APPLIED OPTOELECTRONICS, INC. 10-K

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    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 2021 February 20, there were 36 holders of record of our common stock (not including beneficial holders of our common stock holding in street name).   The graph below shows the cumulative total stockholder return of an investment of $100 (and the reinvestment of any dividends thereafter) on September 26, 2013 (the first trading day of our common stock) in (i) our common stock, (ii) the NASDAQ Composite Index and (iii) the NASDAQ Telecommunications Index. Our stock price performance shown in the graph 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 such information be incorporated by reference into any future filing, except to the extent that we specifically state that such graph and related information are incorporated by reference into such filing.      29   Table of Contents   PERCENT 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 % 12/31/2017     379.72 %     139.28 %     182.27 % 12/31/2018     251.61 %     146.03 %     186.50 % 12/31/2019     119.28 %     159.83 %     236.90 % 12/31/2020     85.44 %     195.05 %     340.29 %   For equity compensation plan information refer to Item 12 of this 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 cash dividends on our common stock for the foreseeable future. We currently intend to retain all available funds and future earnings for use in the operation and expansion of our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend upon our financial condition, results of operations, terms of financing arrangements, 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.    30   Table of Contents   Item 6. Selected Financial Data      The selected consolidated financial data in this section is not intended to replace our consolidated financial statements 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 consolidated financial statements and related notes, all included elsewhere in this Form 10-K. We derived the consolidated statements of operations data for the years ended December 31, 2020, 2019 and 2018 and the consolidated balance sheet data as of December 31, 2020 and 2019 from our consolidated financial statements appearing elsewhere in this Form 10-K. The consolidated statement of operations data for the years ended December 31, 2017 and 2016 and the consolidated balance sheet data as of December 31, 2018, 2017 and 2016 are derived from our audited consolidated financial statements that have previously been filed with the SEC. Our historical results are not necessarily indicative of the results to be expected in the future and results of interim periods are not necessarily indicative of results for the entire year.    The following table sets forth our consolidated results of operations for the periods presented (in thousands, except share and per share data):        Years ended December 31,       2020     2019     2018     2017     2016   Consolidated Statements of Operations Data:                                         Revenue   $ 234,623     $ 190,872     $ 267,465     $ 382,329     $ 260,713   Cost of goods sold (1)     184,082       144,671       179,692       216,049       173,759   Gross profit     50,541       46,201       87,773       166,280       86,954   Operating expenses:                                         Research and development (1)     43,393       43,399       49,903       35,365       31,780   Sales and marketing (1)     14,087       10,060       9,141       8,702       6,627   General and administrative (1)     41,903       41,489       39,497       35,262       25,527   Total operating expenses     99,383       94,948       98,541       79,329       63,934   Income (loss) from operations     (48,842 )     (48,747 )     (10,768 )     86,951       23,020   Interest and other income (expense), net:                                         Interest income     255       925       282       221       247   Interest expense     (5,635 )     (5,405 )     (1,106 )     (858 )     (1,717 ) Other income (expense), net     2,998       1,840       1,814       (1,788 )     (547 ) Total interest and other income (expense), net     (2,382 )     (2,640 )     990       (2,425 )     (2,017 ) Income (loss) before income taxes     (51,224 )     (51,387 )     (9,778 )     84,526       21,003   Income tax (expense) benefit     (7,228 )     (14,662 )     7,632       (10,575 )     10,231   Net income (loss) attributable to common stockholders   $ (58,452 )   $ (66,049 )   $ (2,146 )   $ 73,951     $ 31,234   Net income (loss) per share attributable to common stockholders:                                         Basic   $ (2.67 )   $ (3.31 )   $ (0.11 )   $ 3.87     $ 1.82   Diluted   $ (2.67 )   $ (3.31 )   $ (0.11 )   $ 3.76     $ 1.76   Weighted average shares used to compute net income (loss) per share attributable to common stockholders:                                         Basic     21,866,630       19,982,363       19,646,646       19,097,355       17,201,731   Diluted     21,866,630       19,982,363       19,646,646       20,139,105       17,712,928   (1) These expenses include share-based compensation expense. Share-based compensation expense is accounted for at fair value, using the Black-Scholes option-pricing model for stock options and at the fair market value based on quoted market 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 sold and operating expenses as follows:   31   Table of Contents   The following table provides share-based compensation expense for the periods presented (in thousands):          Years ended December 31,       2020     2019     2018   Cost of goods sold   $ 937     $ 772     $ 795   Research and development     2,812       2,557       2,419   Sales and marketing     1,191       1,070       925   General and administrative     8,106       7,405       6,981   Total share-based compensation expense   $ 13,046     $ 11,804     $ 11,120     The following table provides selected balance sheet data for the periods presented (in thousands):        As of December 31,       2020     2019     2018     2017     2016   Consolidated balance sheet data:                                         Total cash, restricted cash, cash equivalents and short-term investments   $ 50,114     $ 67,028     $ 58,004     $ 83,984     $ 52,008   Working capital (1)     106,021       101,449       116,857       158,953       97,579   Total assets     480,805       466,825       466,840       452,948       322,318   Short-term obligations (2)     55,155       40,663       28,217       559       8,172   Long-term obligations (3)     99,766       101,676       60,328       48,964       34,961   Common stock and additional paid-in-capital     354,710       303,421       292,500       285,395       265,282   Total retained earnings (deficit)   $ (88,509 )   $ (30,057 )   $ 35,992     $ 38,138     $ (37,013 ) (1) Working capital is defined as total current assets less total current liabilities. (2) Short-term obligations are defined as short-term loans, operating and financing leases, notes payable and bank acceptance payable. (3) Long-term obligations are defined as long-term loans, operating and financing leases, notes payable and convertible senior notes.    32   Table of Contents   Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations     You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes appearing elsewhere in this Form 10-K. This discussion and other parts of this Form 10-K contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute 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 communications products at varying levels 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 laser components. From these foundational products, we design and manufacture a wide range of products to meet our customers’ needs and specifications, and such products differ from each other by their end market, intended use and level of integration. We are primarily focused on the higher-performance segments within the internet data center, CATV, telecom and FTTH markets which increasingly demand faster connectivity and innovation. Our vertically integrated manufacturing model provides us several advantages, including rapid product development, fast response times to customer requests and control over product quality and manufacturing costs.    