The following tables set forth the Company’s revenue and asset information by geographic region. Revenue isclassified based on the location of where the product is manufactured. Long-lived assets in the tables below comprise onlyproperty, plant, equipment and intangible assets (in thousands): For the years ended December 31, 2018 2017 2016 Revenues: United States $10,795 $18,209 $18,035 Taiwan 113,547 241,820 161,611 China 143,123 122,300 81,067 $267,465 $382,329 $260,713 As of December 31, 2018 2017 2016 Long-lived assets: United States $88,815 $75,446 $66,028 Taiwan 65,451 67,379 48,728 China 89,736 59,929 34,113 $244,002 $202,754 $148,869 The Company serves four primary markets, the internet data center, CATV, telecom and FTTHmarkets. Of the Company’s total revenues in 2018, the Company earned $200.2 million, or 74.9%, from theinternet data center market, $51.7 million, or 19.3%, from the CATV market, $13.2 million, or 4.9%, fromthe telecom market and $0.8 million, or 0.3%, from the FTTH market. Of the Company’s total revenues in2017, the Company earned $306.7 million, or 80.2%, from the internet data center market, $60.8 million, or15.9%, from the CATV market, $12.9 million, or 3.4%, from the telecom market and $0.5 million, or 0.1%,from the FTTH market. Of the Company’s total revenues in 2016, theF - 27 Table of ContentsCompany earned $201.3 million, or 77.2%, from the internet data center market, $43.6 million, or 16.7%,from the CATV market, $12.9 million, or 5.0%, from the telecom market and $1.6 million, or 0.6%, fromthe FTTH market. NOTE Q—EMPLOYEE BENEFIT PLANS On August 1, 2000, the Company established a 401(k) profit sharing plan covering employees meeting certain ageand service requirements. The plan provides for discretionary Company contributions to be allocated based on theemployee’s eligible contributions. The Company made contributions of $0.8 million, $0.6 million and $0.6 million to the401(k) plan for the years ended December 31, 2018, 2017 and 2016, respectively. Employees of Global participate in a state-mandated social security program in China. Under this program, pensioncosts are recorded on the basis of required monthly contributions to employees’ individual accounts during their serviceperiods. Under the regulations of the People’s Republic of China, Global is required to make fixed contributions to a fund,which is under the administration of the local labor departments. Pension expense for Global was $0.9 million, $0.8 millionand $0.6 million in the years ended for the year ended December 31, 2018, 2017 and 2016, respectively. Employees Prime World’s Taiwan branch participate in a pension program under the Taiwan Labor Pension Act.Pension expense for the Prime World’s Taiwan branch was $0.9 million, $0.9 million and $0.8 million for the years endedDecember 31, 2018, 2017 and 2016, respectively. NOTE R—COMMITMENTS AND CONTINGENCIES Commitments The Company conducts part of its operations from leased facilities and also leases equipment. Rent expense was$1.2 million, $1.1 million and $1.1 million, respectively, for the years ended December 31, 2018, 2017 and 2016,respectively. At December 31, 2018, the approximate minimum rental commitments under noncancellable leases in excess of oneyear that expire at varying dates through 2029 were as follows (in thousands): Year ending December 31, Amount 2019 $1,233 2020 1,144 2021 1,031 2022 993 2023 1,017 thereafter 5,748 $11,166 Employment Agreements and Consultancy Agreements The Company has entered into employment and indemnification agreements with three executive officers. Theseagreements provide that if their employment is terminated as a result of a change of control of the Company, or if theiremployment is terminated for certain other reasons set forth in the agreements, the Company will be required to pay aseverance payment in an amount equal to their annual base salary, and other additional compensation due under the terms ofthe agreements. The Company has also entered into employment and indemnification agreements with one other executive officer.These agreements provide that if their employment is terminated as a result of a change of control of the Company, theCompany will be required to pay a severance payment in an amount equal to six months of their annual base salary and otheradditional compensation due under the terms of the agreements. F - 28 Table of ContentsContingencies From time to time, the Company may be subject to legal proceedings and litigation arising in the ordinary course ofbusiness, including, but not limited to, inquiries, investigations, audits and other regulatory proceedings, such as describedbelow. The