PART I: FINANCIAL
INFORMATION
ITEM 1: FINANCIAL
STATEMENTS
ALLIANCE FIBER
OPTIC PRODUCTS, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
|
September 30,
2007
|
December 31,
2006
|
Assets
|
|
|
|
(Unaudited)
|
|
|
|
|
Current
assets:
|
|
|
Cash and
cash equivalents
|
|
|
$
|
5,256
|
|
$
|
4,321
|
|
Short-term
investments
|
|
|
|
29,195
|
|
|
26,857
|
|
Accounts
receivable, net
|
|
|
|
5,208
|
|
|
4,009
|
|
Inventories,
net
|
|
|
|
4,507
|
|
|
4,465
|
|
Prepaid
expense and other current assets
|
|
|
|
812
|
|
|
601
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
|
44,978
|
|
|
40,253
|
|
|
|
|
Property and
equipment, net
|
|
|
|
4,141
|
|
|
4,264
|
|
Other
assets
|
|
|
|
282
|
|
|
176
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
|
$
|
49,401
|
|
$
|
44,693
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
Current
liabilities:
|
|
|
Accounts
payable
|
|
|
$
|
3,665
|
|
$
|
2,950
|
|
Accrued
expenses
|
|
|
|
3,341
|
|
|
2,815
|
|
Current
portion of bank loans
|
|
|
|
130
|
|
|
94
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
|
7,136
|
|
|
5,859
|
|
Other
long-term liabilities
|
|
|
Bank
loans
|
|
|
|
587
|
|
|
545
|
|
Other
long-term liabilities
|
|
|
|
431
|
|
|
385
|
|
|
|
|
|
|
|
|
|
Total
long term liabilities
|
|
|
|
1,018
|
|
|
930
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
|
8,154
|
|
|
6,789
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (Note 8)
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
Common
stock, $0.001 par value: 250,000,000 shares authorized;
|
|
|
41,011,006
and 40,540,128 shares issued and outstanding at
|
|
|
September
30, 2007 and December 31, 2006, respectively
|
|
|
|
41
|
|
|
41
|
|
Additional
paid-in-capital
|
|
|
|
110,549
|
|
|
109,793
|
|
Accumulated
deficit
|
|
|
|
(69,491
|
)
|
|
(71,809
|
)
|
Accumulated other
comprehensive income (loss)
|
|
|
|
148
|
|
|
(121
|
)
|
|
|
|
|
|
|
|
|
Stockholders'
equity
|
|
|
|
41,247
|
|
|
37,904
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders' equity
|
|
|
$
|
49,401
|
|
$
|
44,693
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.
1
ALLIANCE FIBER
OPTIC PRODUCTS, INC.
Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share data)
|
Three Months Ended
September 30,
|
|
Nine Months Ended September
30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenues
|
|
|
$
|
9,170
|
|
$
|
7,573
|
|
$
|
24,572
|
|
$
|
19,046
|
|
Cost of
revenues
|
|
|
|
6,291
|
|
|
5,402
|
|
|
16,822
|
|
|
13,907
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
|
2,879
|
|
|
2,171
|
|
|
7,750
|
|
|
5,139
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
|
876
|
|
|
815
|
|
|
2,413
|
|
|
2,282
|
|
Sales
and marketing
|
|
|
|
556
|
|
|
543
|
|
|
1,759
|
|
|
1,684
|
|
General
and administrative
|
|
|
|
817
|
|
|
789
|
|
|
2,593
|
|
|
2,272
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
|
2,249
|
|
|
2,147
|
|
|
6,765
|
|
|
6,238
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from operations
|
|
|
|
630
|
|
|
24
|
|
|
985
|
|
|
(1,099
|
)
|
Interest and
other income, net
|
|
|
|
435
|
|
|
334
|
|
|
1,333
|
|
|
1,103
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
$
|
1,065
|
|
$
|
358
|
|
$
|
2,318
|
|
$
|
4
|
|
|
|
|
|
|
|
|
|
|
Net income per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
$
|
0.03
|
|
$
|
0.01
|
|
$
|
0.06
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
$
|
0.02
|
|
$
|
0.01
|
|
$
|
0.05
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Shares used in
computing net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40,980
|
|
|
40,205
|
|
|
40,799
|
|
|
40,023
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
|
44,929
|
|
|
43,728
|
|
|
44,747
|
|
|
43,545
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in costs and expenses above:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock based compensation charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
|
$
|
29
|
|
$
|
33
|
|
$
|
121
|
|
$
|
65
|
|
Research and development
|
|
|
|
13
|
|
|
17
|
|
|
50
|
|
|
38
|
|
Sales and marketing
|
|
|
|
9
|
|
|
6
|
|
|
33
|
|
|
22
|
|
General and administrative
|
|
|
|
40
|
|
|
27
|
|
|
114
|
|
|
67
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
$
|
91
|
|
$
|
83
|
|
$
|
318
|
|
$
|
192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.
2
ALLIANCE FIBER
OPTIC PRODUCTS, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands, excpet share data)
|
Nine Months Ended September 30,
|
|
2007
|
2006
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
Net
Income
|
|
|
$
|
2,318
|
|
$
|
4
|
|
Adjustments to reconcile
net income to net cash used
|
|
|
|
|
|
|
|
|
in
operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and
amortization
|
|
|
|
868
|
|
|
993
|
|
Loss on disposal of
property and equipment
|
|
|
|
53
|
|
|
34
|
|
Amortization of
stock-based compensation
|
|
|
|
318
|
|
|
192
|
|
Provision for doubtful accounts and
sales returns
|
|
|
|
(59
|
)
|
|
67
|
|
Provision for
inventory obsolescence
|
|
|
|
(352
|
)
|
|
384
|
|
Changes in assets
and liabilities:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
|
(1,140
|
)
|
|
(369
|
)
|
Inventories
|
|
|
|
310
|
|
|
(1,526
|
)
|
Prepaid
expenses
|
|
|
|
(211
|
)
|
|
(166
|
)
|
Accounts
payable
|
|
|
|
715
|
|
|
817
|
|
Accrued
expenses
|
|
|
|
526
|
|
|
177
|
|
Other assets
|
|
|
|
(106
|
)
|
|
(46
|
)
|
Other
long-term liabilities
|
|
|
|
44
|
|
|
3
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
|
3,284
|
|
|
564
|
|
|
|
|
|
|
Cash flows
from investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of short-term investments
|
|
|
|
(15,803
|
)
|
|
(10,693
|
)
|
Proceeds
from sales and maturities of short-term investments
|
|
|
|
13,486
|
|
|
11,465
|
|
Purchase
of of property and equipment
|
|
|
|
(728
|
)
|
|
(496
|
)
|
|
|
|
|
|
Net
cash (used in) provided by investing activities
|
|
|
|
(3,045
|
)
|
|
276
|
|
|
|
|
|
|
Cash flows
from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of common stock under ESPP
|
|
|
|
276
|
|
|
200
|
|
Proceeds
from the exercise of common stock options
|
|
|
|
162
|
|
|
194
|
|
Proceeds
of bank borrowings
|
|
|
|
150
|
|
|
--
|
|
Repayment of bank
borrowings
|
|
|
|
(78
|
)
|
|
(54
|
)
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
|
510
|
|
|
340
|
|
|
|
|
|
|
Effect of
exchange rate changes on cash and cash equivalents
|
|
|
|
186
|
|
|
(10
|
)
|
|
|
|
|
|
Net increase
in cash and cash equivalents
|
|
|
|
935
|
|
|
1,170
|
|
Cash and cash
equivalents at beginning of period
|
|
|
|
4,321
|
|
|
2,714
|
|
|
|
|
|
|
Cash and cash
equivalents at end of period
|
|
|
$
|
5,256
|
|
$
|
3,884
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these Condensed Consolidated Financial
Statements.
3
ALLIANCE FIBER OPTIC PRODUCTS,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Summary of Significant Accounting
Policies
The Company
Alliance Fiber Optic Products, Inc. (the "Company") was incorporated in California on
December 12, 1995 and reincorporated in Delaware on October 19, 2000. The Company
designs, manufactures and markets fiber optic components for communications equipment
manufacturers. The Company's headquarters are located in Sunnyvale, California, and it has
operations in Taiwan and China.
Basis of
presentation
The condensed consolidated financial
information as of September 30,
2007
included herein is unaudited, has been
prepared by the Company in accordance with generally accepted accounting principles in the
United States of America, and reflects all adjustments, consisting only of normal recurring
adjustments, which in the opinion of management are necessary to state fairly the Company's
consolidated financial position, results of its consolidated operations, and consolidated
cash flows for the periods presented.
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the financial statements as well as the
reported amounts of revenue and expenses during the reporting period. Actual results could
differ from those estimates, and such differences may be material to the financial
statements.
These financial statements should be
read in conjunction with the Company's audited consolidated financial statements included
in the Company's Annual Report on Form 10-K for the year ended December 31, 2006. The
results of operations for the three and nine months ended September 30,
2007
are not necessarily indicative of the
results to be expected for any future periods.
Revenue
Recognition
The Company recognizes revenue upon
shipment of its products to its customers, provided that the Company has received a
purchase order, the price is fixed, collection of the resulting receivable is reasonably
assured and transfer of title and risk of loss has occurred. Subsequent to the sale of its
products, the Company has no obligation to provide any modification or customization
upgrades, enhancements or post contract customer support.
Allowances are provided for estimated returns. A provision for estimated sales return
allowances is recorded at the time revenue is recognized based on historical returns,
current economic trends and changes in customer demand. Such allowances are adjusted
periodically to reflect actual and anticipated experience. Such adjustments, which are
recorded against revenue in the period, could be material.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with a maturity of three months or less
when purchased to be cash equivalents. Cash equivalents consist primarily of market rate
accounts, municipal bonds, and highly rated commercial paper that are stated at cost, which
approximates fair value.
4
Concentrations of
Risk
The Company's dense wavelength division multiplexing ("DWDM") related products contributed
revenues of $3.0 million and $8.2 million for the three and nine months ended September 30,
2007, respectively and $2.9 million and $7.0 million for the three and nine months ended
September 30, 2006, respectively. In the nine months ended September 30, 2007 and September
30, 2006, the Company's top 10 customers comprised 54.5% and 58.1% of its revenues,
respectively. For the nine months ended September 30, 2007 and September 30, 2006, one
customer accounted for 18.2% and 13.4% of revenues, respectively.