The four end markets we target are all driven by significant bandwidth demand fueled by the growth of network-connected devices, video traffic, cloud computing and online social networking. Within the internet data center market, we benefit from the increasing use of higher-capacity optical networking technology as a replacement for copper cables, particularly as speeds reach 10 Gbps and above, as well as the movement to open internet data center architectures and the increasing use of in-house equipment design among leading internet companies. Within the CATV market, we benefit from a number of ongoing trends including the move to higher bandwidth networks among CATV service providers and the outsourcing of system design among CATV networking equipment companies. In the FTTH market, we benefit from continuing PON deployments and system upgrades among telecom service providers. In the telecom market, we benefit from deployment of new high-speed fiber-optic networks by telecom network operators, including 5G networks.    In 2020, 2019 and 2018, our revenue was $234.6 million, $190.9 million, and $267.5 million and our gross margin was 21.5%, 24.2%, and 32.8%. We have grown our annual revenue at a compound annual growth rate, or CAGR, of 17.2% between 2011 and 2020. In the years ended December 31, 2020, 2019 and 2018, we had net loss of $58.5 million, $66.0 million, and $2.1 million, respectively. At December 31, 2020 and 2019, our accumulated deficit was $88.6 million and $30.1 million, respectively. In 2020, we earned 73.9% of our total revenue from the internet data center market, and 16.2% of our 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 center operators. In 2020, revenue from the internet data center market, CATV market, telecom market and FTTH markets provided 73.9%, 16.2%, 9.0%, and 0.0% of our revenue, respectively, compared to75.2%, 19.6%, 4.4%, and 0.1% of our 2019 revenue, respectively. In 2020, our key customers in the data center market included, Microsoft Corp (Microsoft), Amazon.com (Amazon) and a multinational computer technology company. In 2020, 2019, and 2018, Microsoft accounted for 38.3%, 32.2%, and 22.1% of our revenue, Amazon accounted for 11.5%, 24.0%, and 12.1% of our revenue, and the multinational computer technology company accounted for 8.0%, 0.4%, and 0.0% of our revenue, respectively. In 2020, our key customers in the CATV market included Cisco Systems, Inc. (Cisco), a global broadband access and media distributor, and CommScope. In 2020, 2019 and 2018, Cisco accounted for 7.5%, 10.0%, and 9.9% of our revenue, respectively; CommScope accounted for 2.1%, 3.7%, and 2.1% of our revenue, respectively. The global broadband access and media distributor is a new customer in 2020, it accounted for 3.7% of our revenue in 2020.    33   Table of Contents   In 2020, our revenue increase of 22.9% over the prior-year was driven primarily by increased demand for our 100 Gbps transceivers in our data center market, and laser chips used in the manufacture of transceivers for 5G wireless communications in our telecom market. The increase in 100 Gbps demand includes increased demand from several existing customers, along with new customer additions.  We believe that some of this increase is related to increased demand for cloud-based services as a result of a shift to remote-working arrangements in the US and other areas, which in turn caused our customers to increase capacity in their data centers requiring more optical transceivers, especially 100 Gbps transceivers. The increase in 5G-related sales came mainly from customers in China, as wireless operators in that country have begun to deploy advanced 5G mobile networks. The slight increase in revenue for our CATV products is due to increased demand from CATV MSOs as they began to add capacity to their networks.  This increase in demand was at least partially attributable to network capacity expansion, particularly in the upstream direction, which is related to changes in network traffic due to increased working from home in the US earlier in the year.   We expect continued sales of our 40 Gbps and 100 Gbps products in 2021, and we expect that sales of 100 Gbps products will likely exceed sales of 40 Gbps products. However, quarter-to-quarter results may show considerable variability as is usual in a period of technology transition.  Similar to revenue, our gross margins can fluctuate materially depending on a variety of factors including average selling price changes, product mix, raw material cost reduction or increase, manufacturing utilization rate and changes in manufacturing efficiency. Furthermore, we are continuing to monitor and assess the effects of the coronavirus outbreak on our commercial and manufacturing operations, including any impact on our revenue in 2020.    Our sales model focuses on direct engagement and close coordination with our customers to determine product design, qualifications, performance and price. Our strategy is to use our direct sales force to sell to key accounts and to expand 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 and internet data center operators. Throughout our sales cycle, we work closely with our customers to qualify our products into their product lines. As a result, we strive to build strategic and long-lasting customer relationships and deliver products that are customized to our customers’ requirements.    Our business depends on winning competitive bid selection processes to develop components, systems and equipment for use in our customers’ products. These selection processes are typically lengthy, and as a result our sales cycles will vary based on the level of customization required, market served, whether the design win is with an existing or new customer and whether our solution being designed in our customers’ product is our first generation or subsequent generation product. We do not have any long-term purchase commitments (in excess of one year) with any of our customers, most of whom purchase our products on a purchase order basis, however, once one of our solutions is incorporated into a customer’s design, we believe that our solution is likely to continue to be purchased for that design throughout that product’s life cycle because of the time and expense associated with redesigning the product or substituting an alternative solution.    In 2020, 2019 and 2018, we had 30, 31, and 26 design wins, respectively. We define a design win as the successful completion of the evaluation stage, where our customer has tested our product, verified that our product meets substantially all of their requirements and has informed us that they intend to purchase the product from us. Although we believe that our ability to obtain design wins is a key strength and can provide meaningful and recurring revenue, an increase or decrease in the mere number of design wins does not necessarily correlate to a likely increase or decrease in revenue, particularly in the short term. As such, the number of design wins we achieve on a quarterly or annual basis and any increase or decrease in design wins will not necessarily result in a corresponding increase or decrease in revenue in the same or immediately succeeding quarter or year. For example, if our total number of design wins in an annual or quarterly period increases or decreases compared to the total number of design wins in a prior period, this does not necessarily mean that our revenue in such period will be higher or lower than our revenue in the prior period. In fact, our experience is that some design wins result in significant revenue and some do not, and the timing of such revenue is difficult to predict as it depends on the success of the end customer’s product that uses our components. Thus, some design wins result in orders and significant revenue shortly after the design win is awarded and other design wins do not result in significant orders and revenue for several months or longer after the initial design win (if at all). We do believe that over a period of years the collective impact of design wins correlates to our overall revenue growth.   COVID-19 Pandemic   We are subject to risks and uncertainties as a result of the COVID-19 pandemic. The extent of the impact of the COVID-19 pandemic on our business is highly uncertain and difficult to predict as coronavirus continues to spread around the world. The vaccine still has not become widely available to our workforce, and treatments are limited. In March 2020, we instituted travel restrictions and implemented sanitation and disinfection procedures to safeguard the health and safety of our employees which continue today. We have modified our workplace practices, which resulted in many employees working remotely. The spread of COVID-19 may still impact our supply chain operations through restrictions, reduced capacity and shutdown of business activities by suppliers whom we rely on for sourcing components and materials and third-party partners whom we rely on for manufacturing, warehousing and logistics services. Although demand for our products has been strong in the short-term as subscribers seek more bandwidth, customers’ purchasing decisions over the long-term may be impacted by the pandemic and its impact on the economy, which could in turn impact our revenue and results of operations. The extent to which the COVID-19 pandemic may materially impact our financial condition, liquidity or results of operations is uncertain.   