Oplink Communications 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 000-31581
OPLINK COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
46335 Landing Parkway, Fremont, CA 94538
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (510) 933-7200
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 1934 during 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 requirements for the past 90 days. Yes R No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £ No £
The number of shares of the Registrant’s common stock outstanding as of October 29, 2010 was 19,561,981.
OPLINK COMMUNICATIONS, INC.
NOTE: The registrant’s fiscal year ends on the Sunday closest to June 30 and each of its fiscal quarters ends on the Sunday closest to the calendar quarter end. For ease of presentation, throughout this report the registrant refers to its fiscal years as ending on June 30 and to its fiscal quarters as ending on the calendar quarter end. For example, the registrant’s most recently completed fiscal year ended on Sunday, June 27, 2010 and its most recently completed fiscal quarter ended on Sunday, October 3, 2010, but throughout this report those periods will be referred to as having ended on June 30, 2010 and September 30, 2010, respectively.
ITEM 1- FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(1) The condensed consolidated balance sheet at June 30, 2010 has been derived from the audited consolidated financial statements at that date.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
OPLINK COMMUNICATIONS, INC.
1. Description of Business. Oplink Communications, Inc. (“Oplink” or the “Company”) was incorporated in California in September 1995 and was later reincorporated in Delaware in September 2000. The Company is headquartered in Fremont, California and has manufacturing, design and research and development facilities in Zhuhai, Shanghai and Wuhan, China, in Taiwan and in Woodland Hills, California.
Oplink designs, manufactures and sells optical networking components and subsystems. Its products expand optical bandwidth, amplify optical signals, monitor and protect wavelength performance, redirect light signals, ensure signal connectivity and provide signal transmission and reception within an optical network. Its products enable greater and higher quality bandwidth over longer distances, which reduces network congestion and transmission cost per bit. Its products also enable optical system manufacturers to provide flexible and scalable bandwidth to support the increase of data traffic on the Internet and other public and private networks.
Oplink offers its customers design, integration and optical manufacturing solutions (“OMS”) for the production and packaging of highly-integrated optical subsystems and turnkey solutions, based upon a customer’s specific product design and specifications. Oplink also offers solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions.
Oplink’s product portfolio also includes optical transmission products that broaden the addressable markets as well as the range of solutions that Oplink can now offer its customers. Oplink’s transmission products consist of a comprehensive line of high-performance fiber optic modules, including fiber optic transmitters, receivers, transceivers, and transponders, primarily for use in metropolitan area network (“MAN”), local area network (“LAN”), and fiber-to-the-home (“FTTH”) applications. Fiber optic modules are pre-assembled components that are used to build network equipment. Oplink’s transmission products convert electronic signals into optical signals and back into electronic signals, thereby facilitating the transmission of information over fiber optic communication networks.
Oplink also offers communications system equipment makers a broadened suite of precision-made, cost-effective, and reliable optical connectivity products to establish multiple-use, quick pluggable fiber links among network devices for bandwidth deployment, as well as in a test and measurement environment for a wide range of system design and service applications.
2. Basis of Presentation. The unaudited condensed consolidated financial statements included herein have been prepared by the Company in conformity with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, these unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of the Company at September 30, 2010, the results of its operations for the three-month periods ended September 30, 2010 and 2009 and its cash flows for the three-month periods ended September 30, 2010 and 2009. The results of operations for the periods presented are not necessarily indicative of those that may be expected for the full year. The condensed consolidated financial statements presented herein have been prepared by management, without audit by independent auditors who do not express an opinion thereon, and should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2010 included in the Company’s Annual Report on Form 10-K.
The Company operates and reports using a fiscal year, which ends on the Sunday closest to June 30. Interim fiscal quarters end on the Sundays closest to each calendar quarter end. For presentation purposes, the Company presents each fiscal year as if it ended on June 30. The Company presents each of the fiscal quarters as if it ended
on the last day of each calendar quarter. October 3, 2010 represents the Sunday closest to the period ended September 30, 2010. The quarters ended September 30, 2010 and 2009 consist of 14 and 13 weeks, respectively. The quarter ending December 31, 2010 is a 13-week fiscal period. Fiscal 2011 will consist of 53 weeks, one week more than a typical fiscal year.
The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. With the exception of the Company’s Optical Communication Products, Inc. (“OCP”) subsidiaries, the Company presents the financial information of its consolidated foreign operating subsidiaries in its consolidated financial statements utilizing accounts as of a date one month earlier than the accounts of its parent company, U.S. subsidiary and its non-operating non-U.S. subsidiaries to ensure timely reporting of consolidated results.