Company records a loss provision when it believes it is both probable that a liability has been incurred and theamount can be reasonably estimated. Unless otherwise disclosed, the Company is unable to estimate the possible loss orrange of loss for the legal proceeding described below. Except for the lawsuits described below, the Company believes that there are no claims or actions pending orthreatened against it, the ultimate disposition of which would have a material adverse effect on it.Class Action and Shareholder Derivative Litigation On August 5, 2017, a lawsuit was filed in the U.S. District Court for the Southern District of Texas against theCompany and two of its officers in Mona Abouzied v. Applied Optoelectronics, Inc., Chih-Hsiang (Thompson) Lin, andStefan J. Murry, et al., Case No. 4:17-cv-02399. The complaint in this matter seeks class action status on behalf of theCompany’s shareholders, alleging violations of Sections 10(b) and 20(a) of the Exchange Act against the Company, its chiefexecutive officer, and its chief financial officer, arising out of its announcement on August 3, 2017 that “we see softer thanexpected demand for our 40G solutions with one of our large customers that will offset the sequential growth and increaseddemand we expect in 100G.” The complaint requests unspecified damages and other relief. The Company disputes theallegations set forth in the complaint and is vigorously contesting the matter. The briefing on the Company’s motion todismiss the complaint was completed on May 21, 2018, and the motion is still pending. On August 7, 2018, a derivative lawsuit was filed in the United States District Court for the Southern District ofTexas styled Lei Jin, derivatively on behalf of Applied Optoelectronics, Inc. v. Chih-Hsiang (“Thompson”) Lin, Stefan J.Murry, William H. Yeh, Alex Ignatiev, Richard B. Black, Min-Chu Chen, Alan Moore, and Che-Wei Lin and AppliedOptoelectronics, Inc., No. 4:18-cv-02713 alleging breaches of fiduciary duties, unjust enrichment, and violations of Section14(a) of the Exchange Act based on similar factual allegations as in the Abouzied Securities Class Action. On December 18,2018, a second derivative complaint was filed styled Yiu Kwong Ng v. Chih-Hsiang (“Thompson”) Lin, Stefan J. Murry,William H. Yeh, Alex Ignatiev, Richard B. Black, Min-Chu Chen, Alan Moore, and Che-Wei Lin and Applied Optoelectronics,Inc., No. 4:18-cv-4751 alleging the same causes of actions as the Jin complaint and additional factual allegations regardingthe Company’s announcement on September 28, 2018 that it had “identified an issue with a small percentage of 25G laserswithin a specific customer environment.” On January 11, 2019, the court consolidated these two derivative actions, and onJanuary 15, 2019, the court entered an order staying the actions pending the outcome of the motion to dismiss in theAbouzied Securities Class action and the forthcoming motion to dismiss in the Taneja Securities Class Action, described inthe following paragraph. The complaint requests unspecified damages and other relief. The Company disputes theallegations and intends to vigorously contest the matter if and when the stay is lifted. On October 1, 2018, a securities class action was filed in the United States District Court for the Southern District ofTexas styled Gaurav Taneja v. Applied Optoelectronics, Inc., Thompson Lin, and Stefan Murry, Case No. 4:18-cv-3544. Thecomplaint in this matter seeks class action status on behalf of the Company’s shareholders, alleging violations of Sections10(b) and 20(a) of the Exchange Act against the Company, the chief executive officer, and the chief financial officer, arisingout of the Company’s announcement on September 28, 2018 that it had “identified an issue with a small percentage of 25Glasers within a specific customer environment.” The original complaint requests unspecified damages and other relief. TheCompany disputes the allegations set forth in the original complaint and intends to vigorously contest the matter. The casehas been consolidated with two identical complaints that were subsequently filed on October 10, 2018 and October 18, 2018,styled Davin Pokoik v. Applied Optoelectronics, Inc., Chih-Hsiang Lin, and Stefan J. Murry, Case No. 4:18-cv-3722 andStephen McGrath v. Applied Optoelectronics, Inc., Chih-Hsiang Lin, and Stefan J. Murry, respectively. The three cases wereconsolidated on January 4, 2019, and Mark Naglich was appointed Lead Plaintiff on that same date. The original complaintrequests unspecified damages and other relief. The Company disputes the allegations in the complaint and intends tovigorously contest the matter. The