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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 2001
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-31861
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OPTICAL COMMUNICATION PRODUCTS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware 95-4344224
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
20961 Knapp Street
Chatsworth, California 91311
(Address of principal executive offices, including zip code)
Registrant's Telephone Number, Including Area Code: (818) 701-0164
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, $0.001 par value The Nasdaq National Market
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by a check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation SK is not contained herein, and will not be contained, to
the best of registrant"s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10K or any
amendment to this Form 10K. [_]
As of December 5, 2001, the approximate aggregate market value of voting
stock held by non-affiliates of the registrant was $62,947,715 (based upon the
last closing price for shares of the Registrant's Common Stock as reported by
The National Market System of the National Association of Securities Dealers
Automated Quotation System as of that date). Shares of Common Stock held by
each officer, director, and holder of 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
As of December 5, 2001, there were approximately 42,038,300 shares of Class
A Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required in Part III hereto is incorporated by reference
to the Proxy Statement for the Registrant's 2002 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Form 10-K.
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OPTICAL COMMUNICATION PRODUCTS, INC.
FORM 10K ANNUAL REPORT
TABLE OF CONTENTS
Page
----
PART I. ................................................................ 1
ITEM 1. BUSINESS.................................................. 1
ITEM 2. PROPERTIES................................................ 23
ITEM 3. LEGAL PROCEEDINGS......................................... 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....... 25
PART II. ............................................................... 26
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS....................................... 26
ITEM 6. SELECTED FINANCIAL DATA................................... 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................... 27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK...................................................... 36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............... 36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE....................... 36
PART III. .............................................................. 37
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........ 37
ITEM 11. EXECUTIVE COMPENSATION.................................... 37
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 37
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............ 37
PART IV. ............................................................... 38
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8K................................................... 38
This Annual Report on Form 10-K, including information incorporated herein
by reference, contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements relate to expectations concerning
matters that are not historical facts. Words such as "projects," "believes,"
"anticipates," "will," "estimate," "plans," "expects," "intends," and similar
words and expressions are intended to identify forward-looking statements.
Although we believe that such forward-looking statements are reasonable, we
cannot assure you that such expectations will prove to be correct. Important
language regarding factors which could cause actual results to differ
materially from such expectations are disclosed in this Report, including
without limitation under the caption "Risk Factors" beginning on page 13 of
this Report, and the other documents we file with the Securities and Exchange
Commission ("SEC"), including our most recent reports on Form 8-K and Form 10-
K, and amendments thereto. All forward-looking statements attributable to
Optical Communication Products are expressly qualified in their entirety by
such language. We do not undertake any obligation to update any forward-
looking statements.
PART I.
ITEM 1. BUSINESS
We design, manufacture and sell a comprehensive line of high performance,
highly reliable fiber optic subsystems and modules for the metropolitan area
and high-speed premises markets. Subsystems and modules are preassembled
components that are used to build network equipment. Our subsystems and
modules are integrated into systems which address the bandwidth limitations in
metropolitan area networks and high-speed premises networks. Metropolitan area
networks are communication networks in cities and urban areas that connect
telephone exchanges, Internet service providers, businesses and consumers.
High-speed premises networks are communication networks that connect buildings
within a business or campus setting. Our subsystems and modules include
optical transmitters, receivers, transceivers and transponders that convert
electronic signals into optical signals and back to electronic signals,
enabling high-speed communication of voice and data traffic over public and
private fiber optic networks. Our products support a wide range of network
applications, transmission speeds, distances and standards, including
international transmission standards.
The Company was founded in October 1991 with initial funding from The
Furukawa Electric Company, Ltd. of Japan ("Furukawa"). We offer a
comprehensive line of high performance, cost-effective solutions to our
customers supported by volume production capabilities. We believe that our
close working relationship with leading fiber optic communication equipment
manufacturers allows us to quickly design and build advanced fiber optic
subsystems and modules, enabling our customers to focus on their core
competencies in designing and building overall systems. Our customers include
communication equipment manufacturers, such as Acterna Corporation, Alcatel,
CIENA, Cisco Systems, ECI Telecom, Lucent Technologies, Marconi
Communications, Nortel Networks, Redback Networks and Unisphere Networks some
of whom purchase through contract manufacturers such as Celestica,
Flextronics, Jabil Circuits, Sanmina, SCI Systems, and Solectron.
Industry Background
Increased network traffic
During the past several years, the amount of voice and data transmitted over
communication networks has increased significantly. This growth is primarily
attributed to the rapid growth and popularity of data intensive applications,
such as Internet access, real-time data backup, e-mail, video conferencing,
multimedia file transfers and the movement of large blocks of stored data
across networks. To meet this demand, communication service providers have
upgraded their communication networks to expand capacity, which greatly
reduced transmission costs per bit. This cost reduction has, in turn, further
increased the demand for and usage of communication networks. This cycle,
increased demand fueling increased capacity at reduced costs and increasing
demand further, has enabled the prolonged dramatic growth in voice and data
traffic across networks.