The Company conducts its business within one business segment and has no organizational structure dictated by product, service lines, geography or customer type.
There have been no significant changes in new accounting pronouncements or to the Company’s significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended June 30, 2010.
3. Risks and Uncertainties. There are a number of risks and uncertainties facing the Company that could have a material adverse effect on the Company’s financial condition, operating results or cash flows. These risks and uncertainties include, but are not limited to, a further and sustained downturn in the telecommunications industry or the overall economy in the United States and other parts of the world, possible further reductions in customer orders, intense competition in the Company’s target markets and potential pricing pressure that may arise from changing supply or demand conditions in the industry. In addition, the Company obtains most of its critical materials from a single or limited number of suppliers and generally does not have long-term supply contracts with them. The Company could experience discontinuation of key components, price increases and late deliveries from its suppliers. Also, substantially all of the Company’s manufacturing operations are located in China and are subject to laws and regulations of China. These and other risks and uncertainties facing the Company are described from time to time in the Company’s periodic reports filed with SEC.
4. Net Income Per Share. Basic net income per share is computed by dividing the net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period, if dilutive. Potentially dilutive common equivalent shares are composed of the incremental common shares issuable upon the exercise of stock options, the vesting of restricted stock units (“RSUs”) and purchases under the employee stock purchase plan. The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations and the antidilutive common stock equivalents excluded from the computations for the periods presented (in thousands, except per share data):
5. Comprehensive Income. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of comprehensive income consist of foreign currency translation adjustments, foreign currency transaction gains and losses from intercompany transactions and balances for which settlement is not planned or anticipated in the foreseeable future, and changes in unrealized gains and losses on investments. For presentation purposes, cumulative translation adjustment includes foreign currency transaction gains and losses from intercompany transactions and balances for which settlement is not planned or anticipated in the foreseeable future. The balance of accumulated other comprehensive income is as follows (in thousands):
The reconciliation of net income to comprehensive income for the three months ended September 30, 2010 and 2009 is as follows (in thousands):
6. Cash and Cash Equivalents. The Company’s cash equivalents at September 30, 2010 consist primarily of money market funds, unrestricted deposits and commercial paper. Cash includes amounts restricted for letters of credit for purchases and deposits for equipment maintenance of $383,000 and $322,000 at September 30, 2010 and June 30, 2010, respectively.
7. Short-Term and Long-Term Investments. The Company generally invests its excess cash in certificates of deposit, debt instruments of the U.S. Treasury, government agencies and corporations with strong credit ratings.
Such investments are made in accordance with the Company’s investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. Available-for-sale investments are reported at their fair value. Unrealized gains and losses on these securities are reported as a separate component of accumulated other comprehensive income until realized. Held-to-maturity investments are reported at amortized costs.
Short-term and long-term investments at September 30, 2010 and June 30, 2010 consist of the following (in thousands):
The amortized cost and fair value of available-for-sale and held-to-maturity investments at September 30, 2010 and June 30, 2010 are presented in the following tables (in thousands):
There were no gross realized gains (losses) on sales of available-for-sale or held-to-maturity securities for the three months ended September 30, 2010 or 2009. The unrealized losses on available-for-sale securities are primarily due to decreases in the fair value of debt securities as a result of changes in market interest rates. The Company has the intent and the ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment. The Company expects to realize the full value of all of these investments upon maturity. In addition, the Company does not believe that it will be required to sell these securities to meet its cash or working capital requirements or contractual or regulatory obligations. Therefore, the Company has determined that the gross unrealized losses on its available-for-sale securities at September 30, 2010 are temporary in nature. The following table provides a breakdown of the Company’s available-for-sale securities with unrealized losses as of September 30, 2010 (in thousands):
The amortized cost and estimated fair value of debt securities at September 30, 2010 and June 30, 2010 by contractual maturities are shown below (in thousands):
8. Fair Value Accounting. Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. The Company applies the fair value hierarchy which has the following three levels of inputs to measure fair value:
The Company’s Level 1 financial assets generally include money market funds. The Company’s Level 2 financial assets generally include United States Treasury securities, United States government agency debt securities, certificates of deposit, commercial paper, and corporate bonds.