2. Recent Accounting
Pronouncements
In February 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 159,
"The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159
permits entities to elect to measure many financial instruments and certain other items at
fair value that are not currently required to be measured at fair value. This election is
irrevocable. SFAS No. 159 will be effective for the Company on January 1, 2008. The Company
is currently assessing the potential impact that the adoption of SFAS 159 will have on its
financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS 157),
which defines fair value, establishes guidelines for measuring fair value and expands
disclosures regarding fair value measurements. SFAS 157 does not require any new fair value
measurements but rather eliminates inconsistencies in guidance found in various prior
accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November
15, 2007. Earlier adoption is permitted, provided the Company has not yet issued financial
statements, including for interim periods, for that fiscal year. The Company is currently
evaluating the impact of SFAS 157, but does not expect the adoption of SFAS 157 to have a
material impact on its consolidated financial position, results of operations or cash
flows.
In July 2006, the FASB issued FASB
Interpretation 48, "Accounting for Uncertainty in Income Taxes" (FIN 48) - an
interpretation of FASB No. 109, "Accounting for Income Taxes." FIN 48 prescribes a
comprehensive model for recognizing, measuring, presenting and disclosing in the financial
statements tax positions taken or expected to be taken on a tax return, including a
decision on whether or not to file in a particular jurisdiction. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." The
provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this
standard. Only tax positions that meet a "more-likely-than-not" recognition threshold at
the effective date may be recognized or
continue to be
recognized upon adoption of FIN 48. The cumulative effect of applying the provisions
of FIN 48 is reported as an adjustment to the opening balance of retained earnings.
FIN 48 is effective for years beginning after December 15, 2006; therefore, the
Company has adopt
ed
FIN 48 as of
January 1, 2007. The Company expects the adoption of this accounting standard will
increase the level of disclosure that the Company provides regarding its tax positions. The
adoption of FIN 48 is not expected to have a material impact on the Company's
consolidated financial position and results of operations.
In June 2006, the
Emerging Issues Task Force ("EITF") issued EITF issue No.06-03, "How Taxes Collected from
Customers and Remitted to Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross versus Net Presentation)" ("EITF 06-03"). EITF 06-03 provides
guidance regarding accounting for certain taxes assessed by a governmental authority that
are imposed on a revenue-producing transactions between a seller and a customer. These
taxes may include, but are not limited to, sales, use, value added, and some excise taxes.
The Company has historically presented and plans
to continue to present
on a net basis in the accompanying
Condensed
Consolidated Statement
of Operations and record as a liability until amounts are remitted to the respective taxing
authority. EITF 06-3 is effective for interim and annual reporting periods beginning after
December 15, 2006, with earlier application permitted. The Company adopted EITF 06-3
effective January 1, 2007. Adoption of this issue had no effect on the consolidated
financial statements and related disclosures.
5
3. Stock-based
Compensation
The Company adopted the provisions of
FASB Statement No. 123 (revised 2004), "Share-Based Payment" and the Securities and
Exchange Commission Staff Accounting Bulletin No. 107 (collectively, "Statement
No. 123(R)")
on January
1,
2006. This statement
establishs
accounting for share-based payment
("SBP") awards exchanged for employee services and requires companies to expense the
estimated fair value of these awards over the requisite employee service period.
Statement No. 123(R) requires
companies to record compensation expense for stock options measured at fair value, on the
date of grant, using an option-pricing model. The fair value of stock options is determined
using the Binomial Lattice Model instead of the Black-Scholes Model previously utilized
under Statement No. 123. The Company believes that the former represents a more likely
projection of actual outcomes.
Statement No. 123(R) requires that
the realized tax benefit related to the excess of the deductible amount over the
compensation expense recognized be reported as a financing cash flow rather than as an
operating cash flow, as required under previous accounting guidance. The Company does not
recognize any tax benefit related to this based on the Company's historical operating
performance, lack of taxable income and the accumulated deficit.
As of September 30, 2007, there was $0.8 million of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the Company's
various option plans; that cost is expected to be recognized over a period of 2.25
years.
For the three and
nine
months ended
September
30, 2007, the fair value of SBP awards
were estimated using the Binomial-Lattice valuation model, with the following
weighted-average assumptions and fair values as follows:
|
Three
Months Ended
September 30,
|
|
Nine Months
Ended
September
30,
|
|
|
2007
|
2006
|
|
2007
|
2006
|
|
Volatility
(percent)*
|
|
52.0
|
36.7
|
|
52.0
|
36.7
|
|
Expected term
(in years)**
|
|
4
|
4
|
|
4
|
4
|
|
Risk-free
interest rate (percent)***
|
|
4.30
|
4.74
|
|
4.57
|
4.80
|
|
Expected
dividend rate (percent)
|
|
--
|
--
|
|
--
|
--
|
|
Forfeiture
rate (percent)****
|
|
11
|
10
|
|
11
|
10
|
|
Weighted-average
fair value per option
|
|
|
|
|
|
|
|
granted
|
|
$
2.20
|
$
0.71
|
|
$
2.13
|
$
0.71
|
|
|
|
|
|
|
|
|
|
* Volatility is projected using
Industry Analysis forecasts for earnings, earnings per share, and stock price, and the
Company's earning forecast.
** The expected term represents the weighted average period the option is expected to be
outstanding and is based primarily on the historical exercise behavior of employees.
*** The risk free interest rate is based on the U.S. Treasury zero-coupon yield with a
maturity that approximates the expected life of the option.
**** Forfeiture rate is the estimated percentage of options forfeited by employees by
leaving or being terminated before vesting.
At September 30, 2007, the Company had two stock-based compensation plans. They are: (a)
1997 Stock Option Plan and (b) 2000 Stock Incentive Plan, which are described
below.
(a) 1997 Stock Option Plan
In May 1997, the Company adopted its 1997 Stock Plan under which 3,000,000 shares of common
stock were reserved for issuance to eligible employees, directors and consultants upon
exercise of stock options and stock purchase rights. During the year ended
December 31, 2000, an additional 5,200,000 shares were reserved for issuance under the
1997 Stock Plan. Incentive stock options are granted at a price not less than 100% of the
fair market value of the Company's common stock and at a price of not less than 110% of the
fair market value for grants to any person who owned more than 10% of the voting power of
all classes of stock on the date of grant. Nonstatutory stock options are granted at a
price not less than 85% of the fair market value of the common stock and at a price not
less than 110% of the fair market value for grants to a person who owned more than 10% of
the voting power of all classes of stock on the date of the grant. Options granted under
the 1997 Stock Plan generally vest over four years and are exercisable for not more than
ten years (five years for grants to any person who owned more than 10% of the voting power
of all classes of stock on the date of the grant). In November 2000, the 1997 Stock Plan
was replaced by the 2000 Stock Incentive Plan.
6
(b) 2000 Stock Incentive Plan
In November 2000, the Company adopted
its 2000 Stock Incentive Plan under which 1,500,000 shares of common stock were reserved
for issuance to eligible employees, directors and consultants upon exercise of stock
options and stock purchase rights. On January 1 of each year, beginning on January 1,
2001, the number of shares available for grant will automatically increase by the lesser
of: (i) 1,700,000 shares; (ii) 5% of the fully diluted outstanding shares of
stock on that date; or (iii) a lesser amount as may be determined by the Board of
Directors. The Board of Directors determined not to increase the number of shares available
under the Plan on January 1, 2006 and 2007, respectively. Incentive stock options and
nonstatutory stock options are granted at 100% of the fair market value of the Company's
common stock on the date of grant.
Options granted under the 2000 Stock Incentive Plan generally vest over four years and are
exercisable for not more than ten years.
The following information relates to
the stock option activity for the nine months ended September 30, 2007:
|
Nine Months Ended
September 30, 2007
|
Options
|
Shares
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contractual
Life
|
Aggregate
Intrinsic
Value
|
Outstanding at
December 31, 2006
|
|
|
5,046,083
|
$
|
1.24
|
|
|
|
|
Granted
|
|
|
375,500
|
$
|
2.13
|
|
|
|
|
Exercised
|
|
|
(230,125)
|
$
|
0.71
|
|
|
|
|
Forfeited
|
|
|
(65,500)
|
$
|
1.55
|
|
|
|
|
Outstanding at
September 30, 2007
|
|
|
5,125,958
|
$
|
1.33
|
|
6.7 Years
|
$
|
2,839,458
|
Vested and expected
to vest at September 30, 2007
|
|
|
5,069,398
|
$
|
1.32
|
|
6.7 Years
|
$
|
2,814,495
|
Exercisable at
September 30, 2007
|
|
|
6,057,621
|
$
|
1.31
|
|
6.5 Years
|
$
|
2,612,515
|
The aggregate intrinsic value in the table
above represents the total pre-tax intrinsic value (the difference between the Company's
closing stock price on the last trading day of the third quarter of fiscal 2007 and the
exercise price, multiplied by the number of in-the-money options) that would have been
received by the option holders had all option holders exercised their options on September
30, 2007. This amount changes based on the fair market value of the Company's stock. The
total intrinsic value of options exercised for the three months ended September 30, 2007
and 2006 was $75,000 and $25,000, respectively. The total intrinsic value of options
exercised for the nine months ended September 30, 2007 and 2006 was $286,000 and $327,000,
respectively.
7
The weighted average grant date fair
value of options granted during the quarter ended September 30, 2007 was $419,000.
No options were granted during the
quarter ended September 30, 2006.
The weighted average grant date fair
value of options granted during the nine months ended September 30, 2007 was
$801,000.
The weighted average
grant date fair value of options granted during the nine months ended September 30, 2006
was $133,000.
The expected dividend rate is 0%
for
all periods.
Cash received from option exercises during the three and nine months ended September 30,
2007 was $63,000 and $162,000, respectively, and is included within the financing
activities section in the accompanying condensed consolidated statements of cash flows.