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Evolution of network infrastructure
Communication networks were originally designed to handle voice traffic. The
infrastructure of existing prior generation, or legacy, networks consists of
copper cabling along which voice communications are transmitted in the form of
electronic signals. While copper cabling is generally a reliable transmission
medium, its ability to transmit large volumes of data at high speed is
limited, and it is prone to electromagnetic interference, or EMI, from nearby
electronic equipment and other sources. EMI interferes with the transmission
of a signal and degrades signal quality.
To overcome the limitations of the legacy copper cable infrastructure and
meet increasing demand for high capacity and high-speed voice and data
transmission, communication service providers have adopted fiber optic
technology in their networks. Fiber optic technology involves the transmission
of data in optical fiber via digital pulses of light, which allows for greater
bandwidth over longer distances than copper cable and higher quality
transmissions that are not subject to EMI.
Widespread deployment of fiber optic technology initially occurred in the
long-haul network. Long-haul networks connect the communications networks of
metropolitan areas around the world and facilitate the transport of large
amounts of voice and data traffic over long distances, up to thousands of
miles. Companies designing equipment for this segment have typically focused
on providing as much bandwidth as possible between any two locations. The
long-haul market was the first to face increasing network congestion as data,
aggregated from expanding metropolitan area and local area networks, began to
overload long-haul networks. Long-haul network managers, focused on
maintaining network performance, were the first to adopt advanced subsystems
and modules to increase the capacity of existing fiber. Long-haul network
managers have typically been concerned more about network performance than
transmission equipment cost. That is because the cost of increasing the
capacity of long-haul networks through adding fiber is expensive relative to
upgrading the transmission equipment to higher data transmission rates.
The build-out of optical long-haul networks through the adoption of advanced
subsystems and modules to increase capacity represents an important step in
improving network infrastructure to support increased demand for new services
and greater traffic volumes. While optical fiber continues to be deployed, and
its transmission capacity expanded in long-haul networks, fiber optic
technologies are increasingly being adopted to support high data rate
connections to connect end-users to the long-haul networks. These high data
rate connections consist of three segments: metro core, metro access and
premises.
Metropolitan area networks
Metro core networks--Metro core networks are the distribution points between
long-haul networks and metro access networks. In a typical system, a long-haul
network connects to a city-wide metropolitan area network through which long-
haul data is aggregated by network managers, such as Internet service
providers, and distributed to local users via an access network. Metro core
networks enable enterprises and communication providers to interconnect
network systems over areas from as small as a city block or corporate campus
to a wider geographic area.
Metro access networks--Metro access networks connect business and
residential end-users to metro core networks. These end-users have
increasingly demanded high-speed connections to take advantage of new data-
intensive computer and multimedia applications and to keep up with higher
speed local area networks that feed into access networks. Access networks
traditionally have used relatively slow copper cable based connections. A
number of high-speed transmission technologies have been developed to improve
the speed of access networks, including digital technologies such as digital
subscriber line, or DSL, integrated services digital network, or ISDN, and
cable modem technologies. DSL and ISDN technologies utilize the legacy copper-
based infrastructure to provide users with increased bandwidth at low cost.
Cable modems, which connect computers to local cable TV lines, also provide
users with access to high bandwidth at low cost. As these high data rates and
new services become more widely available to end-users, legacy copper cable
connections are expected to become increasingly insufficient to meet demand.
Consequently, communication service providers are beginning to
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deploy fiber optic cable directly to end-users or to neighborhood distribution
points, enabling the business or residential end-user to obtain a wide range
of current and future services.
Premises Networks
Premises networks consist of local area networks and storage area networks.
Local area networks connect users within a building or groups of buildings.
Storage area networks connect computers and data storage sites within
buildings or groups of buildings. Premises networks were originally developed
as copper cable networks using standards such as Ethernet and Fast Ethernet.
As performance requirements increased, these networks have been upgraded to
multimode fiber, an early generation fiber optic technology. As the
performance required of these networks increases further, they are being
upgraded to even higher performing single mode fiber optics supporting high-
speed networking standards such as Fibre Channel, Gigabit Ethernet and 10
Gigabit Ethernet.
Market Opportunity
With the substantial and increasing volumes of voice and data being
transmitted across long-haul and premises networks, metropolitan area networks
are often the limiting factor in overall network performance. Premises
networks are also increasingly requiring greater bandwidth and performance
capabilities to address congestion caused by increased voice and data traffic
and number of end-users. As a result, network managers have been upgrading
their premises networks to higher speeds using optical transmission
technologies and high-speed networking standards such as Gigabit Ethernet and
Fibre Channel.
As demand for bandwidth grows, communication service providers will require
increasingly sophisticated systems for metropolitan area networks and high-
speed premises networks. These systems must meet the unique requirements of
the metropolitan area networks and high-speed premises networks, such as cost-
effectiveness and reliability in harsh environmental conditions. Historically,
metropolitan area network infrastructure has been supplied by large vertically
integrated fiber optic communication equipment manufacturers, which
manufactured their own fiber optic components such as lasers and photodiodes.
The demand for new fiber optic networks has led to the expansion of production
by existing fiber optic communication equipment manufacturers, as well as the
creation of new companies offering cost-effective fiber optic systems. These
new companies are typically not vertically integrated and do not employ system
design teams to create mixed analog/digital circuits required for laser and
photodiode interfaces.