The Company bases the fair value of its financial assets on pricing from third party sources of market information obtained through the Company’s investment brokers. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from brokers. The Company’s investment
brokers obtain pricing data from a variety of industry standard data providers (e.g., Bloomberg), and rely on comparable pricing of other securities because the Level 2 securities that the Company holds are not actively traded and have fewer observable transactions. The Company considers this the most reliable information available for the valuation of the securities. There were no changes in valuation techniques or related inputs during the three months ended September 30, 2010.
Items Measured at Fair Value on a Recurring Basis
The Company did not have any financial liabilities that are measured at fair value at September 30, 2010. The following table presents the Company’s financial assets, excluding accrued interest components, which are measured at fair value on a recurring basis at September 30, 2010 and June 30, 2010, consistent with the fair value hierarchy (in thousands):
As of September 30, 2010, the Company did not have any assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value measurement hierarchy during the three months ended September 30, 2010.
Items Measured at Fair Value on a Nonrecurring Basis
Certain assets that are subject to nonrecurring fair value measurement are not included in the table above. These assets include cost method investments in private companies. The Company did not record any other-than-temporary impairment charges for these investments during the three months ended September 30, 2010 or 2009.
9. Inventories. Inventories are stated at the lower of cost or market. Inventory cost is determined using standard costs, which approximates actual cost on a first-in, first-out basis. Inventories consist of (in thousands):
10. Goodwill and Intangible Assets, Net. The following table presents details of the intangible assets acquired as a result of acquisitions as of September 30, 2010 and June 30, 2010 (in thousands):
The following table presents details of the amortization expense of intangible assets as reported in the condensed consolidated statements of operations (in thousands):
The future amortization of intangible assets is as follows (in thousands):
The Company had goodwill of $572,000 on its condensed consolidated balance sheet at September 30, 2010 and June 30, 2010 as a result of the acquisitions of Emit Technology Co., Ltd and Oridus, Inc. in fiscal 2010. During the three months ended September 30, 2010, there were no indicators of impairment for the goodwill.
11. Accrued Liabilities. Accrued liabilities consist of (in thousands):
12. Product Warranties. The Company provides reserves for the estimated cost of product warranties at the time revenue is recognized based on its historical experience of known product failure rates and expected material and labor costs to provide warranty services. The Company generally provides a one-year warranty on its products. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Alternatively, if estimates are determined to be greater than the actual amounts necessary, the Company may reverse a portion of such provisions in future periods.
Changes in the warranty liability, which is included as a component of “Accrued liabilities” on the condensed consolidated balance sheets as disclosed in Note 11, is as follows (in thousands):
13. Stock-Based Compensation. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the employee requisite service period. The Company’s stock-based compensation is generally accounted for as an equity instrument. The effect of recording stock-based compensation for the three months ended September 30, 2010 and 2009 was as follows (in thousands, except per share data):
Forfeitures are estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.
During the three months ended September 30, 2010 and 2009, the Company granted 44,000 and 26,000 stock options, respectively, with an estimated total grant-date fair value of $347,000 and $169,000, respectively. The Company estimated that the stock compensation expense for the stock options granted in the three months ended September 30, 2010 and 2009 not expected to vest was $42,000 and $23,000, respectively.
In addition, the Company granted 221,800 and 479,733 restricted stock awards (“RSAs”) and restricted stock units (“RSUs”), with a total grant-date fair value of $4.2 million and $6.7 million during the three months ended September 30, 2010 and 2009, respectively. The Company estimated that the stock compensation expense for the RSUs granted in the three months ended September 30, 2010 and 2009 not expected to vest was $577,000 and $1.2 million, respectively.
As of September 30, 2010, the unrecognized stock compensation expense related to stock options to purchase Oplink common stock was $3.7 million which will be recognized over an estimated weighted average amortization period of 2.0 years. The unrecognized stock compensation expense related to RSUs was $7.1 million which will be recognized over an estimated weighted average amortization period of 3.1 years. Approximately $8,000 of stock compensation was capitalized as inventory at September 30, 2010 and June 30, 2010.
The Company estimates the fair value of stock options and purchase rights under the Company’s employee stock purchase plan using a Black-Scholes valuation model. The fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model and the straight-line attribution approach with the following weighted-average assumptions:
No purchase rights were granted under the Company’s employee stock purchase plan during the three months ended September 30, 2010 or 2009.
The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options or purchase rights. The expected term calculation for stock options is based on the observed historical option exercise behavior and post-vesting forfeitures of options by the Company’s employees. The expected term assumption for purchase rights is based on the average exercise date for the four purchase periods in each 24-month offering period.