4. Inventories, net (in
thousands)
|
September 30, 2007
|
December 31, 2006
|
|
|
|
|
|
|
Inventories
|
|
|
|
|
|
Finished
goods
|
|
$ 1,553
|
|
$ 1,415
|
|
Work-in-process
|
|
1,872
|
|
1,751
|
|
Raw
materials
|
|
1,082
|
|
1,299
|
|
|
|
|
|
|
Total
|
|
$ 4,507
|
|
$ 4,465
|
|
|
|
|
|
|
|
|
|
5. Net
Income
Per
Share
Basic net income per share is computed by dividing net income for the period 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
combination of dilutive common share equivalents, comprised of shares issuable under the
Company's stock-based compensation plans, and the weighted average number of common shares
outstanding during the period. There were no incremental dilutive common share equivalents
in the periods presented.
The following table sets forth the
computation of basic and diluted net income per share for the periods indicated (in
thousands, except per share data):
|
Three Months
Ended September 30,
|
|
Nine Months
Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
$
|
1,065
|
|
$
|
358
|
|
$
|
2,318
|
|
$
|
4
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
40,980
|
|
|
40,205
|
|
|
40,799
|
|
|
40,023
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
|
44,929
|
|
|
43,728
|
|
|
44,747
|
|
|
43,545
|
|
|
|
|
|
|
|
|
|
|
Net income per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
$
|
0.03
|
|
$
|
0.01
|
|
$
|
0.06
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
$
|
0.02
|
|
$
|
0.01
|
|
$
|
0.05
|
|
$
|
0.00
|
|
|
|
|
|
|
|
|
|
|
All outstanding stock options and shares subject to repurchase by the Company have been
excluded from the calculation of diluted net income per share as all such securities were
anti-dilutive for all periods presented. The total number of shares excluded from the
calculation of diluted net income share is as follows (in thousands):
8
|
Nine Months
Ended September 30,
|
|
|
|
2007
|
2006
|
|
|
Options to
purchase common stock and
|
|
|
|
3,949
|
|
|
1,002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6.
Comprehensive Income
Comprehensive income is defined as the
change in equity of a company during a period resulting from transactions and other events
and circumstances, excluding transactions resulting from investments by owners and
distributions to owners. The difference between net income and comprehensive income
for the Company is due to foreign
exchange translations adjustments and unrealized gain on available-for-sale securities.
The components of comprehensive income are as follows (in thousands):
|
Three Months
Ended September 30,
|
|
Nine Months
Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net income
|
|
|
$
|
1,065
|
|
$
|
358
|
|
$
|
2,318
|
|
$
|
4
|
|
Cumulative translation
adjustments
|
|
|
|
189
|
|
|
42
|
|
|
248
|
|
|
18
|
|
Unrealized gain on short-term
investments
|
|
|
|
11
|
|
|
9
|
|
|
21
|
|
|
22
|
|
|
|
|
|
|
|
|
|
|
Total
comprehensive income
|
|
|
$
|
1,265
|
|
$
|
409
|
|
$
|
2,587
|
|
$
|
44
|
|
|
|
|
|
|
|
|
|
|
7. Income Taxes
The Company adopted the
provisions of FASB Interpretation No. 48,
"
Accounting for Uncertainty in Income
Taxes
"
on January 1, 2007.
FIN 48 prescribes a recognition threshold and measurement attribute for financial
statement recognition and measurement of a tax position taken or expected to be taken in a
tax return, and also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure, and transition. The Company has
determined the impact of the adoption of FIN 48 is insignificant to the Company's
consolidated financial position, results of operations and cash flows.
8
. Commitments and Contingencies
Litigation:
From time to time, the Company may be involved in litigation in the normal course of
business. As of the date of these financial statements, the Company is not aware of any
material legal proceedings pending or threatened against the Company.
Indemnification and Product
Warranty:
The Company indemnifies certain customers, suppliers and subcontractors for attorney fees
and damages and costs awarded against these parties in certain circumstances in which
products are alleged to infringe third party intellectual property rights, including
patents, trade secrets, trademarks or copyrights. In all cases, there are limits on and
exceptions to the potential liability for indemnification relating to intellectual property
infringement claims. The Company cannot estimate the amount of potential future payments,
if any, that it might be required to make as a result of these agreements. To date, the
Company has not paid any claim or been required to defend any action related to
indemnification obligations, and accordingly, the Company has not accrued any amounts for
such indemnification obligations. However, the Company may record charges in the future as
a result of these indemnification obligations.
9
The Company generally warrants products against defects in materials and workmanship and
non-conformance to specifications for varying lengths of time. If there is a material
increase in customer claims compared with historical experience, or if costs of servicing
warranty claims are greater than expected, the Company may record a charge against cost of
revenues.
Operating Leases:
The Company leases certain office space under long-term operating leases expiring at
various dates through 2012.
The Company's aggregate future minimum
facility lease payments are as follows (in thousands):
|
|
Three months ending December
31, 2007
|
|
|
$
|
238
|
|
Years ending
December 31:
|
|
|
|
|
|
2008
|
|
|
|
918
|
|
2009
|
|
|
|
550
|
|
2010
|
|
|
|
335
|
|
2011
|
|
|
|
95
|
|
2012
|
|
|
|
41
|
|
|
|
|
Total
|
|
|
$
|
2,177
|
|
|
|
|
|
|
|
|
Letter of Credit:
The Company had a letter of credit of
$0.4 million outstanding as of September 30, 2007. The letter of credit is collateralized
by short-term investments of $0.4 million.
8. Bank Loans
In November 2004,
the Company entered into a ten-year loan of $0.5 million with a lender in Taiwan. The loan
has a fixed interest rate of 2.3% for the first year after which the loan has a variable
interest rate equal to Taiwan's prime rate for the remaining years. The loan is secured by
the Company's building in Taiwan. The net book value of the building was $0.6 million as of
September 30,
200
7.
In September 2007, the Company also
entered
into
two additional
equipment
loans
of $0.2 million
for 3 years and 5 years
with a lender in Taiwan. The
loans
have
a fixed interest rate of
3.6%.
Payments due under the bank
loans
as of September 30,
2007
are as follows (in
thousands):
|
|
Years ending
December 31,
|
|
|
|
|
|
2007
|
|
|
|
38
|
|
2008
|
|
|
|
151
|
|
2009
|
|
|
|
151
|
|
2010
|
|
|
|
124
|
|
2011
|
|
|
|
103
|
|
2012
|
|
|
|
96
|
|
2013
and after
|
|
|
|
124
|
|
|
|
|
Total
payment
|
|
|
|
787
|
|
Less: Amounts
representing interest
|
|
|
|
(70
|
)
|
|
|
|
Present value
of net remaining payments
|
|
|
|
717
|
|
Less: current
portion
|
|
|
|
(130
|
)
|
|
|
|
Long-term
portion
|
|
|
$
|
587
|
|
|
|
|
|
|
10
9. Related Party
Transactions
As of September 30, 2007, Foxconn Holding Limited was a holder of 19.5% of the Company's
common stock, based on share ownership information set forth in a Schedule 13G filed by
Foxconn Holding Limited on January 4, 2002. The Company sells products and purchases raw
materials from Hon Hai Precision Company Limited, who is the parent company of Foxconn
Holding Limited, in the normal course of business. These transactions were made at prices
and terms consistent with those with unrelated third parties. Sales of products to Hon Hai
Precision Industry Company Limited were $0.3 million and $0.7 million for the three and
nine months ended September 30, 2007. Purchases of raw materials from Hon Hai Precision
Company Limited were $0.1 million and $0.3 million for the three and nine months ended
September 30, 2007. Amounts due from Hon Hai Precision Company Limited were $0.2 million at
September 30, 2007. Amounts due to Hon Hai Precision Company Limited were $0.1 million at
September 30, 2007.
10.
Geographic Segment
Information
The Company operates in a single
industry segment. This industry segment is characterized by rapid technological change and
significant competition.
The following is a summary of the Company's revenues generated from geographic segments,
revenues generated by product lines and identifiable assets located in these segments (in
thousands):
|
Three Months
Ended September 30,
|
|
Nine Months
Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
$
|
5,536
|
|
$
|
5,393
|
|
$
|
14,900
|
|
$
|
13,613
|
|
Europe
|
|
|
|
733
|
|
|
453
|
|
|
1,883
|
|
|
1,258
|
|
Asia
|
|
|
|
2,901
|
|
|
1,727
|
|
|
7,789
|
|
|
4,175
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
$
|
9,170
|
|
$
|
7,573
|
|
$
|
24,572
|
|
$
|
19,046
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
Ended September 30,
|
|
Nine Months
Ended September 30,
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Optical
path mulitplexing solution
|
|
|
$
|
6,180
|
|
$
|
4,699
|
|
$
|
16,413
|
|
$
|
12,010
|
|
Dense
wavelength division multiplexer
|
|
|
|
2,990
|
|
|
2,874
|
|
|
8,159
|
|
|
7,036
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
$
|
9,170
|
|
$
|
7,573
|
|
$
|
24,572
|
|
$
|
19,046
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2007
|
|
December 31,
2006
|
Property and
Equipment
|
|
|
|
|
|
|
|
|
United
States
|
|
|
$
|
100
|
|
$
|
144
|
|
Taiwan
|
|
|
|
2,753
|
|
|
3,015
|
|
China
|
|
|
|
1,288
|
|
|
1,105
|
|
|
|
|
|
|
Total
|
|
|
$
|
4,141
|
|
$
|
4,264
|
|
|
|
|
|
|
|
|
|
|
|
|
11
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
When used in this Report, the words
"expects," "anticipates," "believes", "estimates," "plans," "intends," "could," "will,"
"may" and similar expressions are intended to identify forward-looking statements. These
are statements that relate to future periods and include statements as to our operating
results, revenues, sources of revenues, cost of revenues, gross profit, net operating
losses, profitability, the amount and mix of anticipated investments, expenditures and
expenses, our liquidity and the adequacy of our capital resources, exposure to interest
rate or currency fluctuation, anticipated working capital and capital expenditures,
reliance on our OPMS products, our cash flow, trends in average selling prices, our
reliance on the commercial success of our DWDM-related products, plans for future products
and enhancements of existing products, features, benefits and uses of our products, demand
for our products, our success being tied to relationships with key customers, industry
trends and market demand, our efforts to protect our intellectual property, the potential
benefit of indemnification agreements, increases in the number of possible license offers
and patent infringement claims, our competitive position, sources of competition,
consolidation in our industry, our international strategy, inventory management, our
employee relations, the adequacy of our internal controls,
and
the effect of recent and changing
accounting pronouncements and our critical accounting policies, estimates, models and
assumptions. Forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. These risks and
uncertainties include, but are not limited to, those risks discussed elsewhere in this
report, as well as risks related to the development of the metropolitan, last mile access,
and enterprise networks, customer acceptance of our products, our ability to retain and
obtain customers, industry-wide overcapacity and shifts in supply and demand for optical
components and modules, our ability to meet customer demand and manage inventory,
fluctuations in demand for our products, declines in average selling prices, development of
new products by us and our competitors, increased competition, inability to obtain
sufficient quantities of a raw material product, loss of a key supplier, integration of
acquired businesses or technologies, financial stability in foreign markets, foreign
currency exchange rates, interest rates, costs associated with being a public company,
failure to meet customer requirements, our ability to license intellectual property on
commercially reasonable terms, economic stability, and the risks set forth below under Part
II, Item 1A, "Risk Factors." These forward-looking statements speak only as of the
date hereof. The Company expressly disclaims any obligation or undertaking to update or
revise
any forward-looking
statements contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such statement is
based
.