The market demands on fiber optic communication equipment manufacturers to
produce networking systems for metropolitan area and high-speed premises
networks have given rise to a number of significant technical challenges,
including the following:
. Providing solutions which balance performance and cost. The metropolitan
market requires optical subsystems and modules which are designed
specifically to meet the unique performance and cost requirements of
this market.
. Providing long distance operation in metropolitan area networks where
interconnection distances can range from a few kilometers up to 80
kilometers. Systems that are unable to transmit over long distances
require expensive repeaters to boost and regenerate signals.
. Providing wide operating temperature range in metropolitan area networks
where equipment is located in remote locations with no environmental
control. Products that operate from -40 degrees Celsius to 85 degrees
Celsius are a necessity in this market. This is in contrast to the long-
haul network and local area networks where equipment is sited within
temperature controlled buildings.
. Delivering products that address the demand for increasingly smaller
packages to provide higher port density requires greater component
miniaturization expertise.
. Supporting a wide range of data rates, transmission distance
requirements, network standards, optical interfaces and packaging
options requires that fiber optic communication equipment manufacturers
offer a broad range of products.
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. Producing increasingly integrated products requires cross disciplinary
expertise in optics, circuit design, packaging and microwave and radio
frequency engineering.
. Responding to demands for shorter lead times requires manufacturers to
design products and scale production rapidly.
. Producing systems to handle increasingly higher data rates in compliance
with Federal Communications Commission standards for EMI emissions
requires advanced fiber optic subsystem and module design.
Current Industry Environment
During the fiscal year ended September 30, 2001, the telecommunications
sector, and in particular the fiber optic networking sector, suffered a severe
downturn. System providers are scaling back on deployment and have
dramatically slowed their purchases of systems from equipment manufacturers.
As a result, equipment manufacturers have also slowed purchases of components
and modules from our competitors and from us. Moreover, as equipment
manufacturers' sales declined, they have relied on their excess component
inventories to meet reduced demand and have moved to reduce their overall
component and module inventory levels. Consequently, the slowdown continues to
have a negative impact on our business as we face declining sales as the
result of our customers' declining business and the resulting adjustment to
their inventory levels. See "Business--Risk Factors--Unfavorable current
economic and market conditions have resulted in decreased sales and increased
difficulty predicting our future operating results." and "--General economic
factors could negatively impact our growth plan."
However, despite the slowdown in the industry, we believe that the future
market for optical components remains very promising. We believe that Internet
traffic, an important driver of fiber optic network expansion, will continue
to grow in future years with an increasingly large portion of this traffic
expected to include the transfer of data intensive applications requiring
expanded network capacity and transmission speed, such as full motion video,
multi-channel high quality audio, video conferencing, and movement of large
blocks of stored data across networks. With the rapid build-out of the long-
haul network in recent years, network congestion and limitations in overall
network performance remain primarily at the metropolitan area network and
high-speed premises network levels. We believe that once the industry recovers
from its current downturn, communication service providers and equipment
manufacturers will focus on relieving the bottleneck at the metropolitan area
network and high-speed premises network levels. Accordingly, we believe that
specific sectors in the industry, such as the metropolitan area networks and
high-speed premises networks, will experience particularly strong growth when
the industry recovers. However, given our current lack of visibility, we
cannot provide any assurance as to the timing or extent of any industry
recovery or as to any increase in business or other benefits that we may
receive as a result thereof.
Our Solution
We design, manufacture and sell a comprehensive line of high performance,
reliable fiber optic subsystems and modules that are used in fiber optic
transmission systems. Our subsystems and modules are integrated into systems
which address the bandwidth limitations in metropolitan area networks and
high-speed premises networks. We provide fiber optic communication equipment
manufacturers with high performance, reliable, integrated subsystems and
modules designed for the specific requirements of the metropolitan and high-
speed premises network markets, allowing fiber optic communication equipment
manufacturers to focus on their core competencies of designing and building
overall systems.
We provide our customers with the following key benefits:
. High-performance, high reliability, cost-effective products--Our
portfolio of high performance subsystems and modules enables fiber optic
metropolitan area networks and high-speed premises networks to operate
at high data transmission rates, transmit signals over a variety of
distances up to 80 km and operate in wide temperature ranges of between
-40 degrees Celsius to 85 degrees Celsius.
4
Our products are engineered using advanced packaging technologies and
feature low levels of radiated electromagnetic interference. Our
products are qualified under requirements established by Telcordia
(Bellcore), an engineering and administrative services consortium that
establishes industry standards and specifications for the
telecommunications, wireless and fiber optic industries. The Telcordia
requirements relate to the environmental, electrical and optical testing
for fiber optic transmitters and receivers, to ensure that they offer
the high reliability required for critical applications. Our products
are engineered to meet the specific distance, temperature and other
performance requirements of the metropolitan area and high-speed
premises market.
. Comprehensive product line--Our comprehensive fiber optic product line
provides fiber optic communication equipment manufacturers with a broad
range of solutions for metropolitan area and high-speed premises
networks. Our subsystems and modules are available with all the common
fiber optic interfaces, and are available in a wide variety of package
styles. They support a wide range of data rates, standards, wavelengths
and transmission distances.