34   Table of Contents   Factors Affecting Our Performance      Increasing Consumer Demand for Bandwidth. Bandwidth demand in all of our target markets is driving service provider investment in new equipment and in turn generating demand for our products. Increasingly, optical networking technologies 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 cases our products are only minimally differentiated from those of our competitors.  In addition, our sales are heavily concentrated with a small number of end customers.  As a result, there is strong pricing pressure across many of our product lines.  We have addressed this strong pressure in several ways:      ‑ Lowering our material costs.  In some cases, we are able to negotiate more favorable pricing from our raw material suppliers.  Also, where feasible, we are often able to develop internal production for certain materials that were previously purchased from other companies.  This generally has resulted in lower material costs for us.      ‑ Enhancing the efficiency of our production process.  We have been able to automate many of our production processes, which often results in lower labor costs and reduced scrap or rework rates, both of which lower our production cost.  In some cases, we have been able to redesign our products to make them less complex to manufacture, and when possible during these redesigns we also incorporate lower cost raw materials.      ‑ Introducing new products.  In many cases, newly released products have more features and often higher prices compared with older products.  By regularly introducing new products, we attempt to minimize the average price reduction we experience.  However, we often initially experience lower gross margins on new products, as our pricing is based upon anticipated volume-driven cost reductions over the life of the design win. Thus, if we are unable to realize our expected cost reductions, we may experience declining gross margins on such products.    Our product pricing is established when the product is initially introduced to the market, and thereafter through periodic negotiations with customers. We generally do not agree to periodic automatic price reductions. Furthermore, due to the dynamics in the CATV market and the value of our outsourced design services to our customers, we believe we face less downward price pressure than many of our competitors in this market. We sell a wide variety of products among our four target markets and our gross margin is heavily dependent in any quarter on the product mix achieved during that period as well as any price changes that we have agreed upon with our customers.    Customer Concentration within End Markets. Historically, our revenue has been significantly concentrated, first within the CATV market and now2020 within the internet data center market. Moreover, within these markets, revenue tends to be concentrated among a small number of customers. In the last three years, we have taken several actions to increase the diversity of our customer base. These actions include hiring additional sales staff to improve our ability to serve new customers and introduction of new products that we believe 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. We had two and four customers that each accounted for more than 10% of our revenue in 2020 and 2019, respectively.    Product Development. We invest heavily to develop new and innovative products. The majority of our research and development 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 of our research and development expenditures.    35   Table of Contents   Discussion 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 we anticipate that we will continue to do so for the foreseeable future. The following chart provides the revenue contribution from each of the markets we serve for the years 2020, 2019 and 2018, as well as the corresponding percentage of our total revenue for each period (in thousands, except percentages):       Years ended December 31,   Market   2020     2019     2018   Data Center   $ 173,437     $ 143,562     $ 200,236   CATV     37,944       37,328       51,699   Telecom     21,092       8,429       13,159   FTTH     110       190       818   Other     2,040       1,363       1,553   Total   $ 234,623     $ 190,872     $ 267,465         Percentage of Revenue   Data Center     73.9 %     75.2 %     74.9 % CATV     16.2 %     19.6 %     19.3 % Telecom     9.0 %     4.4 %     4.9 % FTTH     0.0 %     0.1 %     0.3 % Other     0.9 %     0.7 %     0.6 % Total Revenue     100 %     100 %     100 %   In 2020, 2019 and 2018, our top ten customers represented 84.3%, 88.1%, and 92.9% of our revenue, respectively.    Revenue is recognized when obligations under the terms of a contract with our customer are satisfied; generally this occurs with the transfer of control of products or services. Revenue is measured as the amount of consideration we expect to receive 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, 2020, 36.3% of our total revenue was manufactured at our China-based subsidiary, with $12.8 million denominated in RMB and 55.9% of our total revenue was from products manufactured at our Taiwan-based facility with no revenue denominated in NT dollars. We expect a similar portion of our sales to be denominated in foreign currencies in 2021.    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 as increases or decreases in the cost of raw materials used in production. We typically experience lower yields and higher associated costs on new products. For our mature products, we can experience lower yields and higher production costs if customer 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 product declines over time as a result of increasing efficiencies in the manufacturing processes, or supply cost declines, as well as yield improvements and testing enhancements.    We manufacture products in three of our four facilities located in the U.S., Taiwan and China. Generally, laser chips and optical components are manufactured in our Sugar Land facility, optical components and subassemblies are manufactured in our Taiwan facility, and optical components, subassemblies 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 and finished goods that we sell between and among our respective manufacturing operations. We base those internal sales upon established transfer pricing methodologies. However, we eliminate all of those internal sales, and cost of goods sold transactions, to arrive at total revenue and cost of goods sold on a consolidated basis.    36   Table of Contents   We 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 manufacturing location.    Gross profit as a percentage of total revenue, or gross margin, has been and is expected to continue to be affected by a variety of factors, including the introduction of new products, production volumes, the mix of products sold, the geographic 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 average selling prices of our products. Although our overall gross margins over the past three years have been between 21.5% and 32.8%, our gross margins vary more broadly on a product-by-product basis. Our newer and more advanced products typically have higher average selling prices and higher gross margins; however, until the product volumes scale, the gross margin from newer and advanced products may initially be lower. Within our markets, we may sell similar products to different geographic regions at different prices, and therefore realize different gross margins among those similar products. Our strategy is to improve our gross margins through vertical integration such as utilization of our own laser chips and optical sub-components in our solutions. We expect that our gross margins are likely to continue to fluctuate from quarter to quarter because 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 administrative expenses. Personnel costs are the most significant component of operating expenses and include salaries, benefits, bonuses and 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 and allocated 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. Customers rely upon us to assist them with the development of new products and modification of existing products because of our extensive optical design and manufacturing expertise. We work closely with our customers in the critical design phase of product development and are occasionally reimbursed for some of these development efforts. We expect research and development expense to increase on a dollar basis, but will likely decrease as a percentage of our revenue to the extent that revenue increases over time.   