The weighted-average grant date fair value for options to purchase Oplink common stock granted under the Company’s stock option plans was $7.88 and $6.49 for the three months ended September 30, 2010 and 2009, respectively.
Equity Incentive Program
Oplink adopted the 2000 Equity Incentive Plan (the “2000 Plan”) in July 2000. The 2000 Plan was terminated in November 2009 immediately upon the effectiveness of the Company’s new 2009 Equity Incentive Plan (the “2009 Plan”). No further awards will be granted under the 2000 Plan. However, the 2000 Plan will continue to govern awards previously granted under that plan.
The 2009 Plan was adopted by the Company in September 2009 and became effective upon approval by the Company’s stockholders at the annual meeting held in November 2009. The 2009 Plan provides for the grant of equity awards to employees, directors and consultants. These equity awards include stock options, RSAs, RSUs, stock appreciation rights, performance units, and performance shares. The maximum aggregate number of shares of common stock that may be issued under the 2009 Plan is 2,500,000 shares, plus any shares subject to equity awards granted under 2000 Plan that expire or otherwise terminate without having been exercised in full, or that are forfeited to or repurchased by the Company. Shares subject to “full value” awards (RSUs, RSAs, performance shares and performance units) will count against the 2009 Plan’s share reserve as 1.3 shares for every one share subject to such awards. Accordingly, if such awards are forfeited or repurchased by the Company, 1.3 times the number of shares forfeited or repurchased will return to the 2009 Plan. The maximum term of stock options and stock appreciation rights under the 2009 Plan is 7 years.
The following table summarizes activity under the equity incentive plans for the indicated periods:
The options outstanding and exercisable at September 30, 2010 were in the following exercise price ranges:
As of September 30, 2010 and June 30, 2010, options to purchase 2,579,629 and 2,742,536 shares at weighted average exercise prices of $13.41 and $14.35 per share, respectively, were vested and exercisable.
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $19.75 as of October 1, 2010, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of September 30, 2010 was 2,473,006. The total intrinsic value of options exercised during the three months ended September 30, 2010 and 2009 was $901,000 and $795,000, respectively. The total cash received by the Company from employees as a result of employee stock option exercises during the three months ended September 30, 2010 and 2009 was approximately $2.8 million and $1.1 million, respectively.
The aggregate intrinsic value and weighted average remaining contractual term of RSUs outstanding as of September 30, 2010 was $13.3 million and 1.9 years, respectively. There were no RSUs vested as of September 30, 2010.
The aggregate intrinsic value and weighted average remaining contractual term of RSUs expected to vest as of September 30, 2010 was $11.9 million and 1.8 years, respectively. The number of RSUs that are expected to vest is 602,488 shares.
The Company settles employee stock option exercises and RSUs with newly issued common shares.
Employee Stock Purchase Plan
The Company’s employee stock purchase plan authorizes the granting of stock purchase rights to eligible employees during an offering period not more than 27 months with exercise dates approximately every six months. Shares are purchased through employee payroll deductions at purchase prices equal to 85% of the lesser of the fair market value of the Company’s common stock at either the first day of each offering period or the date of purchase. No shares were purchased under the employee stock purchase plan during the three months ended September 30, 2010 or 2009. As of September 30, 2010, 1,676,785 shares were available for issuance under the Company’s employee stock purchase plan.
14. Repurchase of Common Stock. On June 1, 2010, the Company announced a program to repurchase up to $40 million of the Company’s common stock. Repurchases under the program will be made in open market or privately negotiated transactions in compliance with Securities and Exchange Commission Rule
10b-18, subject to market conditions, applicable legal requirements and other factors. $5.3 million of its common stock was repurchased under this repurchase plan during the three months ended September 30, 2010. As of September 30, 2010, repurchases of $10.8 million have been made under this repurchase program.
15. Recent Accounting Pronouncements. In January 2010, the FASB issued additional disclosure requirements for fair value measurements. The guidance requires an entity to disclose significant transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and the timing of the transfers. The additional requirements became effective for interim and annual reporting periods beginning after December 15, 2009. The adoption of this new guidance did not have an impact on the Company’s consolidated financial position, results of operations or cash flows as this guidance relates only to additional disclosures. In addition, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The changes are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not believe that the adoption will have an impact on the Company’s consolidated financial position, results of operations or cash flows as this guidance relates only to additional disclosures.
In various areas, including revenue recognition, stock option and purchase accounting, accounting standards and practices continue to evolve. The Company believes that it is in compliance with all of the rules and related guidance as they currently exist. However, any changes to accounting principles generally accepted in the United States of America in these areas could impact the future accounting of its operations.