deadline for Lead Plaintiff to file a consolidated amended complaint is March 5, 2019,and the deadline for our motion to dismiss is sixty days after the consolidated amended complaint is filed. F - 29 Table of ContentsNOTE S—SUBSEQUENT EVENTS The Company has evaluated subsequent events through the date the financial statements were issued. On January 3, 2019, the Company repaid its revolving bank line of credit of $23.1 million. On January 21, 2019, Prime World entered into a second Purchase and Sale Contract (the “Second Sales Contract”),Promissory Note, and a second Finance Lease Agreement, (collectively, the “Second Financing Agreements”) with Chaileasein connection with certain equipment, structured as a sale lease-back transaction. Pursuant to the Second Sales Contract,Prime World sold certain equipment to Chailease for a purchase price of NT$267,333,186, or approximately $8.7 million.Simultaneously, Prime World leased the equipment back from Chailease for a term of three-years, pursuant to the SecondFinance Lease Agreement. Prime World is obligated to pay an initial monthly payment of NT$67,333,186, or approximately$2.2 million, thereafter the monthly lease payments range from NT$5,570,167, or approximately $0.2 million toNT$6,082,131, or approximately $0.2 million. Based on the lease payments made under the Second Finance LeaseAgreement, the annual interest rate is calculated to be 3.5%. Upon an event of default under the Second Finance LeaseAgreement, Prime World’s payment obligation will be secured by a promissory note to Chailease at the amount ofNT$209,555,736 or approximately $6.8 million, subject to certain terms and conditions. The title of the equipment will betransferred to Prime World upon expiration of the Second Finance Lease Agreement. On February 1, 2019, the Company executed a Second Amendment to Loan Agreement with BB&T. The originalloan agreement with BB&T, executed on September 28, 2017, and a first amendment to the original loan agreement,executed on March 30, 2018, provided the Company with a three-year $60 million line of credit; a $26 million five-yearcapital expenditure loan (the “CapEx Loan”) and a $21.5 million seventy-month real estate term loan for the Company’splant and facilities in Sugar Land, Texas. The Second Amendment to Loan Agreement extends the CapEx Loan draw-downdate from March 30, 2019 to September 30, 2019, requires the Company to provide BB&T monthly financial statements andrevises certain financial covenants. NOTE T—SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following tables set forth a summary of the Company’s quarterly financial information for each of the four quarters forthe years ended December 31, 2018 and 2017 (in thousands, except per share data): First Second Third Fourth Year ended December 31, 2018 Quarter Quarter Quarter Quarter Revenue $65,239 $87,822 $56,386 $58,018 Cost of goods sold 39,403 53,959 38,849 47,481 Gross profit 25,836 33,863 17,537 10,537 Gross margin 39.6% 38.6% 31.1% 18.2% Operating expenses: Research and development 11,736 12,645 14,180 11,342 Sales and marketing 2,474 2,377 2,370 1,920 General and administrative 9,456 9,898 10,591 9,552 Total operating expenses 23,666 24,920 27,141 22,814 Income (loss) from operations 2,170 8,943 (9,604) (12,277) Interest and other income (expense), net (1,046) 1,387 578 71 Net income (loss) before taxes 1,124 10,330 (9,026) (12,206) Income tax (expense) benefit 996 (2,296) 5,294 3,638 Net income (loss) $2,120 $8,034 $(3,732) $(8,568) Net income (loss) per share—basic $0.11 $0.41 $(0.19) $(0.43) Net income (loss) per share—diluted $0.11 $0.40 $(0.19) $(0.43) F - 30 Table of Contents First Second Third Fourth Year ended December 31, 2017 Quarter Quarter Quarter Quarter Revenue $96,224 $117,371 $88,879 $79,855 Cost of goods sold 54,752 64,089 49,507 47,701 Gross profit 41,472 53,282 39,372 32,154 Gross margin 43.1% 45.4% 44.3% 40.3% Operating expenses: Research and development 7,432 8,073 9,190 10,670 Sales and marketing 1,903 2,158 2,551 2,090 General and administrative 7,822 8,786 9,580 9,074 Total operating expenses 17,157 19,017 21,321 21,834 Income from operations 24,315 34,265 18,051 10,320 Interest and other expense, net (872) (111) (541) (901) Net income before taxes 23,443 34,154 17,510 9,419 Income tax (expense) benefit (3,654) (5,083) 1,865 (3,703) Net income $19,789 $29,071 $19,375 $5,716 Net income per share—basic $1.06 $1.52 $1.00 $0.29 Net income per share—diluted $1.00 $1.43 $0.95 $0.28 F - 31Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued our reports dated February 26, 2019, with respect to the consolidated financial statements and internal controlover financial repor(cid:30)ng included in the Annual Report of Applied Optoelectronics, Inc. on Form 10-K for the year endedDecember 31, 2018. We consent to the incorpora(cid:30)on by reference of said reports in the Registra(cid:30)on Statements of AppliedOptoelectronics Inc. on Form S-3 (File No. 333-214146) and on Forms S-8 (File No. 333-223347, File No. 333-217871, and FileNo. 