Oplink Communications 10-Q 2012
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 1, 2012
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from__________ to __________
Commission file number 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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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
The number of outstanding shares of the Registrant’s common stock, $0.001 par value, as of January 29, 2012, was 19,214,742.
OPLINK COMMUNICATIONS, INC.
PART I—FINANCIAL INFORMATION
PART I. FINANCIAL INFORMATION
OPLINK COMMUNICATIONS, INC.
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.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
OPLINK COMMUNICATIONS, INC.
Note 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.
Note 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 (“U.S. GAAP”) 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 U.S. GAAP 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 as of January 1, 2012, the results of its operations for the three and six months ended January 1, 2012 and January 2, 2011 and its cash flows for the six months ended January 1, 2012 and January 2, 2011. 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 included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2011. The July 3, 2011 condensed consolidated balance sheet data was derived from audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2011 but does not include all disclosures required for annual periods. Certain reclassifications have been made to conform to the current period’s presentation.
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. Fiscal 2012 will consist of 52 weeks, while fiscal 2011 was a 53 week period.
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 the Company’s significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended July 3, 2011.
Note 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 the SEC.
Note 4 - Recent Accounting Pronouncement
In September 2011, the Financial Accounting Standards Board (“FASB”) issued and amended Accounting Standards Update (“ASU”) No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which simplifies how entities test goodwill for impairment. Previous guidance under Topic 350 required an entity to test goodwill for impairment using a two-step process on at least an annual basis. First, the fair value of a reporting unit was calculated and compared to its carrying amount, including goodwill. Second, if the fair value of a reporting unit was less than its carrying amount, the amount of impairment loss, if any, was required to be measured. Under the amendments in this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads the entity to determine that it is more likely than not that its fair value is less than its carrying amount. If after assessing the totality of events or circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then the two-step impairment test is unnecessary. If the entity concludes otherwise, then it is required to test goodwill for impairment under the two-step process. The amendments are affective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial positions, results of operations or cash flow.
Note 5 - Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing the net income (loss) 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 dilutive potential common shares outstanding during the period, if dilutive. Diluted net loss per share is computed using the weighted-average common shares outstanding and excludes all dilutive potential common shares because the Company is in a net loss position and their inclusion would be anti-dilutive. Potentially dilutive common equivalent shares are composed of the incremental common shares issuable upon the exercise of stock options, the vesting of awards and purchases under the employee stock purchase plan. The following is the computations of the basic and diluted net income (loss) per share and the anti-dilutive common stock equivalents excluded from the computations for the periods presented (in thousands, except per share data):
Note 6 - Comprehensive Income (Loss)
Comprehensive income (loss) 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 (loss) 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 reconciliation of net income (loss) to comprehensive income (loss) for the three and six months ended January 1, 2012 and January 2, 2011 was as follows (in thousands):
The balance of accumulated other comprehensive income, net of tax, was as follows (in thousands):
Note 7 - Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company’s cash equivalents consist primarily of money market funds and corporate commercial paper.
Note 8 - Short-Term Investments
The Company generally invests its excess cash in certificates of deposit, debt instruments of the U.S. Treasury, government agencies, corporations with strong credit ratings and equity securities in publicly traded companies. 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. The Company’s investments in marketable debt and equity securities are classified as available-for-sale investments and 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.
Available-for sale investments at January 1, 2012 and July 3, 2011 were as follows (in thousands):
The gross unrealized losses related to marketable debt securities were primarily due to changes in market interest rates. Gross unrealized losses related to public company equity securities were primarily due to changes in market prices. For marketable debt securities, the Company has determined that (i) it does not have the intent to sell any of these investments and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis to meet its cash or working capital requirements or contractual or regulatory obligations. For public company equity securities, the Company has determined that there was no indication of other-than-temporary impairments. The determination was based on several factors, which includes the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investees, and the Company’s intent and ability to hold it for a period of time sufficient to allow for any anticipated recovery in market value.