This Management's Discussion and
Analysis of Financial Condition and Results of Operations should be read in conjunction
with the section entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in the Company's Annual Report on Form 10-K, its Consolidated
Financial Statement and the notes thereto, for the year ended December 31, 2006.
The following discussion should
also
be read in conjunction with our
Condensed Consolidated Financial Statements and Notes thereto.
Critical Accounting Policies and
Estimates
Stock-based Compensation
Expense
On January 1, 2006, we adopted
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation
expense for all share-based payment awards made to our employees and directors including
employee stock options and employee stock purchases pursuant to our Employee Stock Purchase
Plan ("ESPP") based on estimated fair values. We adopted SFAS 123(R) using the modified
prospective transition method, which requires the application of the accounting standard as
of January 1, 2006, the first day of our 2006 fiscal year.
Stock-based compensation expense
recognized under SFAS 123(R) for the three and nine months ended September 30, 2007
was $91,000 and $318,000, respectively,
determined by the Binomial Lattice
valuation model, and represents
stock-based compensation expense related to employee stock options.
As of September 30, 2007, total
unrecognized compensation costs related to unnvested stock options was $0.8
million, which is expected to be
recognized as an expense over a weighted average period of approximately
2.25
years.
Management's discussion and analysis of financial condition and results of operations is
based on our Condensed Consolidated Financial Statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires us to make estimates and judgments
that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to revenue recognition, bad debts, inventories, asset
impairments, income taxes, 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 values for assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different assumptions or
conditions.
12
For additional information regarding
our critical accounting policies and estimates, see the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in our Annual
Report on Form 10-K, for the year ended December 31, 2006.
Overview
We were founded in December 1995 and
commenced operations to design, manufacture and market fiber optic interconnect products,
which we call our Optical Path Management Solution, or OPMS, products. We started selling
our dense wavelength division multiplexing, or DWDM, and other wavelength management
products in July 2000. Since introduction, sales of DWDM-related products have fluctuated
with the overall market for these products.
From our inception through September 30, 2007, we derived a substantial portion of our
revenues from our OPMS product line, although revenues from our DWDM product line have
increased
in recent years
as a percentage of total
sales.
Revenues from our DWDM products
represented
32.6% and
38.0% of total revenues for the three
months ended September 30,
200
7
and 2006, respectively, and
33.2% and
36.9% of total revenues for the nine
months ended September 30, 2007
and 2006, respectively. We market and
sell our products predominantly through our direct sales force.
Our cost of revenues consists of raw
materials, components, direct labor, manufacturing overhead and production start-up costs.
We expect that our cost of revenues as a percentage of revenues will fluctuate from period
to period based on a number of factors including:
|
o
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changes in manufacturing
volume;
|
|
o
|
costs incurred in
establishing additional manufacturing lines and facilities;
|
|
o
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inventory write-downs and
impairment charges related to manufacturing assets;
|
|
o
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changes in our pricing and
pricing from our competitors;
|
|
o
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mix of sales channels
through which our products are sold; and
|
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o
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mix of domestic and
international sales.
|
Research and development expenses
consist primarily of salaries and related personnel expenses, fees paid to outside service
providers, materials costs, test units, facilities, overhead and other expenses related to
the design, development, testing and enhancement of our products. We expense our research
and development costs as they are incurred. We believe that a significant level of
investment for product research and development is required to remain competitive.
Sales and marketing expenses consist primarily of salaries, commissions and related
expenses for personnel engaged in marketing, sales and technical support functions, as well
as costs associated with trade shows, promotional activities and travel expenses.
General and administrative expenses
consist primarily of salaries and related expenses for executive, finance, administrative,
accounting and human resources personnel, insurance and professional fees for legal and
accounting support.
13
Results of Operations
The following table sets forth the relationship between various components of operations,
stated as a percentage of revenues for the periods indicated:
|
Three Months
Ended September 30,
|
|
Nine Months
Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenues
|
|
|
|
100.0%
|
|
|
100.0%
|
|
|
100.0%
|
|
|
100.0%
|
|
Cost of revenues
|
|
|
|
68.6
|
|
|
71.3
|
|
|
68.5
|
|
|
73.0
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
|
31.4
|
|
|
28.7
|
|
|
31.5
|
|
|
27.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development:
|
|
|
|
9.5
|
|
|
10.8
|
|
|
9.8
|
|
|
12.0
|
|
Sales
and marketing:
|
|
|
|
6.1
|
|
|
7.2
|
|
|
7.2
|
|
|
8.9
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|
General
and administrative
|
|
|
|
8.9
|
|
|
10.4
|
|
|
10.5
|
|
|
11.9
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
|
24.5
|
|
|
28.4
|
|
|
27.5
|
|
|
32.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from
operations
|
|
|
|
6.9
|
|
|
0.3
|
|
|
4.0
|
|
|
(5.8)
|
|
Interest and other income,
net
|
|
|
|
4.7
|
|
|
4.4
|
|
|
5.4
|
|
|
5.8
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
11.6%
|
|
|
4.7%
|
|
|
9.4%
|
|
|
0.0%
|
|
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|
|
|
|
|
|
|
|
|
|
Revenues.
Revenues were $9.2
million and $7.6 million for the
three months ended September 30, 2007
and 2006, respectively. Revenues
increased
21.1% in the quarter
ended September 30, 2007
from
the same period in 2006, as a result of an
increase in demand from
a broad base of
our customers, especially for
datacenter related products from
our
Premise Market
customers.
Revenues were
$24.6
million and
$19.0 million for the nine months ended September 30, 2007
and 2006, respectively. Revenues
increased
29.5% in the nine
months ended September 30, 2007
from the same period in 2006,
primarily
as a result of
increases in sales for Fiber to the Home (FTTH) related products, increases in
datacenter related products from our
Premise Market customers, and some general increase in demand from improved market
conditions in the overall communications market.
Cost of Revenues.
Cost of revenues was $6.3
million and $5.4
million for the three months ended
September 30, 2007
and 2006,
respectively. Cost of revenues as a percentage of revenues decreased to
68.6% for the three months ended
September 30, 2007
from
71.3% for the three months ended
September 30, 2006. Cost of revenues was $16.8
million and $13.9
million for the nine months ended
September 30, 2007
and 2006,
respectively. Cost of revenues as a percentage of revenues decreased to
68.5% for the nine months ended
September 30, 2007
from
73.0% for the nine months ended
September 30, 2006. Cost of revenues for the period ended September 30, 2007
benefited from increased factory
utilization and improved manufacturing overhead absorption as a result of increased volume
shipments of our products.
Gross Profit.
Gross profit increased to $2.9 million,
or 31.4% of revenues, for the three months ended September 30, 2007 from $2.2 million,
or 28.7% of revenues, for the same period in 2006. Gross profit increased to $7.8 million,
or 31.5% of revenues, for the nine months ended September 30, 2007 from $5.1 million,
or 27.0% of revenues, for the same period in 2006. For the period ended September 30, 2007,
higher utilization of our factories as a result of increased volume shipments of our
products resulted in an improved gross margin. We expect our gross profit as a percentage
of revenues continue to improve with higher production volumes, which we anticipate will
result in improved absorption of overhead expenses. However,
our
average selling prices
are declining, which
will negatively impact our gross profit
and may offset any benefits from improved absorption.
14
Research and Development
Expenses
.
Research and development expenses
increased to $0.9 million for the three months ended September 30, 2007 from
$0.8 million for the same period in 2006. The increase was primarily due to expenses
for Passive Fiber Optic Components (PFOC) related tests, shipment of new samples, and for
new product development. Research and development expenses
increased to $2.4 million for the nine
months ended September 30, 2007 from $2.3 million for the same period in 2006.
As a percentage of revenues, research
and development expenses decreased to 9.5% in the three months ended
September
30, 2007 from
10.8% for the same period in 2006. As a
percentage of revenues, research and development expenses decreased to
9.8% in the
nine
months ended
September
30, 2007 from
12.0% for the same period in 2006. We
expect research and development expenses on our product development efforts to increase in
the near term as we intend to continue to invest in our research and product development
efforts.
Sales and Marketing
Expenses
. Sales and
marketing expenses
increased
to
$0.6
million for the three months ended
September 30, 2007 from $0.5
for
the same period in 2006. Sales and marketing expenses
increased to $1.8
million for the nine months ended
September 30, 2007 from $1.7
for
the same period in 2006. As a percentage of revenues, sales and marketing expenses
decreased to
6.1% in the three
months ended September 30, 2007
from
7.2% for the same period in 2006. As a
percentage of revenues, sales and marketing expenses decreased to
7.2% in the nine months ended September
30, 2007
from
8.9% for the same period in 2006. We
expect sales and marketing expenses to
remain the same in the near
term.
General and Administrative
Expenses
. General and
administrative expenses remained at $0.8 million for the three months ended September 30,
2007
and for the same period in
2006. General and administrative expenses increased to $2.6
million for the nine months ended
September 30, 2007
from
$2.3
million for the same period
in 2006. As a percentage of revenues, general and administrative expenses decreased
to
8.9% in the three months
ended September 30, 2007
from
10.4% for the same period in 2006. As a
percentage of revenues, general and administrative expenses decreased to 10.5% in the nine
months ended September 30, 2007
from 11.9% for the same period in 2006.