Sales and marketing.   Sales and marketing expense consists primarily of personnel costs, including share-based compensation for our sales and marketing personnel, as well as travel and trade show expense, shipping and tariff expense, sales commissions and the allocation of overall corporate services and facility costs. We sell our products to customers who either incorporate our products into their offering or resell our products to end customers. Because we sell to a limited number of well-established customers, we employ a limited number of sales professionals who are able to cover large markets. We compensate our sales staff through base salary and commissions, with base salary being the largest component of overall compensation. Total sales commissions to employees amounted to less than one percent of our revenue in 2020, 2019 and 2018. Additionally, we pay commissions to third parties on certain product lines and identified customers, which also amounted to less than one percent of our revenue in 2020, 2019 and 2018. As such, our sales and marketing expense does not directly increase with revenue. In the future, we expect sales and marketing expense to increase on a dollar basis as we incrementally increase our overall sales activities, but expect our sales and marketing expense to decline as a percentage of revenue, to the extent our revenue increases over time.   General and administrative.   General and administrative expense consists primarily of personnel costs, including share-based compensation, primarily for our finance, human resources, legal and information technology personnel and certain executive officers, as well as professional services costs related to accounting, tax, banking, legal and information technology services, depreciation of capital equipment and facility costs. We expect general and administrative expense to increase as we continue to grow in both size and complexity as a public company. We expect rising costs including increased audit and legal fees, costs to comply with rules and regulations applicable to companies listed on a national stock exchange, as well as investor relations expense and higher insurance premiums. In the future, we expect general and administrative expense to increase on a dollar basis but to decline as a percentage of revenue, to the extent that our revenue increases over time.   37   Table of Contents    Other income (expense)      Interest income consists of income earned on our cash, cash equivalents and short-term investments. Interest expense consists of amounts paid for interest on our short-term and long-term debt borrowings, and convertible senior notes.    Other income (expense), net is primarily made up of government subsidizes income and foreign currency transaction gains and losses. The functional currency of our China subsidiary is the RMB and the foreign currency transaction gains and losses of our China subsidiary primarily result from their transactions in U.S. dollars. The functional currency of our Taiwan location is the NT dollar and the 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 of countries throughout the world, including Taiwan and China. Consequently, our effective tax rate is impacted by the geographic distribution of our earnings or losses and the tax laws and regulations in each geographical region. We expect that our income taxes will vary in relation to our profitability and the geographic distribution of our profits. In 2020 our effective tax rate was (14.1%). In 2019 and 2018, our effective tax rate was (28.5%) and 78.1%, respectively.    Our wholly owned subsidiary, Global Technology, Inc., has received preferential tax concessions in China as a national high-tech enterprise. In March 2007, China’s parliament enacted the PRC Enterprise Income Tax Law, or the EIT Law, under which, effective January 1, 2008, China adopted a uniform income tax rate of 25% for all enterprises including foreign invested enterprises. Global was recognized as a national high-tech enterprise in 2008 and was entitled to a 15% tax rate for a three year period. Global renewed its national high-tech enterprise certificate in 2011, 2014, 2017 and 2020, extending its three year tax preferential status through December 2023.    For the years ended December 31, 2020 and 2019, we had $0.2 million and $0.2 million, respectively, of unrecognized tax benefits related to U.S. tax benefits recognized for which we do not meet the more likely than not threshold.    See additional information regarding income taxes in Note O, included in Part II, Item 8 of this Form 10-K.    Seasonality      We believe that the demand for our CATV products is seasonal. Historically, revenue derived from our CATV products has usually been highest in the second or third quarter and lowest in the first quarter of each year. The first quarter of the year has historically been negatively affected by reduced economic activity due to the Lunar New Year holiday and the lower 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 our sales data does not indicate a significant trend with respect to these products. In 2017, we began to manufacture a meaningful quantity of internet data center products in our Ningbo, China factory. This factory experiences a lengthy shut-down associated with the Lunar New Year holiday which occurs in Q1 of each year. In addition to the factory shut-down, it is also common for employees in the factory to fail to return to work following resumption of operations. In the years 2020, 2019, and 2018, the percentage of employees in our China factory who resigned or were terminated during Q1, relative to the average number of employees during the quarter was 217%, 122%, and 90%, respectively.   However, we believe that the turnover in 2020 was higher than usual due to the COVID-19 pandemic which caused travel restrictions, additional health check requirements, and a lengthy shutdown of operations in Ningbo.  We believe that our employee turnover would likely have been lower in 2020 without these effects, but we cannot quantitatively estimate the turnover due to COVID-19.  As a result of this employee turnover, we must hire and train replacement employees. These replacement employees require a period of training and improvement, and this impacts the quantity of products we can produce in the quarter. The combined effect of the factory shut-down and employee turnover in the quarter may also contribute to negative seasonality in Q1.   38   Table of Contents   Our gross margin varies quarter to quarter and varies primarily due to the product mix in a particular quarter, as well as from the level of manufacturing efficiencies, production yields (particularly in the laser chip fabrication process) and overall supply costs.    Results of Operations      The following table set forth our results of operations for the periods presented and as a percentage of our revenue for those periods. The period-to-period comparison of our financial results is not necessarily indicative of our financial results to be achieved in future periods.        Years ended December 31,       2020     2019     2018   Revenue, net     100.0 %     100.0 %     100.0 % Cost of goods sold     78.5 %     75.8 %     67.2 % Gross profit     21.5 %     24.2 %     32.8 % Operating expenses                         Research and development     18.5 %     22.7 %     18.6 % Sales and marketing     6.0 %     5.3 %     3.4 % General and administrative     17.9 %     21.7 %     14.8 % Total operating expenses     42.4 %     49.7 %     36.8 % Income (loss) from operations     (20.8 )%     (25.5 )%     (4.0 )% Interest and other income (expense), net     (1.0 )%     (1.4 )%     0.4 % Income (loss) before income taxes     (21.8 )%     (26.9 )%     (3.6 )% Income tax benefit (expense)     (3.1 )%     (7.7 )%     2.8 % Net income (loss)     (25.0 )%     (34.6 )%     (0.8 )%   Comparison of Years Ended December 31, 2020 and 2019    Revenue      We generate revenue through the sale of our products to equipment providers and network operators 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 we anticipate that we will continue to do so for the foreseeable future. The following charts provide the revenue contribution from each of the markets we served for the years ended December 31, 2020 and 2019 (in thousands, except percentages):        Years ended December 31,     Change               % of             % of                       2020     Revenue     2019     Revenue     Amount     %   Data Center   $ 173,437       73.9 %   $ 143,562       75.2 %   $ 29,875       20.8 % CATV     37,944       16.2 %     37,328       19.6 %     616       1.6 % Telecom     21,092       9.0 %     8,429       4.4 %     12,663       150.2 % FTTH     110       0.0 %     190       0.1 %     (80 )     (42.1 )% Other     2,040       0.9 %     1,363       0.7 %     677       49.7 % Total Revenue   $ 234,623       100.0 %   $ 190,872       100.0 %   $ 43,751       22.9 %   The increase in revenue for the year was driven primarily by increased demand for our 100 Gbps transceivers in our data center market, and laser chips used in the manufacture of transceivers for 5G wireless communications in our telecom market. The increase in 100 Gbps demand includes increased demand from several existing customers, along with new customer additions.  