333-192407). /s/ GRANT THORNTON LLPHouston, TexasFebruary 26, 2019 Exhibit 31.1 CERTIFICATION I, Chih-Hsiang (Thompson) Lin, certify that: 1. I have reviewed this Annual Report on Form 10-K of Applied Optoelectronics, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of the circumstances under which such statements were made,not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairlypresent in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, theperiods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (asdefined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this report isbeing prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting tobe designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples; (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered bythis report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred duringthe registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that hasmaterially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal controlover financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financialreporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and reportfinancial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal control over financial reporting. Date: February 26, 2019 /s/ CHIH-HSIANG (THOMPSON) LIN Chih-Hsiang (Thompson) Lin President, Chief Executive Officer Exhibit 31.2 CERTIFICATION I, Stefan J. Murry, certify that: 1. I have reviewed this Annual Report on Form 10-K of Applied Optoelectronics, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of the circumstances under which such statements were made,not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairlypresent in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, theperiods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (asdefined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to bedesigned under our supervision, to ensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities, particularly during the period in whichthis report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting tobe designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples; (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered bythis report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred duringthe registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that hasmaterially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal controlover financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financialreporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize andreport financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role inthe registrant’s internal control over financial reporting. Date: February 26, 2019 /s/ STEFAN J. MURRY Stefan J. Murry Chief Financial Officer Exhibit 32.1 CERTIFICATION Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the“Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the U.S. Code (18 U.S.C. § 1350), Chih-Hsiang (Thompson)Lin, President and Chief Executive Officer of Applied Optoelectronics, Inc. (the “Company”), and Stefan J. Murry, ChiefFinancial Officer of the Company, each hereby certifies that, to the best of his knowledge: 1. The Company’s Annual Report on Form 10-K for the period ended December 31, 2018, to which this Certification isattached as Exhibit 32.1 (the “Annual Report”) fully complies with the requirements of Section 13(a) or Section 15(d) of theExchange Act; and 2. The information contained in the Annual Report fairly presents, in all material respects, the financial condition andresults of operations of the Company. In Witness Whereof, the undersigned have set their hands hereto as of the 26th day of February, 2019. /s/ CHIH-HSIANG (THOMPSON) LIN /s/ STEFAN J. MURRYChih-Hsiang (Thompson) Lin Stefan J. MurryPresident and Chief Executive Officer Chief Financial Officer This certification accompanies the Annual Report to which it relates, is not deemed filed with the Securities and ExchangeCommission and is not to be incorporated by reference into any filing of Applied Optoelectronics, Inc. under the SecuritiesAct of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of theAnnual Report), irrespective of any general incorporation language contained in such filing. 

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