The following tables show the gross unrealized losses and fair value of the Company’s available-for-sale securities, aggregated by length of time that individual securities have been in a continuous unrealized loss position (in thousands):
The amortized cost and estimated fair value of debt securities at January 1, 2012 and July 3, 2011 by contractual maturities are shown below (in thousands):
Non-Marketable Equity Securities
The Company accounts for its equity investments in privately held companies under the cost method. These investments are subject to periodic impairment review and measured and recorded at fair value when they are deemed to be other-than-temporarily impaired. In determining whether a decline in value of its investment has occurred and is other than temporary, an assessment was made by considering available evidence, including the general market conditions, the investee’s financial condition, near-term prospects, market comparables and subsequent rounds of financing. The valuation also takes into account the investee’s capital structure, liquidation preferences for its capital and other economic variables. The valuation methodology for determining the decline in value of non-marketable equity securities is based on inputs that require management judgment. The aggregate carrying value of the Company’s non-marketable equity securities was approximately $0.6 million and $0.4 million, and was classified within other assets on the Company’s condensed consolidated balance sheets as of January 1, 2012 and July 3, 2011, respectively. The Company did not recognize any impairment loss during the three and six months ended January 1, 2012 and January 2, 2011.
Note 9 - Fair Value Measurements
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:
● Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;
● Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
● Leve 3 inputs are unobservable inputs for the asset or liability.
The Company’s Level 1 assets generally include money market funds and public company equity securities. The Company’s Level 2 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 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 and six months ended January 1, 2012.
Items Measured at Fair Value on a Recurring Basis
The following table presents the Company’s assets which were measured at fair value on a recurring basis at January 1, 2012 and July 3, 2011 (in thousands):
As of January 1, 2012 and July 3, 2011, 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 and six months ended January 1, 2012 and July 3, 2011.
Note 10 - 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):
Note 11 - Goodwill and Intangible Assets, Net
The following table presents details of the intangible assets acquired as a result of acquisitions as of January 1, 2012 and July 3, 2011 (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 $0.6 million on its condensed consolidated balance sheet at January 1, 2012 and July 3, 2011 as a result of the acquisitions of Emit Technology Co., Ltd and Oridus, Inc. in fiscal 2010. During the three and six months ended January 1, 2012 and January 2, 2011, there were no indicators of impairment for the goodwill.
Note 12 - Accrued Liabilities
Accrued liabilities consist of (in thousands):
Note 13 - 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 12, was as follows (in thousands):
Note 14 - 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 following table represents details of stock-based compensation expense by function line item for the three and six months ended January 1, 2012 and January 2, 2011 (in thousands):
Stock-based compensation of $8,000 was capitalized as inventory as of January 1, 2012 and January 2, 2011.
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.
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 stock options were granted under the Company’s employee stock option plan during the three months ended January 1, 2012.
The estimated fair value of purchase rights under the Company’s employee stock purchase plan is determined using the Black-Scholes valuation model with the following weighted-average assumptions:
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 four purchase periods in each 24-month offering period.
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, restricted stock awards ("RSAs"), restricted stock units ("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 Company settles employee stock option exercises, RSAs and RSUs with newly issued common shares.
As of January 1, 2012, the unrecognized stock-based compensation expense related to stock options to purchase the Company’s common stock was $1.4 million, which is expected to be recognized over a weighted average period of 1.6 years. The unrecognized stock-based compensation expense related to unvested RSUs was $5.8 million, which is expected to be recognized over a weighted average period of 2.3 years.
During the six months ended January 1, 2012, 0.2 million restricted stock units vested. A majority of these vested restricted stock units were net share settled. During the six months ended January 1, 2012, the Company withheld 0.1 million shares, based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities. Total payments for the employees’ tax obligations to the relevant taxing authorities were $1.2 million for the six months ended January 1, 2012, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.