We believe that some of this increase is related to increased demand for cloud-based services as a result of a shift to remote-working arrangements in the US and other areas, which in turn caused our customers to increase capacity in their data centers requiring more optical transceivers, especially 100 Gbps transceivers. The increase in 5G-related sales came mainly from customers in China, as wireless operators in that country have begun to deploy advanced 5G mobile networks. The slight increase in revenue for our CATV products is due to increased demand from CATV MSOs as they began to add capacity to their networks.  This increase in demand was at least partially attributable to network capacity expansion, particularly in the upstream direction, which is related to changes in network traffic due to increased working from home in the US earlier in the year.  Towards the end of 2020, we saw a slow-down in orders from certain customers in our datacenter and telecom markets.  We attribute the slowdown in datacenter business to absorption of previously-purchased inventory and in our telecom business to slow-down in the rate of deployment of new 5G mobile networks in China.  We believe that both of these effects are temporary and we expect that they should be resolved in 2021.   In the years ended December 31, 2020 and 2019, our top ten customers represented 84.3%, and 88.1% of our revenue, respectively. We believe that diversifying our customer base is critical for our future success, since reliance on a small number of key customers makes our ability to forecast future results dependent upon the accuracy of the forecasts we receive from those key customers.   39   Table of Contents     Cost of goods sold and gross margin          Years ended December 31,                       2020     2019     Change               % of             % of                       Amount     Revenue     Amount     Revenue     Amount     %       (in thousands, except percentages)   Cost of goods sold   $ 184,082       78.46 %   $ 144,671       75.80 %   $ 39,411       27.2 % Gross margin     50,541       21.54 %     46,201       24.20 %                   Cost of goods sold increased by $39.4 million, or 27.2%, from 2019 to 2020, primarily due to a 22.9% increase in sales over the prior year. The decrease in gross margin for the year ended December 31, 2020 compared to the same period ended December 31, 2019 was primarily the result of changes in the mix of products within our datacenter segment. In particular, we saw an increase in sales of certain lower-cost 100 Gbps transceivers, designed for shorter reaches within the datacenter, relative to sales of transceivers designed for longer reaches. This product mix resulted in an overall reduction in gross margin. Also contributing to the reduced gross margin was production inefficiencies, and higher costs of certain raw materials.    Operating expenses          Years ended December 31,                       2020     2019     Change               % of             % of                       Amount     revenue     Amount     revenue     Amount     %       (in thousands, except percentages)   Research and development   $ 43,393       18.5 %   $ 43,399       22.7 %   $ (6 )     (0.0 )% Sales and marketing     14,087       6.0 %     10,060       5.3 %     4,027       40.0 % General and administrative     41,903       17.9 %     41,489       21.7 %     414       1.0 % Total operating expenses   $ 99,383       42.4 %   $ 94,948       49.7 %   $ 4,435       4.7 %   Research and development expense      Research and development expense was comparable between 2019 and 2020. Research and development costs consist of R&D work orders, R&D material usage and other project related costs related to 100 Gbps, 200/400 Gbps data center products, DOCSIS 3.1 capable CATV products, including remote-PHY products and 1.2 GHz-capable amplifier products,  and other new product development, and depreciation expense resulting from R&D equipment investments.     40   Table of Contents   Sales and marketing expense      Sales and marketing expense increased by $4.0 million, or 40.0%, from 2019 to 2020. These increases were primarily due to increase in commission expenses, duties and freight. These increases were partially offset by a decrease in trade show expenses and travel-related costs as a result of the COVID-19 pandemic.  As a result of the pandemic outbreak, the Company has modified many of its customary business practices by limiting employee travel including cancelling in-person participation in various meetings, events and conferences.     General and administrative expense    General and administrative expense increased by $0.4 million, or 1.0%, from 2019 to 2020. These increases were primarily due to an increase in personnel-related costs, share-based compensation expense and insurance expense. These increases were partially offset by a decrease in legal expenses, some of which were paid by our insurance carrier rather than the Company, as legal expenses related to the first of our shareholder class action lawsuits have exceeded the retention in our insurance contract.     Other income (expense), net         Years ended December 31,                       2020     2019     Change               % of             % of                   Amount   revenue     Amount     revenue     Amount           %       (in thousands, except percentages)   Interest income   $ 255       0.1 %   $ 925       0.5 %   $ (670 )     (72.4 )% Interest expense     (5,635 )     (2.4 )%     (5,405 )     (2.8 )%     (230 )     4.3 % Other income (expense), net     2,998       1.3 %     1,840       1.0 %     1,158       62.9 % Total other income (expense), net   $ (2,382 )     (1.0 )%   $ (2,640 )     (1.4 )%   $ 258       (9.8 )%   Interest income decreased by $0.6 million, or 72.4% from 2019 to 2020. The changes are similar to expected rates of fluctuation with the interest rates and cash balances.    Interest expense increased by $0.2 million, or 4.3% from 2019 to 2020 due to higher average debt balances during the year.    Other income increased by $1.2 million, or 62.9% from 2019 to 2020.This increases was primarily due to the receipt of government subsidies associated with COVID-19 pandemic in Taiwan.    Benefit (provision) for income taxes          Years ended December 31,       2020     2019     Change       (in thousands, except percentages)   Benefit (provision) for income taxes   $ (7,228 )   $ (14,662 )     7,434       (50.7 )%   Our income tax provision consists of U.S. income tax, state taxes, and Taiwan and China income tax recorded during the periods. Our effective tax rate is affected by recurring items, such as tax rates in state and foreign jurisdictions and the relative amounts of income we earn in those jurisdictions.   We recorded a tax expense of $7.2 million for the year ended December 31, 2020 as compared to $14.7 million for the year ended December 31, 2019. The income tax expense in the year ended December 31, 2020 was primarily related to the change of the valuation allowance, deferred tax assets, and the recording of a valuation allowance on Taiwan and China deferred tax assets. The income tax expense recorded in the year ended December 31, 2019 was primarily related to recognition of research and development credits, offset by the recognition of a valuation allowance on our US and state deferred tax assets, and due to excess tax benefits attributable to share-based compensation, and as well as the tax rates in foreign jurisdictions.   