16. Commitments and Contingencies.
Contractual obligations as of September 30, 2010 have been summarized below (in thousands):
Finisar Corporation v. Source Photonics, Inc., et al.
On January 5, 2010, Finisar Corporation, or Finisar, filed a complaint in the United States District Court for the Northern District of California against Source Photonics, Inc., MRV Communications, Inc., NeoPhotonics Corporation and the Company, or collectively, the co-defendants. In the complaint, Finisar alleged infringement of certain of its U.S. patents arising from the co-defendants’ respective manufacture, importation, use, sale of or offer to sell certain optical transceiver products in the United States. Finisar sought to recover unspecified damages, up to treble the amount of actual damages, together with attorneys’ fees, interest and costs. Finisar alleged that at least some of the patents asserted are a part of certain digital diagnostic standards for optoelectronics transceivers and, therefore, are being utilized in such digital diagnostic standards. On March 23, 2010, the Company filed an answer to the complaint and counterclaims against Finisar. On May 5, 2010, the court dismissed without prejudice all co-defendants (including the Company) except Source Photonics, Inc., on grounds that such claims should have been asserted in four separate lawsuits, one against each co-defendant. This dismissal without prejudice does not prevent Finisar from bringing a new similar lawsuit against the Company. On May 20, 2010, the Company and Finisar entered into a standstill agreement, agreeing not to refile any claims against each other until at least 90 days after a resolution of the litigation between Source Photonics and Finisar.
On September 10, 2010, Source Photonics, Inc., and its parent company MRV Communications, Inc., entered into a Settlement and Cross License Agreement with Finisar. MRV Communications filed a Form 8-K with SEC on
September 13, 2010 disclosing the settlement terms and furnishing a copy of the settlement agreement. Under the terms of the standstill agreement between the Company and Finisar, Finisar may file a new patent lawsuit against the Company any time after December 10, 2010. If Finisar brings a new similar lawsuit against the Company, and if the Company is unsuccessful in its defense of the Finisar patent infringement claims, a license to use the allegedly infringing technology may not be available to the Company on commercially reasonable terms and therefore may limit or preclude the Company from competing in the market for optical transceivers in the United States, which could materially harm its business.
Although the Company believes that it has meritorious defenses to the infringement allegations and intends to defend any new similar lawsuit vigorously, there can be no assurance that it will be successful in its defense. Even if the Company is successful, it may incur substantial legal fees and other costs in defending the lawsuit. Further, a new lawsuit, if brought, would be likely to divert the efforts and attention of the Company’s management and technical personnel, which could harm its business.
IPO Securities Litigation
In November 2001, Oplink and certain of its officers and directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York. In the amended complaint, the plaintiffs alleged that Oplink, certain of Oplink’s officers and directors and the underwriters of Oplink’s initial public offering (“IPO”) violated Section 11 of the Securities Act of 1933 based on allegations that Oplink’s registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. Similar complaints were filed by plaintiffs against hundreds of other public companies that went public in the late 1990s and early 2000s and their IPO underwriters (collectively, the “IPO Lawsuits”). During the summer of 2008, the parties engaged in a formal mediation process to discuss a global resolution of the IPO Lawsuits. Ultimately, the parties reached an agreement to settle all 309 cases against all defendants, and entered into a settlement agreement in April 2009. The settlement provides for a $586 million recovery in total, divided among the 309 cases. Oplink’s share of the settlement is roughly $327,458, which is the amount Oplink will be required to pay if the settlement is finally approved. In October 2009, the Court certified the settlement class in each case and granted final approval to the settlement. A number of appeals have been filed with the Second Circuit Court of Appeals, challenging the fairness of the settlement. A number of shareholder plaintiffs have also filed petitions for leave to appeal the class certification portion of Judge Scheindlin’s ruling. These appeals and petitions are pending.
IPO 16(b) Claim
In October 2007, Vanessa Simmonds filed in the United States District Court for the Western District of Washington a Complaint for Recovery of Short Swing Profits Under Section 16(b) of the Securities Exchange Act of 1934 against Bank of America and JP Morgan Chase & Company as defendants, and against Oplink as a nominal defendant. The complaint did not seek recovery of damages or other relief against Oplink. The Complaint alleged that in the years 2000 and 2001 the underwriters and unnamed officers, directors and principal shareholders of Oplink acted as a “group” by coordinating their efforts to undervalue the IPO price of Oplink and to thereafter inflate the aftermarket price throughout the six month lock-up period. The Complaint further alleges that the underwriters profited by (a) sharing in profits of customers to whom they had made IPO allocations, (b) allocating shares of Oplink to insiders at other companies from whom the underwriters expected to receive additional work in return; and (c) by creating the opportunity (through the alleged laddering practices) for Oplink’s directors, officers and other insiders to profit through their sale of stock after the lock-up period in return for future business for the underwriter.