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. During the six months ended January 1, 2012, the Company issued 0.1 million shares of common stock under the plan. As of January 1, 2012, 1.5 million shares were available for issuance under the Company’s employee stock purchase plan.
Note 15 - Repurchase of Common Stock
On May 25, 2010, the Company announced that its Board of Directors authorized a program to repurchase up to $40 million of its common stock. $16.0 million and $5.5 million of its common stock were repurchased under this repurchase program during the fiscal year ended July 3, 2011 and June 27, 2010, respectively. During the three months ended October 2, 2011, the Company repurchased 1.2 million shares at an average price of $15.98 per share for a total purchase price of $18.5 million. This program was completed as of October 2, 2011. On October 27, 2011, the Company announced that its Board of Directors approved a new program to repurchase up to $40 million of its outstanding common shares. The Company did not repurchase any shares of its common stock during the three months ended January 1, 2012. Repurchases under the program will be made in open market or privately negotiated transactions in compliance with the Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors.
Note 16 - Commitments and Contingencies
Contractual obligations as of January 1, 2012 have been summarized below (in thousands):
Patent Litigation with Finisar Corporation
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 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. 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 the SEC on September 13, 2010 disclosing the settlement terms and furnishing a copy of the settlement agreement.
On December 20, 2010, Finisar filed a new complaint against the Company and its subsidiary, Optical Communication Products, Inc. ("OCP") in the United States District Court for the Northern District of California. The new complaint is substantially similar to the complaint filed by Finisar in January 2010. On January 24, 2011 the Company filed an answer to the complaint, denying all material allegations and asserting numerous affirmative defenses. A mediation conference with respect to the lawsuit has been scheduled for November 30, 2011.
On March 7, 2011, the Company's subsidiary OCP filed a complaint against Finisar in the United States District Court for the Eastern District of Texas, alleging infringement by Finisar of certain U.S. patents owned by OCP primarily relating to vertical-cavity surface-emitting laser ("VCSEL") technology. On April 29, 2011, Finisar filed an answer to the complaint, denying all material allegations, asserting numerous affirmative defenses and asserting counterclaims against OCP alleging infringement by OCP of certain U.S. patents owned by Finisar primarily relating to pluggable transceiver latch mechanisms.
On December 14, 2011, the Company and OCP entered into a Settlement and Cross License Agreement with Finisar, which agreement resolved and settled all pending litigation between the parties and their respective affiliates. As part of the settlement, the Company paid $4 million to Finisar for a fully paid-up license to the Finisar patents asserted against the Company in the various lawsuits, the Company granted a license to Finisar to the Company’s patents asserted against Finisar in the various lawsuits, and all legal proceedings initiated by each party in all jurisdictions were dismissed. The Company determined that the portion of the $4 million attributable to past damage was approximately $3.3 million and was included in general and administrative expenses in the condensed consolidated statement of operations for the three and six months ended January 1, 2012. The remaining amount of $0.7 million was recorded as a prepaid royalty, of which $0.1 million was included in prepaid and other current assets and $0.6 million was included in other assets on the Company's condensed consolidated balance sheets as of January 1, 2012. Amortization expense will be charged to cost of revenues over the period which the Company expects to benefit from the patents beginning in January 2012.
IPO Securities Litigation
In November 2001, the Company 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 the Company, certain of its officers and directors and the underwriters of the Company’s initial public offering ("IPO") violated Section 11 of the Securities Act of 1933 based on allegations that the Company’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. The Company’s share of the settlement is roughly $327,458, which is the amount the Company 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. On January 12, 2012, the last of these appeals was dismissed with prejudice.
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 the Company as a nominal defendant. The complaint did not seek recovery of damages or other relief against the Company. The Complaint alleged that in the years 2000 and 2001 the underwriters and unnamed officers, directors and principal shareholders of the Company acted as a "group" by coordinating their efforts to undervalue the IPO price of Company 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 the Company 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 the Company’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 the Company 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.
On December 2, 2010, the Ninth Circuit Court of Appeals affirmed the District Court's decision to dismiss the moving issuers' cases (including the Company's) on the grounds that plaintiff's demand letters were insufficient to put the issuers on notice of the claims asserted against them and further ordered that the dismissals be made with prejudice. The Ninth Circuit, however, reversed and remanded the District Court's decision on the underwriters' motion to dismiss as to the claims arising from the non-moving issuers' IPOs, finding plaintiff's claims were not time-barred under the applicable statute of limitations. In remanding, the Ninth Circuit advised the non-moving issuers and underwriters to file in the District Court the same challenges to plaintiff's demand letters that moving issuers had filed.
On December 16, 2010, underwriters filed a petition for panel rehearing and a petition for rehearing en banc. Appellant Vanessa Simmonds also filed a petition for rehearing en banc. On January 18, 2011, the Ninth Circuit denied the petition for rehearing and petitions for rehearing en banc. It further ordered that no further petitions for rehearing may be filed.
On January 24, 2011, the underwriters filed a motion to stay the issuance of the Ninth Circuit's mandate in the cases involving the non-moving issuers. On January 25, 2011, the Ninth Circuit granted the underwriters' motion and ordered that the mandate in the cases involving the non-moving issuers is stayed for ninety days pending the filing of a petition for writ of certiorari in the United States Supreme Court. On January 26, 2011, Appellant Vanessa Simmonds moved to join the underwriters' motion and requested the Ninth Circuit stay the mandate in all cases. On January 26, 2011, the Ninth Circuit granted Appellant's motion and ruled that the mandate in all cases (including the Company's and other moving issuers) is stayed for ninety days pending Appellant's filing of a petition for writ of certiorari in the United States Supreme Court. On April 5, 2011, Appellant Vanessa Simmonds filed a petition for writ of certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit's December 2, 2010 decision.
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 the Company’s consolidated financial position, results of operations or cash flows.
Note 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 was as follows (in thousands):
Top five customers, although not the same five customers together accounted for 45% and 53% of revenues for the three months ended January 1, 2012 and January 2, 2011, respectively, and 44% and 53% of revenues for the six months ended January 1, 2012 and January 2, 2011, respectively.
The breakdown of property, plant and equipment, net by geographical location was as follows (in thousands):
Note 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 January 1, 2012, the Company’s total unrecognized tax benefits were $11.3 million, of which $9.1 million, if recognized, would affect the Company’s effective tax rate. The Company had accrued interest and penalties related to unrecognized tax benefits of approximately $1.2 million as of January 1, 2012.
The Company is required to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. The Company recorded a tax benefit of $0.2 million and a tax provision of $0.8 million for the three months ended January 1, 2012 and January 2, 2011, respectively, and a tax provision of $1.0 million and $1.7 million for the six months ended January 1, 2012 and January 2, 2011, respectively. The decrease in tax provision for the three and six months ended January 1, 2012 compared to the three and six months ended January 2, 2011 was primarily due to lower income before taxes. The effective tax rate for the second quarter of fiscal 2012 differs from the statutory rate primarily due to the mix of foreign earnings and non-deductible stock-based compensation.
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 2010 remain open in several jurisdictions.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, 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 “expect,” “anticipate,” “intend,” “believe,” ”estimate” or “assume” 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, you should carefully consider the information set forth below and under the captions “Risk Factors” in addition to the other information set forth herein. We caution you that our business and financial performance are subject to substantial risks and uncertainties. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Report on Form10-Q.
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 accompanying 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 and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011 filed with the Securities and Exchange Commission (“SEC”).
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 consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) 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:
This is not a comprehensive list of all of our accounting policies.
As of the date of the filing of this quarterly report, we believe there have been no material changes to our critical accounting policies and estimates during the three and six months ended January 1, 2012 compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011 as filed with the SEC. Additional information about these critical accounting policies may be found in the “Management’s Discussion & Analysis of Financial Condition and Results of Operations” section included in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011.
Results of Operations
The decrease in revenues for the three months ended January 1, 2012 compared to the three months ended January 2, 2011 was primarily due to decreased unit shipments in our ROADM optical switching and routing product, line transmission application product, optical amplification product and monitoring and conditioning product, partially offset by increased unit shipments in our multiplexer product. A decline in average selling prices also contributed to the decrease in revenues in the three months ended January 1, 2012 compared to the three months ended January 2, 2011. The decreases in unit shipments and average selling price were driven by the softness in the telecommunications market.
The decrease in revenues for the six months ended January 1, 2012 compared to the six months ended January 2, 2011 was primarily due to a decrease in revenues in our ROADM optical switching and routing products, optical amplification product, monitoring and conditioning product and multiplexer product, partially offset by an increase in revenues in our line transmission application product.
Historically, a relatively small number of customers have accounted for a significant portion of our revenues. Our top five customers, although not necessarily the same five customers, together accounted for 45% and 53% of revenues for the three months ended January 1, 2012 and January 2, 2011, respectively, and 44% and 53% of revenues for the six months ended January 1, 2012 and January 2, 2011, respectively.
For the three months ending April 1, 2012, we expect our revenues to be in the range of $40 million to $43 million.
Gross profit decreased for the three and six months ended January 1, 2012 compared to the three and six months ended January 2, 2011 primarily driven by lower revenues, lower utilization of previously reserved inventory and higher manufacturing overhead expenses, partially offset by lower amortization expense of intangible assets as certain intangible assets acquired from previous acquisitions were fully amortized. The gross profit was positively impacted by the sales of previously reserved inventory of $1.1 million and $1.6 million for the three months ended January 1, 2012 and January 2, 2011, respectively, and $2.0 million and $3.5 million for the six months ended January 1, 2012 and January 2, 2011, respectively.
The decrease in gross profit margin for the three months ended January 1, 2012 compared to the three months ended January 2, 2011 was primarily driven by higher manufacturing overhead expense, increased labor and material costs as a percentage of revenues and lower utilization of previously reserved inventory.
The decrease in gross profit margin for the six months ended January 1, 2012 compared to the six months ended January 2, 2011 was primarily driven by higher manufacturing overhead expense and labor costs as a percentage of revenues and lower utilization of previously reserved inventory, partially offset by the lower material costs as a percentage of revenues .
We expect our gross profit margin for the three months ending April 1, 2012 to be slightly lower compared to the three months ended January 1, 2012, as a result of higher material costs and increased labor costs in China.
Research and Development
Research and development expenses increased $1.1 million and $2.7 million for the three and six months ended January 1, 2012 compared to the three and six months ended January 2, 2011. The increase was primarily due to higher salary and other employee related compensation expenses associated with an increase in headcount and higher R&D material and consulting expenses primarily attributable to the increased new product development activities.
We expect our research and development expenses, excluding stock compensation expense, to increase for the three months ending April 1, 2012 compared to the three months ended January 1, 2012 due to increased headcount and higher R&D material expenses as a result of increased new product development activities.
Sales and Marketing
Sales and marketing expenses increased slightly for the three and six months ended January 1, 2012 compared to the three and six months ended January 2, 2011. The increase was primarily due to an increase in salary and other employee related compensation expenses and higher travel and entertainment expenses partially offset by a decrease in sales commission expense as a result of lower revenues. The increase in stock based compensation expense in the six months ended January 1, 2012 compared to the six months ended January 2, 2011 was primarily due to additional grants to new and existing employees.
We expect our sales and marketing expenses, excluding stock compensation expense, to remain at the same level for the three months ending April 1, 2012 compared to the three months ended January 1, 2012.
General and Administrative