We expect general and administrative expenses will increase due to higher fees and costs
associated with compliance with new laws and regulations such as the Sarbanes-Oxley Act of
2002 and the regulations promulgated thereunder.
Stock-Based
Compensation
. Total stock
based compensation increased to $91,000 for the three months ended September 30,
2007
from $83,000
for the same period in 2006. Total
stock based compensation increased to $318,000 for the nine months ended September 30,
2007
from $192,000
for the same period in 2006.
These increases were due to
the
higher volatility rate
we
projected for the
2007
fiscal
year.
Interest and Other Income,
Net.
Interest and other
income, net, was $0.4
million
and $0.3
million for the three
months ended September 30, 2007
and 2006, respectively. Interest and
other income, net, was $1.3
million and $1.1
million for the nine months ended
September 30, 2007
and 2006,
respectively.
The increase in
interest and other income reflects the growth in interest-earning assets and partially
offset by cumulative exchange losses.
Liquidity and Capital Resources
At September 30, 2007, we had cash and
cash equivalents of $5.3 million and short-term investments of $29.2 million.
Net cash provided by operating
activities was $3.3 million for the nine months ended September 30, 2007. Net cash provided
by operating activities was primarily due to net income of $2.3 million, an increase in
accounts payable of $0.7 million, an increase in accrued expense of $0.5 million, and total
depreciation and amortization expenses of $1.2 million, which was offset by a $1.1 million
increase in accounts receivable, a $0.4 million decreased in inventory provision and a $0.3
million decrease in inventory.
Net cash provided by operating
activities was $0.6 million
for
the nine months ended September 30, 2006. The cash provided was primarily due to
depreciation expenses of $1.0 million and a $0.4 million inventory provision, which was
partially offset by $1.5 million increase in inventory. Accounts receivable increased by
$0.3 million and prepaid expenses and other assets increased by $0.2 million,
offset by a $0.8 million increase in
accounts payable and a $0.2 million increase in
accrued
expenses
.
15
Cash used in investing activities was
$3.0
million for the
nine
months ended
September
30, 2007. In the
nine
months ended
September
30, 2007, we spent a net $2.3
million for the purchase of short-term
securities, and we used $0.7
million to acquire property and
equipment.
Net cash
provided
by investing activities was $0.3 million for the nine
months ended September 30, 2006. This resulted from $0.8 million in net proceeds from sales
of short-term investments offset by $0.5 million
of
spending on equipment.
Cash provided by financing activities was $0.5 million and $0.3 million for the nine months
ended September 30, 2007 and 2006, respectively, and was comprised of proceeds from
exercise of options to purchase common stock and common stock issued through our Employee
Stock Purchase Plan. Cash provided for the nine months ended September 30, 2007 also
included net proceeds from borrowings under an equipment loan of $0.2 million offset by
repayment of bank borrowings.
We believe that our current cash, cash
equivalents and short-term investments will be sufficient to meet our anticipated cash
needs for working capital and capital expenditures for at least the next 12 months.
However, our future growth, including any potential acquisitions, may require additional
funding. If cash generated from operations is insufficient to satisfy our long-term
liquidity requirements, we may need to raise capital through additional equity or debt
financings, additional credit facilities, strategic relationships or other arrangements. If
additional funds are raised through the issuance of securities, these securities could have
rights, preferences and privileges senior to holders of common stock, and the terms of any
debt facility could impose restrictions on our operations. The sale of additional equity or
debt securities could result in additional dilution to our stockholders, and additional
financing may not be available in amounts or on terms acceptable to us, if at all. If we
are unable to obtain additional financing, we may be required to reduce the scope of our
planned product development and marketing efforts. Strategic arrangements, if necessary to
raise additional funds, may require us to relinquish our rights to certain of our
technologies or products. Our failure to raise capital when needed could harm our business,
financial condition and operating results.
Contractual
Obligations
Our corporate headquarters are in
Sunnyvale, California,
where we
lease
a 34,800 square
foot
facility
from a third party
for a current month rent of
approximately $32,000. The lease has a six-year term commencing on July 22,
2004.
In December 2000, we purchased
approximately 8,200 square feet of space immediately adjacent to our leased facility in
Tu-Cheng City, Taiwan for $0.8 million.
Additionally, in February 2006, we
entered into a lease for a total of 21,600 square feet facility located in Hu-Kou, Taiwan.
This lease will expire in January 2009.
In July 2007, we renewed the lease for
our 62,000 square foot facility in the Shenzhen area of China, which will expire in July
2012. Additionally, in February 2007, we entered into a new lease for an 8,200 square feet
dormitory in Shenzhen, which lease will expire in January 2012.
16
ITEM 3: QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate
Sensitivity
We currently maintain our funds primarily in money market funds and highly liquid
marketable securities. We do not have any derivative financial instruments. As of September
30, 2007, $2.8 million, or 8.7% of our investments, had maturities of less than three
months. We expect to continue to invest a significant portion of our existing cash in
interest bearing, investment grade securities, with maturities of less than 12 months
pending their need for other uses. We do not believe that our investments, in the
aggregate, have significant exposure to interest rate risk and we do not believe that a 10%
change in interest rates at September 30, 2007 would have a significant impact on our
investments or interest income.
Exchange Rate
Sensitivity
We currently have operations in the
United States, Taiwan and China. The functional currency of our subsidiaries in Taiwan and
China are the local currencies, and we are subject to foreign currency exchange rate
fluctuations associated with the translation to United States dollars. Though some expenses
are incurred by our Taiwan and China operations, substantially all of our sales are made in
United States dollars; hence, we have minimal exposure to foreign currency rate
fluctuations relating to sales transactions. We do not believe that a hypothetical change
of 10% in the foreign currency exchange rates
in effect at September 30, 2007
would have a material impact on our
financial results.
While we expect our international revenues to continue to be denominated predominately in
United States dollars, an increasing portion of our international revenues may be
denominated in foreign currencies in the future. In addition, we plan to continue to expand
our overseas operations. As a result, our operating results may become subject to
significant fluctuations based upon changes in exchange rates of certain currencies in
relation to the United States dollar. We periodically analyze our exposure to currency
fluctuations and may engage in financial hedging techniques in the future to attempt to
minimize the effect of these potential fluctuations; however, exchange rate fluctuations
may adversely affect our financial results in the future.
ITEM
4: CONTROLS AND PROCEDURES
(a)
Evaluation of disclosure controls
and procedures.
We maintain
"disclosure controls and procedures," as such term is defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act"), that are designed to ensure that
information required to be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized, and reported within the time periods
specified in Securities and Exchange Commission rules and forms, and that such information
is accumulated and communicated to our management, including our Chief Executive Officer
and Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating our disclosure controls and procedures,
management recognized that disclosure controls and procedures, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the objectives of
the disclosure controls and procedures are met. Our disclosure controls and procedures have
been designed to meet reasonable assurance standards. Additionally, in designing disclosure
controls and procedures, our management necessarily was required to apply its judgment in
evaluating the cost-benefit
relationship of possible disclosure
controls and procedures. The design of any disclosure controls and procedures also is based
in part upon certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all potential
future conditions. Based on their evaluation as of the end of the period covered by this
Quarterly Report on Form 10-Q, our Chief Executive Officer and Acting Chief Financial
Officer have concluded that, as of such date, our disclosure controls and procedures were
effective to ensure that material information relating to us, including our consolidated
subsidiaries, is made known to them by others within those entities, particularly during
the period in which this Quarterly Report on Form 10-Q was being prepared.
17
(b)
Changes in internal
controls.
There was no
change in our internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) identified in connection with the evaluation described in Item 4(a) above
that occurred during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
18
PART II:
OTHER INFORMATION
ITEM
1A: RISK FACTORS
We have a history of losses, may experience future losses and may not be able to
generate sufficient revenues in the future to achieve and sustain profitability.
We had net income of approximately $1.1
million and $0.4 million the third quarter of fiscal 2007 and 2006, respectively. Although
we generated a profit in the third quarter, we may not be able to sustain profitability in
the future. Although our cash and cash equivalents increased in the third quarter of fiscal
2007, we could find our cash flows to be negative again in the future as we continue to
invest in our business. As of September 30, 2007, we had an accumulated deficit of
approximately $69.5 million.
Although we continue to experience
fluctuating demand for our products, we
have recently experienced
increasing
demand for our
products.
If this
continues, we expect we will incur
significant and increasing expenses for expansion of our manufacturing operations, research
and development, sales and marketing, and administration, and in
expanding our
direct sales and distribution channels.
Given the rate at which competition in our industry intensifies and the fluctuations in
demand for our products, we may not be able to adequately control our costs and expenses or
achieve or maintain adequate operating margins. As a result, to maintain profitability, we
will need to generate and sustain substantially higher revenues while maintaining
reasonable cost and expense levels. We may not be able to achieve and sustain profitability
on a quarterly or an annual basis.
Our Optical Path Management Solution or OPMS products have historically represented a
significant part of our revenues, and if we are unsuccessful in commercially selling our
DWDM-related products, our business will be seriously harmed.
Sales of our OPMS products accounted for over 67.4% of our revenues in the quarter ended
September 30, 2007 and a substantial portion of our historical revenues. We expect to
substantially depend on these products for our near-term revenues. Any significant decline
in the price of, or demand for, our OPMS products, or failure to increase their market
acceptance, would seriously harm our business. In addition, we believe that our future
growth and a significant portion of our future revenues will depend on the commercial
success of our DWDM-related products, which we began shipping commercially in July 2000.
Demand for these products has fluctuated over the past few years, declining sharply
starting in mid fiscal 2001 and then increasing beginning in 2003. If demand for these
products does not continue to increase and our target customers do not continue to adopt
and purchase our DWDM-related products, our revenues may decline and we may have to
write-off inventory that is currently on our books.
We depend on a small number
of customers for a significant portion of our total
revenue
s
and the loss of, or a significant
reduction in orders from, any of these customers, would significantly reduce our
revenue
s
and harm our operating
results.
In the quarters ended September 30, 2007 and 2006, our top 10 customers comprised 51.8% and
63.1% of our revenues, respectively. One customer accounted for 13.3% of our total revenues
for the three months ended September 30, 2007. Two customers accounted for 14.5% and 11.4%,
respectively, of our total revenues for the three months ended September 30, 2006.
We derive a significant portion of our revenues from a small number of customers, and we
anticipate that we will continue to do so in the foreseeable future. These customers may
decide not to purchase our products at all, to purchase fewer products than they did in the
past, or to alter their purchasing patterns in some other way. The loss of any significant
customer, a significant reduction in sales we make to them, or any problems collecting
receivables from them would likely harm our financial condition and results of
operations.
19
Our quarterly and annual financial results have historically fluctuated due primarily to
introduction of, demand for, and sales of our products, and future fluctuations may cause
our stock price to decline.
We believe that period-to-period comparisons of our operating results are not a good
indication of our future performance. Our quarterly operating results have fluctuated in
the past and are likely to fluctuate significantly in the future due to a number of
factors. For example, the timing and expenses associated with product introductions and
establishing additional manufacturing lines and facilities, changes in manufacturing
volume, declining average selling prices of our products, the timing and extent of product
sales, the mix of domestic and international sales, the mix of sales channels through which
our products are sold, the mix of products sold and significant fluctuations in the demand
for our products have caused our operating results to fluctuate in the past. Because we
incur operating expenses based on anticipated revenue trends, and a high percentage of our
expenses are fixed in the short term, any delay in generating or recognizing revenues or
any decrease in revenues could significantly harm our quarterly results of operations.
Other factors, many of which are more fully discussed in other risk factors below, may also
cause our results to fluctuate. Many of the factors that may cause our results to fluctuate
are outside of our control. If our quarterly or annual operating results do not meet the
expectations of investors and securities analysts, the trading price of our common stock
could significantly decline.
If we cannot attract more optical communications equipment manufacturers to purchase our
products, we may not be able to increase or sustain our revenues.
Our future success will depend on our ability to migrate existing customers to our new
products and our ability to attract additional customers. Some of our present customers are
relatively new companies. The growth of our customer base could be adversely affected
by:
|
o
|
customer unwillingness to
implement our products;
|
|
o
|
any delays or difficulties
that we may incur in completing the development and introduction of our planned
products or product enhancements;
|
|
o
|
the success of our
customers;
|
|
o
|
excess inventory in the
telecommunications industry;
|
|
o
|
new product introductions
by our competitors;
|
|
o
|
any failure of our products
to perform as expected; or
|
|
o
|
any difficulty we may incur
in meeting customers' delivery requirements or product
specifications.
|
The fluctuations in the economy have affected the telecommunications industry.
Telecommunications companies have cut back on their capital expenditure budgets, which has
and may continue to further decrease demand for equipment and parts, including our
products. This decrease has had and may continue to have an adverse effect on the demand
for fiber optic products and negatively impact the growth of our customer base.
We are exposed to risks and
increased expenses and business risk as a result of new Restriction on Hazardous
Substances
, or
RoHS directives.
Following the lead of the European Union, or EU, various governmental agencies have either
already put into place or are planning to introduce regulations that regulate the
permissible levels of hazardous substances in products sold in various regions of the
world. For example, the RoHS directive for EU took effect on July 1, 2006. The labeling
provisions of similar legislation in China went into effect on March 1, 2007. Consequently,
many suppliers of products sold into the EU countries have required their suppliers to be
compliant with the new directive. Many of our customers have adopted this approach and have
required our full compliance. Though we have devoted a significant amount of resources and
effort to planning and executing our RoHS program, it is possible that some of our products
might be incompatible with such regulations. In such event, we could experience the
following consequences: loss of revenue, damaged reputation, diversion of resources,
monetary penalties, and legal action.
20
The market for fiber optic components is increasingly competitive, and if we are unable
to compete successfully our revenues could decline.
The market for fiber optic components
is intensely competitive. We believe that our principal competitors are the major
manufacturers of optical components and integrated modules, including vendors selling to
third parties and business divisions within communications equipment suppliers. Our
principal competitors in the components market include JDS Uniphase Corp., Oplink
Communications Inc., Stratos International, Inc., Corning Incorporated, and Tyco
Electronics Corporation. We believe that we primarily compete with diversified suppliers
for the majority of our product line and to a lesser extent with niche companies that offer
a more limited product line. Competitors in any portion of our business may also rapidly
become competitors in other portions of our business. In addition, our industry has
recently experienced significant consolidation, and we anticipate that further
consolidation will occur. This consolidation has further increased competition.
Many of our current and potential competitors have significantly greater financial,
technical, marketing, purchasing, manufacturing and other resources than we do. As a
result, these competitors may be able to respond more quickly to new or emerging
technologies and to changes in customer requirements, to devote greater resources to the
development, promotion and sale of products, to negotiate lower prices on raw materials and
components, or to deliver competitive products at lower prices.
Several of our existing and potential customers are also current and potential competitors
of ours. These companies may develop or acquire additional competitive products or
technologies in the future and subsequently reduce or cease their purchases from us. In
light of the consolidation in the optical networking industry, we also believe that the
size of suppliers will be an increasingly important part of a purchaser's decision-making
criteria in the future. We may not be able to compete successfully with existing or new
competitors, and we cannot ensure that the competitive pressures we face will not result in
lower prices for our products, loss of market share, or reduced gross margins, any of which
could harm our business.
New and competing technologies are emerging due to increased competition and customer
demand. The introduction of products incorporating new or competing technologies or the
emergence of new industry standards could make our existing products noncompetitive. For
example, there are technologies for the design of wavelength division multiplexers that
compete with the technology that we incorporate in our products. If our products do not
incorporate technologies demanded by customers, we could lose market share causing our
business to suffer.
If we fail to effectively manage our operations, specifically given the past history of
sudden and dramatic downturn in demand for our products, our operating results could be
harmed.
We rapidly expanded our operations domestically and internationally in the final two
quarters of 2000. We had to carefully manage and re-evaluate this expansion given the
sudden and dramatic downturn in demand for our products experienced in 2001 and 2002.
Additionally, we implemented a reduction in force to reduce employees during the second,
third and fourth quarters of 2002 to match our operations to this decreased demand for our
products. As of September 30, 2007, we had a total of 43 full-time employees in Sunnyvale,
California, 395 full-time employees in Taiwan, and 288 full-time employees in China.
Matching the scale of our operations with demand fluctuations, combined with the challenges
of expanding and managing geographically dispersed operations, has placed, and will
continue to place, a significant strain on our management and resources. To manage the
expected fluctuations in our operations and personnel, we will be required to:
21
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improve existing and
implement new operational, financial and management controls, reporting systems
and procedures;
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hire, train, motivate and
manage additional qualified personnel, especially if we experience a
significant increase in demand for our products;
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effectively expand or
reduce our manufacturing capacity, attempting to adjust it to customer demand;
and
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effectively manage
relationships with our customers, suppliers, representatives and other third
parties.
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In addition, we will need to coordinate
our domestic and international operations and establish the necessary infrastructure to
implement our international strategy. If we are not able to manage our operations in an
efficient and timely manner, our business will be severely harmed.
Our success also depends, to a large degree, on the efficient and uninterrupted operation
of our facilities. We have expanded our manufacturing facilities in Taiwan and manufacture
many of our products there. Our facility in China also houses a substantial portion of our
manufacturing operations. There is significant political tension between Taiwan and China.
If there is an outbreak of hostilities between Taiwan and China, our manufacturing
operations may be disrupted or we may have to relocate our manufacturing operations.
Tensions between Taiwan and China may also affect our facility in China. Relocating a
portion of our employees could cause temporary disruptions in our operations and divert
management's attention.
Because of the time it takes to develop fiber optic components, we incur substantial
expenses for which we may not earn associated revenues.
The development of new or enhanced fiber optic products is a complex and uncertain process.
We may experience design, manufacturing, marketing and other difficulties that could delay
or prevent the development, introduction or marketing of new products and enhancements.
Development costs and expenses are incurred before we generate revenues from sales of
products resulting from these efforts. Our total research and development expenses were
approximately $0.9 million and $0.8 million for the three months ended September 30, 2007
and 2006, respectively. Our total research and development expenses were approximately $2.4
million and $2.3 million for the nine months ended September 30, 2007 and 2006,
respectively. We expect that our research and development expense may increase in the last
quarter of 2007 as we intend to continue to invest in our research and product development
efforts. Any such increase could have a negative impact on our earnings in future
periods.
If we are unable to develop new products and product enhancements that achieve market
acceptance, sales of our fiber optic components could decline, which could reduce our
revenues.
The communications industry is characterized by rapidly changing technology, frequent new
product introductions, changes in customer requirements, evolving industry standards and,
more recently, significant variations in customer demand. Our future success depends on our
ability to anticipate market needs and develop products that address those needs. As a
result, our products could quickly become obsolete if we fail to predict market needs
accurately or develop new products or product enhancements in a timely manner. Our failure
to predict market needs accurately or to develop new products or product enhancements in a
timely manner will harm market acceptance and sales of our products. If the development or
enhancement of these products or any other future products takes longer than we anticipate,
or if we are unable to introduce these products to market, our sales will not increase.
Even if we are able to develop and commercially introduce them, these new products may not
achieve the widespread market acceptance necessary to provide an adequate return on our
investment.
Current and future demand for our products depends on the continued growth of the
Internet and the communications industry, which is experiencing rapid consolidation,
realignment, oversupply of product inventory and fluctuating demand for fiber optic
products.
Our future success depends on the
continued growth of the Internet as a widely used medium for communications and commerce,
and the growth of optical networks to meet the increased demand for capacity to transmit
data, or bandwidth. If the Internet does not continue to expand as a medium for
communications and commerce, the need to significantly increase bandwidth across networks
and the market for fiber optic components may not continue to develop. If this growth does
not continue, sales of our products may continue to decline, which would adversely affect
our revenues. Our customers have experienced an oversupply of inventory due to fluctuating
demand for their products that has resulted in inconsistent demand for our products. Future
demand for our products is uncertain and will depend heavily on the continued growth and
upgrading of optical networks, especially in the metropolitan, last mile, and enterprise
access segments of the networks.
22
Inconsistent spending by telecommunication companies over the past several years has
resulted in fluctuating demand for our products. The rate at which communication service
providers and other fiber optic network users have built new fiber optic networks or
installed new systems in their existing fiber optic networks has fluctuated in the past and
these fluctuations may continue in the future. These fluctuations may result in reduced
demand for new or upgraded fiber optic systems that utilize our products and therefore, may
result in reduced demand for our products. Declines in the development of new networks and
installation of new systems have resulted in the past in a decrease in demand for our
products, an increase in our inventory, and erosion in the average selling prices of our
products.
The communications industry is
experiencing consolidation and realignment, as industry participants seek to capitalize on
the rapidly changing competitive landscape developing around the Internet and new
communications technologies such as fiber optic networks. As the communications industry
consolidates and realigns to accommodate technological and other developments, our
customers may consolidate or align with other entities in a manner that results in a
decrease in demand for our products.
We are experiencing fluctuations in
market demand due to overcapacity in our industry and an economy that is stymied by
international terrorism, war and political instability.
Since 2001, the United States economy has experienced
and continues to experience significant fluctuations in consumption and demand. During the
past several years, telecommunication companies have mostly decreased their spending, which
has resulted in excess inventory, overcapacity and a decrease in demand for our products.
We may experience further decreases in the demand for our products due to a weak domestic
and international economy as the fiber optics industry copes with the effects of oversupply
of products, international terrorism, war and political instability. Even if the general
economy experiences a recovery, the activity of the United States telecommunications
industry may lag behind the recovery of the overall United States economy.
The optical networking component industry has in the past, is now, and may in the future
experience declining average selling prices, which could cause our gross margins to
decline.
The optical networking component industry has in the past experienced declining average
selling prices as a result of increasing competition and greater unit volumes as
communication service providers continue to deploy fiber optic networks. Average selling
prices are currently decreasing and may continue to decrease in the future in response to
product introductions by competitors, price pressures from significant customers, greater
manufacturing efficiencies achieved through increased automation in the manufacturing
process and inventory build-up due to decreased demand. Average selling price declines may
contribute to a decline in our gross margins, which could harm our results of
operations.
We will not attract new orders for our fiber optic components unless we can deliver
sufficient quantities of our products to optical communications equipment
manufacturers.
Communications service providers and optical systems manufacturers typically require that
suppliers commit to provide specified quantities of products over a given period of time.
If we are unable to commit to deliver quantities of our products to satisfy a customer's
anticipated needs, we will lose the order and the opportunity for significant sales to that
customer for a lengthy period of time. In addition, we would be unable to fill large orders
if we do not have sufficient manufacturing capacity to enable us to commit to provide
customers with specified quantities of products. However, if we build our manufacturing
capacity and inventory in excess of demand, as we have done in the past, we may produce
excess inventory that may have to be reserved or written off.
23
We depend on a limited number of third parties to supply key materials, components and
equipment, such as ferrules, optical filters and lenses, and if we are not able to obtain
sufficient quantities of these items at acceptable prices, our ability to fill orders would
be limited and our operating results could be harmed.
We depend on third parties to supply the raw materials
and components we use to manufacture our products. To be competitive, we must obtain from
our suppliers, on a timely basis, sufficient quantities of raw materials and components at
acceptable prices. We obtain most of our critical raw materials and components from a
single or limited number of suppliers and generally do not have long-term supply contracts
with them. As a result, our suppliers could terminate the supply of a particular material
or component at any time without penalty. Finding alternative sources may involve
significant expense and delay, if these sources can be found at all. Difficulties in
obtaining raw materials or components in the future may delay or limit our product
shipments, which could result in lost orders, increase our costs, reduce our control over
quality and delivery schedules and require us to redesign our products. If a supplier
became unable or unwilling to continue to manufacture or ship materials or components in
required volumes, we would have to identify and qualify an acceptable replacement. A delay
or reduction in shipments or any need to identify and qualify replacement suppliers would
harm our business.
Because we experience long lead times for materials and components, we may not be able
to effectively manage our inventory levels, which could harm our operating results.
Because we experience long lead times for materials and components and are often required
to purchase significant amounts of materials and components far in advance of product
shipments, we may not effectively manage our inventory levels, which could harm our
operating results. Alternatively, if we underestimate our raw material requirements, we may
have inadequate inventory, which could result in delays in shipments and loss of customers.
If we purchase raw materials and increase production in anticipation of orders that do not
materialize or that shift to another quarter, we will, as we have in the past, have to
carry or write off excess inventory and our gross margins will decline. Both situations
could cause our results of operations to be below the expectations of investors and public
market analysts, which could, in turn, cause the price of our common stock to decline. The
time our customers require to incorporate our products into their own can vary
significantly and generally exceeds several months, which further complicates our planning
processes and reduces the predictability of our forecasts. Even if we receive these orders,
the additional manufacturing capacity that we add to meet our customer's requirements may
be underutilized in a subsequent quarter.
We are exposed to risks and
increased expenses as a result of laws requiring companies to evaluate internal controls
over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to perform an
assessment of our internal controls by December 31, 2007, and our independent auditors to
attest to the effectiveness of our internal controls over financial reporting beginning
with our fiscal year ending December 31, 2008. We have implemented an ongoing program to
perform the system and process evaluation and testing we believe to be necessary to comply
with these requirements, however, we cannot assure you that we will be successful in our
efforts. We expect to incur increased expense and to devote additional management resources
to Section 404 compliance. In the event that our chief executive officer, acting chief
financial officer or independent registered public accounting firm determine that our
internal controls over financial reporting are not effective as defined under Section 404,
investor perceptions of our company may be negatively affected and this could cause a
decline in our stock price.
Changes to financial accounting standards may affect
our results of operations and cause us to change our business practices.
24
We prepare our financial statements to conform with generally accepted accounting
principles, or GAAP, in the United States. These accounting principles are subject to
interpretation by the American Institute of Certified Public Accountants, the Securities
and Exchange Commission and various bodies formed to interpret and create appropriate
accounting policies. A change in those policies can have a significant effect on our
reported results and may affect our reporting of transactions completed before a change is
announced. Changes to those rules or the questioning of current practices may adversely
affect our reported financial results or the way we conduct our business. For example,
accounting policies affecting many aspects of our business, including rules relating to
employee stock option grants, have recently been revised. The Financial Accounting
Standards Board and other agencies have finalized changes to U.S. generally accepted
accounting principles that required us, starting in our first quarter of 2006, to record a
charge to earnings for employee stock option grants and other equity incentives. As a
result of adopting Statement No. 123(R), on January 1, 2006, the Company's income
before income tax and net income for the year ended December 31, 2006 was $657,000, or
$298,000 lower than if it had continued to account for share-based compensation under APB
Opinion 25. The adoption of Statement No. 123(R) did not impact basic and diluted income
and loss per share for the year ended December 31, 2006. In addition, since we historically
have used equity-related compensation as a component of our total employee compensation
program, the accounting change could make the use of equity-related compensation less
attractive to us and therefore make it more difficult to attract and retain employees.
We depend on key personnel to operate our business effectively in the rapidly changing
fiber optic components market, and if we are unable to hire and retain appropriate
management and technical personnel, our ability to develop our business could be
harmed.
Our success depends to a significant
degree upon the continued contributions of the principal members of our technical sales,
marketing, engineering and management personnel, many of whom perform important management
functions and would be difficult to replace. We particularly depend upon the continued
services of our executive officers, particularly Peter Chang, our President and Chief
Executive Officer; David Hubbard, our Vice President, Sales and Marketing; Wei-shin Tsay,
our senior Vice President of Product Development; Anita Ho, our Acting Chief Financial
Officer and Corporate Controller; and other key engineering, sales, marketing, finance,
manufacturing and support personnel. In addition, we depend upon the continued services of
key management personnel at our Taiwanese subsidiary. None of our officers or key employees
is bound by an employment agreement for any specific term, and may terminate their
employment at any time. In addition, we do not have "key person" life insurance policies
covering any of our employees.
Our ability to continue to attract and retain highly skilled personnel will be a critical
factor in determining whether we will be successful in the future. We may have difficulty
hiring skilled engineers at our manufacturing facilities in the United States, Taiwan, and
China. If we are not successful in attracting, assimilating or retaining qualified
personnel to fulfill our current or future needs, our business may be harmed.
If we are not able to achieve acceptable manufacturing yields and sufficient product
reliability in the production of our fiber optic components, we may incur increased costs
and delays in shipping products to our customers, which could impair our operating
results.
Complex and precise processes are
required for the manufacture of our products. Changes in our manufacturing processes or
those of our suppliers, or the inadvertent use of defective materials, could significantly
reduce our manufacturing yields and product reliability. Because the majority of our
manufacturing costs are relatively fixed, manufacturing yields are critical to our results
of operations. Lower than expected production yields could delay product shipments and
impair our operating results. We may not obtain acceptable yields in the future.
In some cases, existing manufacturing techniques, which involve substantial manual labor,
may not allow us to cost-effectively meet our production goals so that we maintain
acceptable gross margins while meeting the cost targets of our customers. We may not
achieve adequate manufacturing cost efficiencies.
Because we plan to introduce new products and product enhancements, we must effectively
transfer production information from our product development department to our
manufacturing group and coordinate our efforts with those of our suppliers to rapidly
achieve volume production. In our experience, our yields have been lower during the early
stages of introducing new product to manufacturing. If we fail to effectively manage this
process or if we experience delays, disruptions or quality control problems in our
manufacturing operations, our shipments of products to our customers could be
delayed.
25
Because the qualification and sales cycle associated with fiber optic components is
lengthy and varied, it is difficult to predict the timing of a sale or whether a sale will
be made, which may cause us to have excess manufacturing capacity or inventory and
negatively impact our operating results.
In the communications industry, service
providers and optical systems manufacturers often undertake extensive qualification
processes prior to placing orders for large quantities of products such as ours, because
these products must function as part of a larger system or network. This process may range
from three to nine months and sometimes longer. Once they decide to use a particular
supplier's product or component, these potential customers design the product into their
system, which is known as a design-in win. Suppliers whose products or components are not
designed in are unlikely to make sales to that customer until at least the adoption of a
future redesigned system. Even then, many customers may be reluctant to incorporate
entirely new products into their new systems, as this could involve significant additional
redesign efforts. If we fail to achieve design-in wins in our potential customers'
qualification processes, we will lose the opportunity for significant sales to those
customers for a lengthy period of time.
In addition, some of our customers require that our products be subjected to
standards-based qualification testing, which can take up to nine months or more. While our
customers are evaluating our products and before they place an order with us, we may incur
substantial sales and marketing and research and development expenses, expend significant
management efforts, increase manufacturing capacity and order long lead-time supplies. Even
after the evaluation process, it is possible a potential customer will not purchase our
products. In addition, product purchases are frequently subject to unplanned processing and
other delays, particularly with respect to larger customers for which our products
represent a very small percentage of their overall purchase activity. Accordingly, our
revenues and operating results may vary significantly and unexpectedly from quarter to
quarter.
If our customers do not qualify our manufacturing lines for volume shipments, our
optical networking components may be dropped from supply programs and our revenues may
decline.
Customers generally will not purchase any of our products, other than limited numbers of
evaluation units, before they qualify our products, approve our manufacturing process and
approve our quality assurance system. Our existing manufacturing lines, as well as each new
manufacturing line, must pass through various levels of approval with our customers. For
example, customers may require that we be registered under international quality standards.
Our products may also have to be qualified to specific customer requirements. This customer
approval process determines whether the manufacturing line achieves the customers' quality,
performance and reliability standards. Delays in product qualification may cause a product
to be dropped from a long-term supply program and result in significant lost revenue
opportunity over the term of that program.
Our fiber optic components are
deployed in large and complex communications networks and may contain defects that are not
detected until after our products have been installed, which could damage our reputation
and cause us to lose customers.
Our products are designed for deployment in large and complex optical networks. Because of
the nature of these products, they can only be fully tested for reliability when deployed
in networks for long periods of time. Our fiber optic products may contain undetected
defects when first introduced or as new versions are released, and our customers may
discover defects in our products only after they have been fully deployed and operated
under peak stress conditions. In addition, our products are combined with products from
other vendors. As a result, should problems occur, it may be difficult to identify the
source of the problem. If we are unable to fix defects or other problems, we could
experience, among other things:
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damage to our
reputation;
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failure to attract new
customers or achieve market acceptance;
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diversion of development
and engineering resources; and
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legal actions by our
customers.
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The occurrence of any one or more of the foregoing factors could cause our net income to
decrease.
The market for fiber optic components is new and unpredictable, characterized by rapid
technological changes, evolving industry standards, and significant changes in customer
demand, which could result in decreased demand for our products, erosion of average selling
prices, and could negatively impact our revenues.
The market for fiber optic components is new and characterized by rapid technological
change, frequent new product introductions, changes in customer requirements and evolving
industry standards. Because this market is new, it is difficult to predict its potential
size or future growth rate. Widespread adoption of optical networks, especially in the
metropolitan, last mile, and enterprise access segments of the networks, is critical to our
future success. Potential end-user customers who have invested substantial resources in
their existing copper lines or other systems may be reluctant or slow to adopt a different
approach, such as optical networks. Our success in generating revenues in this emerging
market will depend on:
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the education of potential
end-user customers and network service providers about the benefits of optical
networks; and
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the continued growth of the
metropolitan, last mile, and enterprise access segments of the communications
network.
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If we fail to address changing market conditions, sales of our products may decline, which
would adversely impact our revenues.
We may be unable to successfully integrate acquired businesses or assets with our
business, which may disrupt our business, divert management's attention and slow our
ability to expand the range of our proprietary technologies and products.
To expand the range of our proprietary technologies and products, we may acquire
complementary businesses, technologies or products, if appropriate opportunities arise. We
may be unable to identify other suitable acquisitions at reasonable prices or on reasonable
terms, or consummate future acquisitions or other investments, any of which could slow our
growth strategy. We may have difficulty integrating the acquired products, personnel or
technologies of any company or acquisition that we may make. Similarly, we may not be able
to attract or retain key management, technical or sales personnel of any other companies
that we acquire or from which we acquire assets. These difficulties could disrupt our
ongoing business, distract our management and employees and increase our expenses.
If our common stock is not relisted on the Nasdaq Global Market, we will be subject to
certain provisions of the California General Corporation Law that may affect our charter
documents and result in additional expenses.
Beginning at the commencement of trading on November 8, 2002, the listing of our common
stock was transferred from the Nasdaq Global Market to the Nasdaq Capital Market. As a
result, we may become subject to certain sections of the California General Corporation Law
that will affect our charter documents if our common stock is not returned to being listed
on the Nasdaq Global Market. A recent Delaware decision has called into question the
applicability of the California General Corporation Law to Delaware corporations. However,
if the California General Corporation Law applies to our Company, we will not be able to
continue to have a classified board or continue to eliminate cumulative voting by our
stockholders. In addition, certain provisions of our Certificate of Incorporation that call
for supermajority voting may need to be approved by stockholders every two years or be
eliminated. Also, in the event of a reorganization, stockholders will have dissenting
stockholder rights under both California and Delaware law. Any of these changes will result
in additional expense as we will have to comply with certain provisions of the California
General Corporation Law as well as the Delaware General Corporation Law. We included these
provisions in our charter documents in order to delay or discourage a change of control or
changes in our management. Because of the California General Corporation Law, we may not be
able to avail ourselves of these provisions.
27
If we fail to protect our intellectual property rights, competitors may be able to use
our technologies, which could weaken our competitive position, reduce our revenues or
increase our costs.
The fiber optic component market is a
highly competitive industry in which we, and most other participants, rely on a combination
of patent, copyright, trademark and trade secret laws, confidentiality procedures and
licensing arrangements to establish and protect proprietary rights. The competitive nature
of our industry, rapidly changing technology, frequent new product introductions, changes
in customer requirements and evolving industry standards heighten the importance of
protecting proprietary technology rights. Since the United States Patent and Trademark
Office keeps patent applications confidential until a patent is issued, our pending patent
applications may attempt to protect proprietary technology claimed in a third party patent
application. Our existing and future patents may not be sufficiently broad to protect our
proprietary technologies as policing unauthorized use of our products is difficult and we
cannot be certain that the steps we have taken will prevent the misappropriation or
unauthorized use of our technologies, particularly in foreign countries where the laws may
not protect our proprietary rights as fully as United States laws. Our competitors and
suppliers may independently develop similar technology, duplicate our products, or design
around any of our patents or other intellectual property. If we are unable to adequately
protect our proprietary technology rights, others may be able to use our proprietary
technology without having to compensate us, which could reduce our revenues and negatively
impact our ability to compete effectively.
Litigation may be necessary to enforce our intellectual property rights or to determine
the validity or scope of the proprietary rights of others. As a result of any such
litigation, we could lose our proprietary rights and incur substantial unexpected operating
costs. Any action we take to protect our intellectual property rights could be costly and
could absorb significant management time and attention. In addition, failure to adequately
protect our trademark rights could impair our brand identity and our ability to compete
effectively.
We may be subject to intellectual property infringement claims that are costly to defend
and could limit our ability to use some technologies in the future.
Our industry is very competitive and is
characterized by frequent intellectual property litigation based on allegations of
infringement of intellectual property rights. Numerous patents in our industry have already
been issued, and as the market further develops and participants in our industry obtain
additional intellectual property protection, litigation is likely to become more frequent.
From time to time, third parties may assert patent, copyright, trademark and other
intellectual property rights to technologies or rights that are important to our business.
In addition, we have and we may continue to enter into agreements to indemnify our
customers for any expenses or liabilities resulting from claimed infringements of patents,
trademarks or copyrights of third parties. Any litigation arising from claims asserting
that our products infringe or may infringe the proprietary rights of third parties, whether
the litigation is with or without merit, could be time-consuming, resulting in significant
expenses and diverting the efforts of our technical and management personnel. We do not
have insurance against our alleged or actual infringement of intellectual property of
others. These claims could cause us to stop selling our products, which incorporate the
challenged intellectual property, and could also result in product shipment delays or
require us to redesign or modify our products or to enter into licensing agreements. These
licensing agreements, if required, would increase our product costs and may not be
available on terms acceptable to us, if at all.
28
Although we are not aware of any intellectual property lawsuits filed against us, we may
be a party to litigation regarding intellectual property in the future. We may not prevail
in any such actions, given their complex technical issues and inherent uncertainties.
Insurance may not cover potential claims of this type or may not be adequate to indemnify
us for all liability that may be imposed. If there is a successful claim of infringement or
we fail to develop non-infringing technology or license the proprietary rights on a timely
basis, our business could be harmed.
If we fail to increase sales of our products to optical communications equipment
manufacturers outside of North America, growth of our business may be harmed.
For the three and nine months ended September 30, 2007, sales to customers located outside
of North America were 39.6% and 39.4% of our revenues, respectively. In order to expand our
business, we must increase our sales to customers located outside of North America. We have
limited experience in marketing and distributing our products internationally and in
developing versions of our products that comply with local standards. Our international
sales will be limited if we cannot establish relationships with international distributors,
establish additional foreign operations, expand international sales channels, hire
additional personnel and develop relationships with international communications equipment
manufacturers. Even if we are able to successfully continue international operations, we
may not be able to maintain or increase international market demand for our products.
Because our manufacturing operations are located in active earthquake fault zones in
Taiwan, and our Taiwan location is susceptible to the effects of a typhoon, we face the
risk that a natural disaster could limit our ability to supply products.
Two of our primary manufacturing
operations are located in Tu-Cheng City, Taiwan, and Hu-Kou City, Taiwan,
each, an
active earthquake fault zone. These
regions have experienced large earthquakes in the past and may likely experience them in
the future. In September 2001, a typhoon hit Taiwan causing businesses, including our
manufacturing facility, and the financial markets to close for two days. Because the
majority of our manufacturing operations are located in Taiwan, a large earthquake or
typhoon in Taiwan could disrupt our manufacturing operations for an extended period of
time, which would limit our ability to supply our products to our customers in sufficient
quantities on a timely basis, harming our customer relationships.
ITEM 6:
EXHIBITS
Exhibits
Exhibit
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Number
Title
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31.1
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Rule 13a-14(a)
certification of Chief Executive Officer
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31.2
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Rule 13a-14(a)
certification of Acting Chief Financial Officer
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32.1*
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Statement of Chief
Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C.
§
1350).
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32.2*
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Statement of Acting Chief
Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C.
§
1350).
|
___________________
**
In accordance with Item 601(b)(32)(ii)
of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management's
Reports on Internal Control Over Financial Reporting and Certification of Disclosure in
Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2
hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purpose of
Section 18 of the Exchange Act.
29
Such certifications will not be deemed
to be incorporated by reference into any filing under the Securities Act or the Exchange
Act, except to the extent that the registrant specifically incorporates it by
reference.
30