41   Table of Contents   Comparison of Years Ended December 31, 2019 and 2018    Revenue      We generate revenue through the sale of our products to equipment providers and network operators for the internet data center, CATV, FTTH, telecom and other markets. We derive a significant portion of our revenue from our top ten customers, and we anticipate that we will continue to do so for the foreseeable future. The following charts provide the revenue contribution from each of the markets we served for the years ended December 31, 2019 and 2018 (in thousands, except percentages):       Years ended December 31,     Change               % of             % of                       2019     Revenue     2018     Revenue     Amount     %   Data Center   $ 143,562       75.2 %   $ 200,236       74.9 %   $ (56,674 )     (28.3 )% CATV     37,328       19.6 %     51,699       19.3 %     (14,371 )     (27.8 )% Telecom     8,429       4.4 %     13,159       4.9 %     (4,730 )     (35.9 )% FTTH     190       0.1 %     818       0.3 %     (628 )     (76.8 )% Other     1,363       0.7 %     1,553       0.6 %     (190 )     (12.2 )% Total Revenue   $ 190,872       100.0 %   $ 267,465       100.0 %   $ (76,593 )     (28.6 )%   The decrease in revenue for the year was driven primarily by decreased demand for our 40 Gbps and 100 Gbps transceivers. The decrease in 100 Gbps demand was mostly from one major customer, while this decrease was partially offset by growth in 100 Gbps transceivers from another of our major customers. We believe that the decrease in 40 Gbps transceiver sales is related to a broad industry trend of reducing 40 Gbps infrastructure in favor of 100 Gbps infrastructure. The decrease in revenue in our CATV market for the year was mainly a result of reduced overall market demand for CATV outside plant products, which we attribute to reduced desire on the part of CATV MSOs to deploy capex to increase their network capacity. The decrease in revenue in our telecom market was primarily attributable to decreased demand for certain of our legacy telecom products by our customers, partially offset by sales of newer-generation products such as those designed for 5G mobile networks.   In the years ended December 31, 2019 and 2018, our top ten customers represented 88.1%, and 92.9% of our revenue, respectively.   Cost of goods sold and gross margin          Years ended December 31,                       2019     2018     Change               % of             % of                       Amount     Revenue     Amount     Revenue     Amount     %       (in thousands, except percentages)   Cost of goods sold   $ 144,671       75.80 %   $ 179,692       67.2 %   $ (35,021 )     (19.5 )% Gross margin     46,201       24.20 %     87,773       32.8 %                   Cost of goods sold decreased by $35.0 million, or 19.5%, from 2018 to 2019, primarily due to a 28.6% decrease in sales over the prior year. The decrease in gross margin for the year ended December 31, 2019 compared to the same period ended December 31, 2018 was primarily the result of changes in the mix of products within our datacenter segment. In particular, we saw an increase in sales of certain lower-cost 100 Gbps transceivers, designed for shorter reaches within the datacenter, relative to sales of transceivers designed for longer reaches. This product mix resulted in an overall reduction in gross margin. Also contributing to the reduced gross margin was quality and testing costs that we incurred in the first part of the year.   Operating expenses          Years ended December 31,                       2019     2018     Change               % of             % of                       Amount     revenue     Amount     revenue     Amount     %       (in thousands, except percentages)   Research and development   $ 43,399       22.7 %   $ 49,903       18.6 %   $ (6,504 )     (13.0 )% Sales and marketing     10,060       5.3 %     9,141       3.4 %     919       10.1 % General and administrative     41,489       21.7 %     39,497       14.8 %     1,992       5.0 % Total operating expenses   $ 94,948       49.7 %   $ 98,541       36.8 %   $ (3,593 )     (3.6 )%   42   Table of Contents   Research and development expense      Research and development expense decreased by $6.5 million, or 13.0%, from 2018 to 2019. Research and development costs consist of R&D work orders, R&D material usage and other project related costs related to 40 Gbps, 100 Gbps, and 200/400 Gbps data center products, DOCSIS 3.1 capable CATV products, including remote-PHY products, and other new product development, and depreciation expense resulting from R&D equipment investments. Research and development costs decreased from 2018 to 2019 due mainly to decreases in costs from R&D work orders, depreciation expense related to R&D equipment, and materials and supplies used in R&D activities. These decreases were offset by increases in personnel related costs.   Sales and marketing expense      Sales and marketing expense increased by $0.9 million, or 10.1%, from 2018 to 2019. This increase was due to increases in personnel costs, share-based compensation expenses, duties and freight, and trade show expenses.    General and administrative expense    General and administrative expense increased by $2.0 million, or 5.0%, from 2018 to 2019. These increases were primarily due to an increase in share-based compensation expenses, depreciation expenses, insurance expenses and professional service fees, including legal expenses. These increases were partially offset by a decrease in personnel related costs.   Other income (expense), net         Years ended December 31,                       2019     2018     Change               % of             % of                       Amount     revenue     Amount     revenue     Amount     %       (in thousands, except percentages)   Interest income   $ 925       0.5 %   $ 282       0.1 %   $ 643       228.0 % Interest expense     (5,405 )     (2.8 )%     (1,106 )     (0.4 )%     (4,299 )     388.7 % Other income (expense), net     1,840       1.0 %     1,814       0.7 %     26       1.4 % Total other income (expense), net   $ (2,640 )     (1.4 )%   $ 990       0.4 %   $ (3,630 )     (366.7 )%   Interest income increased by $0.6 million, or 228.0% from 2018 to 2019 due to higher interest rates and larger cash balances during the year.   Interest expense increased by $4.3 million, or 388.7% from 2018 to 2019 due to higher debt balances, including convertible senior notes and higher interest rates during the year.   Other income increased slightly from 2018 to 2019. This increase was primarily due to the receipt of government subsidies associated with our investments in new product development and for qualifying as a high-tech enterprise in China. These increases were partially offset by the decrease in foreign currency transaction gains.   Benefit (provision) for income taxes        Years ended December 31,       2019     2018     Change       (in thousands, except percentages)   Benefit (provision) for income taxes   $ (14,662 )   $ 7,632       (22,294 )     (292.1 )%   Our income tax expense (benefit) consisted of U.S. income tax, state taxes, Taiwan and China income tax recorded during the periods. Our effective tax rate was affected by recurring items, such as tax rates in state and foreign jurisdictions and the relative amounts of income we earned in those jurisdictions.   We recorded a tax expense of $14.7 million for the year ended December 31, 2019 as compared to the tax benefit of $ 7.6 million for the year ended December 31, 2018. The income tax expense in the year ended December 31, 2019 was primarily related to the recognition of research and development credits, offset by the recognition a valuation allowance on our US and state deferred tax assets, and due to excess tax benefits attributable to share-based compensation, and as well as the tax rates in foreign jurisdictions. The income tax benefit recorded in the year ended December 31, 2018 was primarily 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.     43   Table of Contents    Liquidity and Capital Resources    As of December 31, 2020, we had $28.6 million of unused borrowing capacity from all of our loan agreements. As of December 31, 2020, our cash, cash equivalents, restricted cash and short-term investments totaled $50.1 million. Cash and cash equivalents are held for working capital purposes and are invested primarily in money market or time deposit funds.   On October 24, 2019, we filed a Registration Statement on Form S-3 with the Securities and Exchange Commission, which was declared effective on January 9, 2020, providing for the public offer and sale of certain securities of the Company from time to time, at our discretion, up to an aggregate amount of $250 million.    On February 28, 2020, we entered into an Equity Distribution Agreement (the “Agreement”) with Raymond James & Associates, Inc. (the “Sales Agent”) pursuant to which the Company may issue and sell shares of the Company’s common stock, par value $0.001 per share (the “Shares”) having an aggregate offering price of up to $55 million from time to time through the Sales Agent.  Upon delivery of a placement notice and subject to the terms and conditions of the Agreement, sales, if any, of the Shares will be made through the Sales Agent in transactions that are deemed to be “at the market” offerings as defined in Rule 415 of the Securities Act of 1933, as amended (the “Securities Act”), including sales made through the facilities of the Nasdaq Global Market, the principal trading market for the Company’s common stock, on any other existing trading market for the Company’s common stock, to or through a market maker or as otherwise agreed by the Company and the Sales Agent. In the placement notice, the Company will designate the maximum number of Shares to be sold through the Sales Agent, the time period during which sales are requested to be made, the minimum price for the Shares to be sold, and any limitation on the number of Shares that may be sold in any one day. Subject to the terms and conditions of the Agreement, the Sales Agent will use its commercially reasonable efforts to sell Shares on the Company’s behalf up to the designated amount specified in the placement notice. The Company has no obligation to sell any Shares under the Agreement and may at any time suspend offers and sales of the Shares under the Agreement.   The Agreement provides that the Sales Agent will be entitled to compensation of up to 2% of the gross sales price of the Shares sold through the Sales Agent from time to time. The Company has also agreed to reimburse the Sales Agent for certain specified expenses in connection with the registration of Shares under state blue sky laws and any filing with, and clearance of the offering by, the Financial Industry Regulatory Authority Inc., not to exceed $10,000 in the aggregate, and any associated application fees incurred. Additionally, if the Agreement is terminated under certain circumstances, and the Company fails to sell a minimum amount of the Shares as set forth in the Agreement, then the Company has agreed to reimburse the Sales Agent for reasonable out-of-pocket expenses, including the reasonable fees and disbursements of counsel incurred by the Sales Agent, up to a maximum of $30,000 in the aggregate. The Company agreed to indemnify the Sales Agent against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that the Sales Agent may be required to make because of any of those liabilities.   In March 2020, we commenced sales of common stock through an At-The-Market (ATM) Offering. The details of the shares of common stock sold through the ATM Offering through December 31, 2020 are as follows (in thousands, except shares and weighted average per share price):    Distribution Agent   Month   Weighted Average Per Share Price     Number of Shares Sold     Net Proceeds     Compensation to Distribution Agent   Raymond James & Associates, Inc.   March 2020   $ 9.2131       4,300     $ 39     $ 1.00   Raymond James & Associates, Inc.   May 2020     8.7387       923,160       7,906       161   Raymond James & Associates, Inc.   June 2020     9.5314       654,558       6,114       125   Raymond James & Associates, Inc.   July 2020     11.0942       689,936       7,501       153   Raymond James & Associates, Inc.   August 2020     13.652       89,988       1,204       25   Raymond James & Associates, Inc.   November 2020     7.7575       1,189,861       9,046       185   Raymond James & Associates, Inc.   December 2020     8.4844       918,377       7,636       156     As of December 31, 2020, the total gross sales were $40.3 million and thus remaining amount of common stock we have available to sell under the ATM Offering is $14.7 million. The Company completed its ATM Offering in January 2021. Also refer to Note U “Subsequent Event” to the consolidated financial statements for further discussion of the Notes.   On March 5, 2019, the Company issued $80.5 million of 5% convertible senior notes due 2024, bearing interest at a rate of 5% per year maturing on March 15, 2024, unless earlier repurchased, redeemed or converted in accordance with their terms. The sale of the Notes generated net proceeds of $76.4 million, after expenses. Also refer to Note L “Convertible Senior Notes” to the consolidated financial statements for further discussion of the Notes.   The table below sets forth selected cash flow data for the periods presented (in thousands):       Years ended December 31,       2020     2019     2018   Net cash provided by (used in) operating activities   $ (44,009 )   $ (1,754 )   $ 14,029   Net cash used in investing activities     (19,347 )     (32,116 )     (76,514 ) Net cash provided by financing activities     47,441       42,596       34,803   Effect of exchange rates on cash and cash equivalents     (999 )     298       1,738   Net increase (decrease) in cash   $ (16,914 )   $ 9,024     $ (25,944 )     44   Table of Contents     Operating activities     In 2020, net cash used in operating activities was $44.0 million. Net cash used in operating activities consisted of our net loss of $58.5 million, after the exclusion of non-cash items of $48.9 million, an increase in accounts receivable from our customers of $8.4 million and an increase in inventory of $23.7 million and decrease in accounts payable to our vendor of $3.3 million.   In 2019, net cash used in operating activities was $1.8 million. Net cash used in operating activities consisted of our net loss of $66.0 million, after the exclusion of non-cash items of $57.8 million, an increase in accounts receivable from our customers of $4.3 million and a decrease in accrued liabilities of $0.3 million. These cash decreases were offset by a decrease in inventory of $1.6 million, an increase in accounts payable to our vendors of $3.2 million, a decrease in prepaid tax of $1.0 million and a decrease in other current assets of $5.5 million.   In 2018, net cash provided by operating activities was $14.0 million. Net cash provided by operating activities consisted of our net loss of $2.1 million, after the exclusion of non-cash items of $38.5 million, an increase in accounts receivable from our customers of $29.3 million and an increase in accrued liabilities of $0.6 million. These cash increase were offset by an increase in inventory of $28.4 million, a decrease in account payable to our vendors of $13.7 million, a decrease in accrued income tax of $7.4 million and an increase in other current assets of $3.0 million.   Investing activities      Our investing activities consisted primarily of capital expenditures and purchases of intangible assets.    In 2020, net cash used in investing activities was $19.3 million. The net cash used consisted of spending on China factory construction, purchase and prepaid of additional property, plant and equipment of $19.1 million.   In 2019, net cash used in investing activities was $32.1 million. The net cash used consisted of spending on China factory construction, purchase and prepaid of additional property, plant and equipment of $31.5 million.    In 2018, net cash used in investing activities was $76.5 million. The net cash used consisted of spending on property, plant and equipment and land use rights of $77.4 million offset by sales proceeds from equipment of $0.7 million.    Financing activities      Our financing activities have historically consisted primarily of proceeds from the issuance of common stock and arrangements with various commercial lenders.    In 2020, our financing activities provided $47.4 million in cash. This increase in cash was due to $39.2 million of net proceeds from our At The Market (ATM) Offering, $6.2 million proceeds from PPP term loan, and $3.4 million net proceeds from acceptances payable and long-term debt.    In 2019, our financing activities provided $42.6 million in cash. We received $76.4 million proceeds from the issuance of convertible senior notes offset by net bank loan and bank acceptance notes repayments of $32.9 million. These activities were offset by $0.9 million related to tax withholding associated with employee share-based compensation.    In 2018, our financing activities provided $34.8 million in cash. We received $38.8 million in net borrowings associated with our bank loans and bank acceptance notes. These activities were offset by $4.1 million related to tax withholding associated with employee share-based compensation.         45   Table of Contents     Loans and commitments     We have lending arrangements with several financial institutions. In the US, we have a revolving line of credit and a PPP Term Note with Truist Bank. The line of credit contains financial covenants that may limit the amount and types of debt that we may incur. As of December 31, 2020, we were in compliance with these covenants.    In Taiwan, we have a revolving credit facility with Taishin International Bank, and an equipment finance agreement with Chailease Finance Co., Ltd. for Prime World’s Taiwan Branch. In China, we have a revolving line of credit with China Merchants Bank Co., Ltd. and Shanghai Pudong Development Bank Co., Ltd and a credit facility with China Zheshang Bank Co., Ltd. for our China subsidiary, Global.   As of December 31, 2020, we had $28.6 million of unused borrowing capacity.    On March 5, 2019, the Company issued $80.5 million of 5% convertible senior notes due 2024. The Notes will mature on March 15, 2024, unless earlier repurchased, redeemed or converted in accordance with their terms.   See Note K “Notes Payable and Long-term Debt” and Note L “Convertible Senior Notes” of our Consolidated Financial Statements for a description of our notes payable and long-term debt and convertible senior notes.    China factory construction    On February 8, 2018, we entered into a construction contract with Zhejiang Xinyu Construction Group Co., Ltd. for the construction of a new factory and other facilities at our Ningbo, China location.  Construction costs for these facilities under this contract are estimated to total approximately $27.5 million. As of December 31, 2020, construction of the building is complete, and approximately $27.4 million of this total cost has been paid and the remaining portion will be paid in yearly installments for three years after final inspection. We anticipate additional expenses for building improvements to the factory and we are in the process of evaluating the timing of these expenditures and obtaining bids for any such work.     Future liquidity needs      We believe that our existing cash and cash equivalents, cash flows from our operating activities, and available credit will be sufficient to meet our anticipated cash needs for the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support our research and development efforts, the expansion of our sales and marketing activities, the introduction of new and enhanced products, changes in our manufacturing capacity and the continuing market acceptance of our products.  In the event we need additional liquidity, we will explore additional sources of liquidity. These additional sources of liquidity could include one, or a combination, of the following: (i) issuing equity or debt securities, (ii) incurring indebtedness secured by our assets and (iii) selling product lines, other assets and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all.    Contractual Obligations and Commitments      The following summarizes our contractual obligations as of December 31, 2020 (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 (1)   $ 68,029     $ 54,125     $ 13,904     $ —     $ —   Convertible senior notes (2)     93,279       4,025       8,050       81,204       —   Operating leases (3)     10,615       1,334       2,571       2,520       4,190   Financing leases (3)     109       22       87       —       —   Total commitments   $ 172,032     $ 59,506     $ 24,612     $ 83,724     $ 4,190     (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 the principal portion and estimated interest expense for the obligations.   (2) We issued convertible senior notes due 2024. The amount presented in the table represents the principal portion and estimated interest expense for the obligation.   (3) We have entered into various non-cancellable lease agreements for our offices in Taiwan and in the U.S.    46   Table of Contents   Inflation      We believe that the relatively low rate of inflation in the U.S. over the past few years has not had a significant impact on our sales or operating results or on the prices of raw materials. To the extent we expand our operations in China and Taiwan, such actions may result in inflation having a more significant impact on our operating results in the future.    Off-Balance Sheet Arrangements      During 2020, 2019 and 2018, we did not have any off-balance sheet arrangements that we believe have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, 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 consolidated financial statements, which have been prepared in accordance with U.S. GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses and cash flows, and related disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, share-based compensation expense, impairment analysis of goodwill and long-lived assets, valuation of inventory, warranty liabilities and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences 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 financial statements appearing elsewhere in this Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.      47   Table of Contents   Long-lived assets    We evaluate the carrying value of long-lived assets for potential impairment when we determine a triggering event has occurred, or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. When indicators exist, recoverability of assets is measured by a comparison of the carrying value of the asset group to the estimated undiscounted future net cash flows expected to be generated by the asset. Examples of such triggering events include a significant disposal of a portion of such assets, an adverse change in the market involving the business employing the related asset, a significant decrease in the benefits realized from an acquired business, difficulties or delays in integrating the business, and a significant change in the operations of an acquired business. If such assets are determined not to be recoverable we perform an analysis of the fair value of the asset group and will recognize an impairment loss when the fair value is less than the carrying amount of such assets. The fair value, based on reasonable and supportable assumptions and projections, require subjective judgments. Depending on the assumptions and estimates used, the fair value projected in the evaluation of long-lived assets can vary within a range of outcomes. We consider the likelihood of possible outcomes in determining the best estimate for the fair value of the assets. We did not record any asset impairment charges in 2020, 2019 or 2018.    Valuation of inventories    Inventories are stated at the lower of cost (average-cost method) or market. Work in process and finished goods includes materials, labor and allocated overhead. We assess the valuation of our inventory on a periodic basis and provide an allowance for the value of estimated excess and obsolete inventory based on estimates of future demand. During the years ended December 31, 2020, 2019 and 2018, we recorded excess and obsolete inventory reserve charges of $3.9 million, $6.8 million, and $7.2 million, respectively. For the years December 2020, 2019 and 2018, the direct inventory write-offs related to scrap, discontinued products and damaged inventories were $20.4 million, $13.4 million, and $12.3 million, respectively.    We have an accounting policy to write down the value of obsolete inventory. We considered the following factors in our determination of the appropriate reserve level: how often we buy material in bulk; the overall market value of raw material, semi-finished goods and finished goods across our varied product lines and within markets; changes in expected demand for our products; the change in valuations historically; the determined safety stock for key customers; and the likelihood of postponement in delivery schedules for materials already placed in finished goods inventory.   48   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 is used to account for deferred income taxes. Under the liability method, deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The ability to realize deferred tax assets is evaluated annually and a valuation allowance is provided if it is unlikely that the deferred tax assets will 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) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.   On the basis of this evaluation, as of December 31, 2020, a valuation allowance of $10.6 million and $ 3.1 million has been recorded related to Taiwan and China deferred tax assets to recognize only the portion of the deferred tax assets that are more likely than not to be realized. The amount of the deferred tax assets considered realizable, however, could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as our projections for growth.   We recognize interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included on the related tax liability line in the consolidated balance sheet.       See additional information regarding income taxes in Note O of our Consolidated Financial Statements.    Recent Accounting Pronouncements      See Note B of our Consolidated Financial Statements for a description of recent accounting pronouncements.    49   Table of Contents