The complaint against Oplink and its underwriters was one of a total of 54 nearly identical lawsuits filed by Ms. Simmonds in October 2007 against companies and underwriters that had completed IPOs in the early 2000s. All of these cases were transferred to one judge at the U.S.District Court. In March 2009, the judge dismissed the complaints, ruling that the plaintiff made an insufficient demand on the issuers and that the cases did not merit tolling the statute of limitations. The plaintiff filed notices of appeal in each of the 54 cases in April 2009, and the
appeals were consolidated in June 2009 in the Ninth Circuit Court of Appeals. Each of Ms. Simmonds and the issuer and underwriter defendants has submitted their appeal briefs to the court. Oral arguments on the appeals were held on October 5, 2010. No ruling on the appeals has yet been issued.
The Company is subject to legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on Oplink’s consolidated financial position, results of operations or cash flows.
17. Segment Reporting. The Company has determined that it has one reportable segment: fiber optic component and subsystem product sales. This segment consists of organizations located in the United States and China, which develop, manufacture, and/or market fiber optic networking components.
The geographic breakdown of revenues by customers’ bill-to location is as follows (in thousands):
Top five customers, although not the same five customers for each period, together accounted for 55% and 58% of revenues for the three months ended September 30, 2010 and 2009, respectively.
The breakdown of property, plant and equipment, net by geographical location is as follows (in thousands):
18. Income Taxes. The Company accounts for income taxes under the liability method, which recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts, and for net operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company records a valuation allowance against deferred tax assets when it is more likely than not that such assets will not be realized.
The Company accounts for uncertain tax positions in accordance with the authoritative guidance on income taxes under which the Company may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as
a component of income tax expense.
As of June 30, 2010, the Company’s total unrecognized tax benefits were $5,232,000 of which $2,832,000, if recognized, would affect the Company’s effective tax rate. There is no significant change for the three months ended September 30, 2010. The Company had accrued interest and penalties related to unrecognized tax benefits of approximately $668,000 at September 30, 2010.
Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, California, and China. The tax years 2004 to 2009 remain open in several jurisdictions.
19. Subsequent Event. The Company has reviewed and evaluated events subsequent to September 30, 2010 through the date that the condensed consolidated financial statements were issued. On October 14, 2010, the Company entered into a contract to purchase a facility in Wuhan, China, totaling approximately 86,000 square feet for approximately $3.6 million. The facility will be used for manufacturing and research and development.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions, or future strategies that are signified by the words “expects,” “anticipates,” “intends,” “believes,” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, prospective investors should carefully consider the information set forth below under the caption “Risk Factors” in addition to the other information set forth herein. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes in this report, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, related financial information and audited consolidated financial statements contained in our Form 10-K for the fiscal year ended June 30, 2010 as filed with the Securities and Exchange Commission on September 10, 2010.
We design, manufacture and sell optical networking components and subsystems. Our products expand optical bandwidth, amplify optical signals, monitor and protect wavelength performance, redirect light signals, ensure bandwidth distribution connectivity and provide signal transmission and reception within an optical network. Our products enable greater and higher quality bandwidth over longer distances, which reduces network congestion and transmission cost per bit. Our products also enable optical system manufacturers to provide flexible and scalable bandwidth to support the increase of data traffic on the Internet and other public and private networks.
We offer our customers design, integration and optical manufacturing solutions (“OMS”) for the production and packaging of highly-integrated optical subsystems and turnkey solutions, based upon a customer’s specific product design and specifications. We also offer solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions.
Use of Estimates and Critical Accounting Policies
The preparation of our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure. On an ongoing basis, we evaluate our estimates, including those related to product returns, accounts receivable, inventories, intangible assets, warranty obligations, restructuring accruals, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis and by the audit committee of our board of directors at the end of each quarter prior to the public release of our financial results. We believe the following critical accounting policies and our procedures relating to these policies, affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.
We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. These policies may require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations. Our critical accounting policies cover the following areas: