Applied Optoelectronics (NASDAQ:AAOI) Is Making Moderate Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Applied Optoelectronics, Inc. (NASDAQ:AAOI) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Applied Optoelectronics

What Is Applied Optoelectronics's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Applied Optoelectronics had debt of US$148.9m, up from US$140.2m in one year. However, it does have US$45.5m in cash offsetting this, leading to net debt of about US$103.4m.

A Look At Applied Optoelectronics' Liabilities

We can see from the most recent balance sheet that Applied Optoelectronics had liabilities of US$98.4m falling due within a year, and liabilities of US$99.5m due beyond that. Offsetting these obligations, it had cash of US$45.5m as well as receivables valued at US$49.0m due within 12 months. So its liabilities total US$103.4m more than the combination of its cash and short-term receivables.

Applied Optoelectronics has a market capitalization of US$216.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Applied Optoelectronics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Applied Optoelectronics reported revenue of US$244m, which is a gain of 37%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Applied Optoelectronics managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping US$45m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$70m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Applied Optoelectronics you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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