. Innovative design capabilities--We believe that our expertise in high-
speed electronic circuit design and packaging of fiber optic devices,
enhanced by our close working relationships with customers, enables us
to provide innovative subsystems and modules for the metropolitan area
and high-speed premises networks. Our engineers work closely with
Furukawa and other suppliers to combine advanced semiconductor lasers
and custom fiber optic packaging techniques. We also have expertise in
designing the complex transmitter circuitry that converts a digital
logic signal into the proper signal for the laser or light emitting
diode. We design and manufacture our own fiber optic receiver
subassemblies using our proprietary automated processes. As a result of
our fiber optic device design expertise and our close customer
relationships, we are able to quickly adapt our products to respond to
new standards and our customers' requirements for subsystems and
modules.
. Reduced time to market--Our subsystems and modules allow fiber optic
communication equipment manufacturers to design and assemble fiber optic
interfaces as easily as standard electronic components by eliminating
the need for complex setup of individual lasers or receivers. By
designing our products closely with our customers, our product designs
allow our customers to shorten their design cycle times which allows
them to develop and bring new products to market quickly.
. Scalable manufacturing capabilities--Our broad portfolio of products use
modular designs which enable us to rapidly configure and manufacture
subsystems and modules to meet each customers specifications and to
rapidly scale our production to deliver these products in volume. We can
easily customize our products for example by implementing different
electrical connections, or pin configurations, voltages and package
sizes as requested by our customers, without impairing the functionality
of our products.
Products
We offer a comprehensive line of high-performance fiber optic subsystems and
modules, including fiber optic transmitters, receivers, transceivers and
transponders, primarily for use in metropolitan area networks and high-speed
premises networks. Fiber optic subsystems and modules are preassembled
components that are used to build network equipment. Our products convert
electronic signals into optical signals and back into electronic signals,
thereby facilitating the transmission of information over fiber optic
communication networks.
Our fiber optic products integrate advanced optical devices with mixed
analog/digital integrated circuits. These circuits allow continuously varying
signals and digital data to be designed in the same circuit rather than
separate circuits. Our products provide subsystem/module functionality over a
wide variety of connectivity speeds, distances, standards and operating
temperature ranges.
Our products are engineered with varying levels of integration to suit our
customers. The lowest level of integration involves separate transmitter and
receiver modules, which provides our customers the greatest flexibility in
product design by allowing them to place the transmitters and the receivers
according to their design
5
specifications. We believe our products' technical specifications meet or
exceed industry standards for fiber optic subsystems and modules. Transceivers
offer the next highest level of integration by placing both the transmitter
and receiver in the same package with a dual fiber or connector interface.
Transponders provide the highest level of integration by combining the
functionality of a transceiver with the addition of multiplexer and
demultiplexer circuits in the same package.
Current products
Transmitters and Receivers--Transmitters convert an electronic digital input
signal into an optical output signal for transmission over a fiber optic
network. Receivers detect optical signals from a fiber optic network and
convert them into an electronic signal in standard digital/logic format for
further signal processing. We offer separate transmitter and receiver modules
that provide our customers with the greatest flexibility in product design by
allowing them to place transmitters and receivers separately according to
design specifications.
Our optical transmitter and receiver products support the SONET/SDH, Fast
Ethernet, Gigabit Ethernet and Fibre Channel transmission standards and are
offered in a wide range of data rates, transmission distances and packaging
options.
DWDM Transmitter--Dense wavelength division multiplexing, or DWDM,
transmitters allow the mixing of optical signals using different standards
such as SONET/SDH, asynchronous transfer mode, or ATM, and Gigabit Ethernet,
by utlizing different wavelengths. Our DWDM transmitters are available in a
compact, low-profile 24-pin package along with two supply voltage options and
will operate in the temperature range of -20(degrees)C to +70(degrees)C. Also,
the transmitters are provided with additional functions such as disable
inputs, LD degradation alarm, and wavelength deviation alarm signals.
Transceivers--Optical transceivers are products that contain both a
transmitter and a receiver in a single device and serve as high data rate
interconnects between network devices, such as hubs, switches, servers and
storage elements. Our optical transceivers are available in a wide variety of
fiber optic interfaces, or form factors, and support a wide range of data
rates, wavelengths, modes and transmission distances. Our transceivers support
the SONET/SDH, Fast Ethernet, Gigabit Ethernet and Fibre Channel transmission
standards.
CWDM Transceivers--Coarse wavelength division multiplexing, or CWDM,
transceivers allow the mixing of optical signals by utilizing different
wavelengths. The CWDM transceivers uses lasers with a wide channel wavelength
spacing, typically 20 nm, which allows the equipment to achieve a lower
overall system cost. This lower cost is the result of a lower transmitter cost
since no temperature and wavelength control is needed, as well as a lower
optical MUX/DMUX cost due to wider tolerance on the wavelength stability and
bandwidth.
Our CWDM transceivers are available in all the common industry standard
transceiver footprints of 1x9, 2x9, GBIC and SFF, and provide four wavelength
channels at nominally 1510 nm, 1530 nm, 1550 nm and 1570 nm. They are
available in a multi-rate format which allows operation at all speeds from 100
Mbd Ethernet up to Gigabit Ethernet.
SFP Transceivers--Small form-factor pluggable, or SFP, transceivers are
"hot-pluggable" optical transceivers which can be removed or inserted into the
equipment without turning off the power of the system. This feature allow our
customers to readily reconfigured their systems without interrupting their
network services, thereby, eliminating system downtime during upgrades and
maintenance.
Our SFP transceiver is available in a variety of distances and speeds and
uses the popular small form factor LC fiber optic connector interface,
allowing fiber optic equipment makers to increase their port density. They are
also offered in speeds from 155 Mbd up to 1250 Mbd including multimode LED and
850nm VCSEL as well as singlemode 1310 and 1550 nm lasers.
Transponders--Our optical transponders combine the functionality of a
transceiver with integrated circuits for electronic multiplexing and
demultiplexing in the same package. We have provided samples of these products
6
to customers for initial testing. Multiplexers are paired with transmitters
and allow the system designer to combine multiple low-speed electronic data
streams onto a single optical wavelength, while demultiplexers and receivers
reverse this process. The transmitter portion of the transponder accepts
sixteen 155 Mb/s electronic signals, multiplexes them together and provides at
the output a single 2,488 Mb/s optical signal. The receiver portion of the
transponder performs the reverse function, namely accepting a single optical
signal and providing back sixteen 155 Mb/s electronic signals. The advantage
of this product is the compact overall design that minimizes the equipment
size and the low speed electronic interface that simplifies our customers
printed circuit design. As equipment speeds increase, this type of product is
becoming widely used.
Products under development
Our product development efforts have, and will continue to be, focused on
developing new products and technologies to support increased transmission
speeds, distances and capacities. We have been developing products to support
future generations of fiber optic metropolitan area and high-speed premises
networks by utilizing coarse wavelength division multiplexing, or CWDM, dense
wavelength division multiplexing, or DWDM, and 10 Gbp/s transmission
standards.
Multiplexers are integrated circuits that combine signals from many inputs
into a single output, and demultiplexers are integrated circuits that
accomplish the reverse, or create many outputs from a single input. Wavelength
division multiplexing is a technology which allows multiple signals to be sent
along the same optical fiber by using different colors of light for each
signal.
We plan to introduce multi-channel optical transmitters, receivers and
transceivers using both DWDM and CWDM technologies. These are being designed
to allow the mixing of optical signals using different standards, such as
SONET/SDH, asynchronous transfer mode, or ATM and Gigabit Ethernet, by
utilizing different wavelengths. We also plan to develop a series of pluggable
transceivers for applications in the different standards.
We believe that some of our competitors are developing similar products to
those that we have under development. While we are currently developing
products in all of the areas described above, we may choose to prioritize or
redirect our development efforts in response to market demands. Therefore, it
is not certain that we will introduce products for all of the categories
listed above.
Customers
We sell our products to fiber optic communication equipment manufacturers
directly and through contract manufacturers who incorporate them into systems
they assemble for fiber optic communication equipment manufacturers. Contract
manufacturers assemble specific products for fiber optic communication
equipment manufacturers. We define our customers as fiber optic communication
equipment manufacturers who have purchased our products directly or ordered
our products for incorporation into systems produced by contract
manufacturers, such as Celestica, Flextronics, Jabil Circuits, Sanmina, SCI
Systems, and Solectron. Fiber optic communication equipment manufacturers make
the purchasing decisions on substantially all of the products we sell through
contract manufacturers. We typically do not enter into long-term contracts
with our customers.
A small number of customers have historically accounted for a significant
portion of our total revenue. For the fiscal year ended September 30, 2001,
our 10 largest customers accounted for 74.2% of our total revenue, with
Alcatel and Cisco Systems (including sales to each of their contract
manufacturers) accounting for approximately 20.9% and 19.8% of our total
revenue, respectively. No other customer accounted for more than 10.0% of our
revenue during the fiscal year ended September 30, 2001.
For financial reporting purposes, we consider our customers to be the
contract manufacturers and fiber optic communications equipment manufacturers
who place purchase orders with us or otherwise purchase our products directly.
For the fiscal year ended September 30, 2001, revenue from our two largest
direct sales customers, Cisco Systems and Alcatel USA Sourcing L.P., accounted
for 12.7% and 10.5%, respectively, of our total revenue. No
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other direct sales customer accounted for more than 10% of our total revenue.
See "Business--Risk Factors--We derive a significant portion of our total
revenue from a few significant customers, and our total revenue may decline
significantly if any of these customers cancels, reduces or delays purchases
of our products or extracts price concessions from us."
Technology
The development and manufacture of high-performance fiber optic subsystems
and modules for metropolitan area networks and high-speed premises networks
require diverse technical skills and expertise. We believe that our
understanding of fundamental optical devices, their packaging and high speed
circuit design allows us to extend the performance of low cost packaging and
technology, which we originally designed for smaller local area networks, to
provide the high-performance required for fiber optic metropolitan area
networks and high-speed premises networks. Key elements of our technological
capabilities include:
. Optical device technology--We understand the performance requirements
for optical devices in fiber optic systems. There is a wide range of
optical source and detector technologies available, and these must be
optimized for each application. We have design expertise with six
different types of light sources used to send light along a fiber, and
three different types of detector technologies. Each of these devices
has performance characteristics which must be carefully chosen to meet
specific system requirements
. Optical packaging/subassembly design--We work closely with Furukawa and
other suppliers to combine advanced semiconductor laser designs and
custom optical packaging techniques to produce advanced optical
subassemblies. Less than one micron tolerances, or variability in the
alignment of components, are required in these laser packages and
reliability specifications require us to hold these mechanical
tolerances over a wide range of temperatures and the specified life of
our products. A micron is one thousandth of a millimeter. We believe
these designs and technologies improve the performance of our products
as well as enhance yields and reduce material costs. We also design our
receiver packages for automated assembly, and we design and manufacture
our own optical subassemblies for our receivers. This allows us to
provide design flexibility, high-performance and the ability to
manufacture in volume.
. Links with Furukawa--We have worked closely with Furukawa to develop new
optical devices for our products using technology that they have
developed. Furukawa supplies us with the majority of the optical
devices, such as lasers, needed for some of the optical subassemblies
used in our products.
. Electronic circuit design--We have the expertise to design complex
transmitter circuitry that converts a digital logic signal into the
proper signal for the laser or light emitting diode. This circuit has
compensation and feedback control loops which change the current to
maintain constant optical power output. This electronic signal must also
be modulated and the waveform of the modulation must be carefully
controlled to ensure that the optical output meets the fiber optic
communications equipment manufacturer's defined specifications. We also
have considerable expertise in designing receivers to minimize the
effects of external noise that can significantly affect the performance
of a receiver. Our products operate at speeds up to 2.5 Gb/s and we are
working to develop future products to work at 10 Gb/s. At these speeds,
microwave and radio frequency design techniques must be used to ensure
that the waveforms do not degrade and meet the parameters defined in
standards. We believe our technical competencies in these areas enable
us to produce fiber optic subsystems and modules with low
electromagnetic interference emission levels.
. Fast product development cycle time--Our products are designed using a
building block approach that allows us to combine different
subassemblies in different ways to provide a wide range of products. Our
integrated subassemblies allow us to quickly adapt our products to
respond to new standards and our customers' requirements for special
subsystems and modules. This ability, in combination with our market
knowledge, allows us to select the commercial opportunities we believe
to be the best and provide samples and production volumes in very short
time frames.
8
Manufacturing
We assemble, burn in and test all of our products in our facility in
Chatsworth, California. We also conduct all of our manufacturing engineering,
quality assurance and documentation control at this facility.
We use a number of subcontractors and suppliers, including Furukawa, to
supply subassemblies. We rely upon domestic and international contract
manufacturers for most of our printed circuit board assembly. Our
manufacturing supply chain management team manages these relationships
supported by our research and development group. We do not have any long-term
contracts with any of our contract manufacturers and none of them are
obligated to perform assembly services for us for any specific period or at
any specific price, except as may be provided in a particular purchase order.
We provide quality assurance through internal testing procedures throughout
the entire manufacturing process. Our quality control procedures include
vendor inspection, incoming material inspection, in-process testing and
outgoing inspection. We provide specialized training to assure the competency
of our manufacturing personnel, and we maintain ISO 9002 certification.
We purchase several key components for our products from a limited number of
suppliers. The components that we purchase include integrated circuits,
lasers, light emitting diodes, vertical cavity surface-emitting lasers,
photodiode devices and other passive electronic components. We have
periodically experienced shortages and delivery delays for these materials.
Because we operate in an industry where material supplies are constrained, we
maintain an inventory of some limited source components to decrease the risk
of shortage. As a result, we have excess inventory of these components which
have led to write downs of excess inventory.
Research and Development
In fiscal 1999, 2000 and 2001, our research and development expenses were
$1.1 million, $2.5 million and $3.0 million, respectively. We also incurred
development costs of $84,000 paid to Furukawa in 2000 for the automation of
our product testing procedure. We believe that our experienced optics
engineers and the modular nature of our products allowed us to enjoy
relatively low research and development expenses in the past. In addition,
Furukawa has developed a number of innovative components that we have
integrated into our products and has assisted in the automation of key
portions of our manufacturing process. We plan to continue to collaborate with
Furukawa as we expand our internal research and development capabilities.
However, we have no research contracts or agreements with Furukawa at this
time.
We expect to increase our total research and development expenses to provide
resources to develop new product lines and fund development contracts with
universities, research institutes and companies. As a result, we expect our
future research and development expenses to increase in absolute dollars and
as a percentage of revenue. We will continue to focus our research and
development activities on enhancing our existing products, developing new
products to meet the evolving needs of our customers within our existing
markets and supporting emerging standards that are consistent with our product
strategies.
Sales, Marketing and Technical Support
We market and sell our products primarily through our direct sales force
supported by independent manufacturers' representatives and distributors. We
focus our marketing on fiber optic communication equipment manufacturers in
the fiber optic metropolitan area and high-speed premises networks markets.
Our direct sales force maintains close contact with our customers and provides
technical support to our manufacturers' representatives and distributors. Our
direct sales force is located in our sales offices in Chatsworth, California,
Franklin, Massachusetts, Bury St. Edmunds, England, Richardson, Texas and
Ottawa, Canada. We plan to expand our direct sales force and open an
additional sales office in San Jose, California. Our customer service
department in our Chatsworth facility provides day-to-day updates on orders
and deliveries to our customers.
9
We have established contractual relationships with manufacturers'
representatives and distributors in North America, Europe, Israel and Asia.
Manufacturers' representatives and distributors are third parties who provide
commercial and technical support in selling our products to customers.
Manufacturers' representatives represent us with customers, but customers
place orders directly with us. We pay the manufacturers' representatives a fee
for this service. Distributors perform the same function, but differ in that
the distributor buys products from us and resells them at a profit to the end
customer. We have short-term contracts with our manufacturers' representatives
and distributors which can be cancelled by either party upon 30 days notice.
We have an office in England which provides commercial and technical support
to our customers in Europe. We also have an office in Ottawa, Canada which
provides commercial and technical support to our customers in Canada. We
intend to expand our indirect sales activity by establishing relationships
with additional independent manufacturer's representatives and distributors.
Please refer to Note 12 to our Notes to Financial Statements for further
information about our geographic areas.
Our marketing efforts are focused on increasing customer awareness of our
brand name, and the features and benefits of our optical subsystems and
modules. The key components of our marketing efforts include:
. Interaction with customers during product development and through
detailed technical interaction during the product sampling phase;
. Expansion of our applications group to provide our customers with
complete technical information on our products as well as design and
troubleshooting assistance and reference designs with chip sets supplied
by the major integrated circuit companies; and
. Participation in major trade show events and conferences in the
communications network industry to promote our broad lines of optical
subsystems and modules.
In addition, we advertise and promote our activities in industry trade
journals and publications targeting design engineers. We also interact with
our customers in industry associations and standards committees to promote and
further enhance Gigabit Ethernet, Fibre Channel and other industry standards
and to increase our visibility as industry experts.
We provide extensive technical support to our customers during their design
and qualification process through direct contact with our engineers, our
applications group and our Web site, which includes product documentation and
application notes. After the design-in phase, we provide support for our
customers during their manufacturing process. Our account managers and our
customer service personnel, who work closely with our manufacturing and
quality groups, provide this support.
Competition
The metropolitan area and high-speed premises networks markets for optical
subsystems and modules for optical communication network applications is
highly competitive and subject to rapidly changing technology. We believe the
primary competitive factors impacting our business are as follows:
. cost-effective products that balance performance requirements with the
cost of the product;
. timeliness of new product introductions;
. scope and responsiveness of service and technical support;
. established reputation with key customers;
. technical innovation;
. quality and reliability of our products;
. breadth of product offerings;
. gaining design approval during our customers design cycle;
. compatibility with emerging industry standards;
. price characteristics;
10
. ability to rapidly scale production for high volumes; and
. data rate, port density and other performance features.
We believe that we have established a favorable position in the metropolitan
area and high-speed premises network markets by identifying and focusing on
fiber optic subsystems and modules specifically for these markets. We believe
that we have a combination of comprehensive product offerings, management and
design expertise, market understanding and manufacturing capabilities that are
focused on these markets. We compete primarily with Agere Systems, Agilent
Technologies, ExceLight Communications, Finisar, Infineon Technologies, IBM,
JDS Uniphase, Luminent, Stratos Lightwave and Tyco International. Many of our
current and potential competitors have significantly greater financial,
technical, marketing, purchasing and other resources than we do. We have
competitors for all of our current products. However, we believe that we do
not have a single competitor that offers the same range of products as us.
Our products may also compete with technologies that provide alternatives to
optical networking, including fixed and mobile radio, free space point-to-
point optical transmission and copper-based technologies such as digital
subscriber line, or DSL, and cable modems. Most of these technologies provide
lower speed and shorter distance capabilities than optical networking
technologies, but may provide certain advantages such as lower costs and
mobile capabilities. However, in our primary market for high-speed
communications, we do not expect to face significant competition from these
technologies in the future. See "Business--Risk Factors--Our markets are
highly competitive, some of our customers are also our competitors, and our
other customers may choose to purchase our competitors' products rather than
our products or develop internal capabilities to produce their own fiber optic
subsystems and modules."
Intellectual Property
Our success and ability to compete is dependent in part on our proprietary
technology. We are able to rely on a combination of copyright, trademark and
trade secret laws and confidentiality agreements to establish and protect our
proprietary rights. To date, we have relied primarily on proprietary processes
and know-how to protect our intellectual property. Although we currently do
not have any patents or patent applications pending, our intellectual property
primarily consists of proprietary processes and know-how relating to our
product design processes, assembly drawings, assembly processes and testing
procedures.
We currently do not license to or from any third parties the technology used
in the manufacture of our fiber optic subsystems and modules. In addition, no
technology is transferred or licensed in connection with our supply
relationship with Furukawa. Accordingly, Furukawa owns the technology relating
to the manufacture of its laser and other products we purchase for
incorporation into our products and may license or sell this technology to
other parties. We own the technology relating to the manufacture of our fiber
optic subsystems and modules. A disruption of our supply relationship with
Furukawa would not have a material impact on our rights to the technology
required to produce our products. We have not transferred to Furukawa any
intellectual property rights that would allow it to compete with us in the
metropolitan area markets. However, there can be no assurance that Furukawa
would not develop in the future internal capabilities to manufacture fiber
optic subsystems and modules similar to and competitive with our products.
Litigation may be necessary in the future to enforce our intellectual
property rights or to determine the validity and scope of the proprietary
rights of others. This litigation could result in substantial costs and
diversion of resources and could significantly harm our business. See
"Business--Risk Factors--If we are unable to protect our proprietary
technology, this technology could be misappropriated, which would make it
difficult for us to compete in our industry." From time-to-time, third parties
may assert patent, copyright, trademark and other intellectual property rights
to technologies and in various jurisdictions that are important to our
business. We are currently defendants in an alleged infringement lawsuit
brought by Methode Electronics, Inc. and Stratos Lightwave, Inc. For further
details see "Legal Proceedings." Any claims asserting that our products
infringe or may infringe proprietary rights of third parties, if determined
adversely to us, could significantly harm our business. Any claims, with or
without merit, could be time-consuming, result in costly litigation, divert
the efforts
11
of our technical and management personnel, cause product shipment delays or
require us to enter into royalty or licensing agreements, any of which could
significantly harm our business. Royalty or licensing agreements, if required,
may not be available on terms acceptable to us, if at all. In addition, our
agreements with our customers typically require us to indemnify our customers
from any expense or liability resulting from claimed infringement of third
party intellectual property rights. In the event a claim against us is
successful, we could be liable for significant monetary damages. If we cannot
obtain a license to the relevant technology on acceptable terms or license a
substitute technology or redesign our products to avoid infringement, our
business would be significantly harmed. See "Business--Risk Factors--We could
be subjected to additional litigation regarding intellectual property rights,
which may divert management attention, cause us to incur significant costs or
prevent us from selling our products."
Employees
As of September 30, 2001, we had 285 full-time employees and no part-time
employees. On July 30, 2001, we announced the elimination of approximately 110
jobs, primarily in the manufacturing area, effective during our fourth
quarter. Positions in research and development and sales and marketing were
not affected. Our employees are not represented by any collective bargaining
agreements and we have never experienced a work stoppage. Notwithstanding the
current downturn, we consider our employee relations to be generally good.
Our Relationship with Furukawa
We were incorporated as a California corporation in October 1991. In
November 1991, a wholly owned subsidiary of The Furukawa Electric Co., Ltd.
provided our initial capital investment. Furukawa, a publicly held company
incorporated under the laws of Japan, is one of the world's leading
manufacturers of electric wire and cable, nonferrous metals and related
products. It also provides engineering services, including the installation of
power and telecommunications cables, and is a major manufacturer of fiber
optic cable. Furukawa's stock is publicly traded on the Tokyo Exchange Nikkei
in Japan. Furukawa beneficially owns all of our outstanding Class B common
stock, which as of December 5, 2001 represented 61.1% of our outstanding
shares of common stock and 94.0% of the combined voting power of all of our
outstanding common stock.
Our relationship with Furukawa has allowed us to benefit from the optical
device and packaging technologies developed at its laboratories in Japan which
are incorporated into laser products that we purchase from Furukawa for
inclusion in our products. We have also established a close working
relationship with Furukawa's research and development team through periodic
meetings and discussions to understand our product and manufacturing
requirements. Under these arrangements, Furukawa customizes to our
specifications the components that it supplies to us. For example, Furukawa
has developed laser products with customized features in the areas of package
design and power output. We have not licensed from Furukawa any of its optical
device or other technologies.
We currently purchase the majority of lasers from Furukawa using short-term
purchase orders. These lasers are critical parts in the manufacture of our
subsystems and modules. We have enjoyed a reliable supply of these critical
components from Furukawa in the past. However, we do not have a long-term
supply contract with Furukawa and we have no plans to enter into a long-term
supply contract in the future. Consequently, we may in the future seek
alternative suppliers or to develop our own laser production capabilities.
From time to time our research and development team works closely with
Furukawa's team to assist in the development of our design and manufacturing
process. For example, in July 2000 we entered into a short-term development
contract with Furukawa to assist us in the purchase, system design, operation,
study, and execution of new equipment orders to automate our product testing
operations. We paid Furukawa $84,000 for these services under the development
contract. We may enter into similar development agreements with Furukawa in
the future. However we have no current commitments and currently have no
development agreements under negotiation with Furukawa. We believe that our
prior business dealings with Furukawa and its subsidiaries and affiliates were
on terms that were no less favorable than terms that would be available from
unrelated third parties for similar transactions.
12
RISK FACTORS
You should carefully consider the following risks before you decide to buy
shares of our Class A common stock. The risks and uncertainties described
below are not the only ones facing us. Additional risks and uncertainties,
including those risks set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below, may also adversely
impact and impair our business. If any of the following risks actually occur,
our business, results of operations or financial condition would likely
suffer. In such case, the trading price of our Class A common stock could
decline, and you may lose all or part of the money you paid to buy our stock.
This Report contains forward-looking statements based on the current
expectations, assumptions, estimates and projections about us and our
industry. These forward-looking statements involve risks and uncertainties.
Our actual results could differ materially from those discussed in these
forward-looking statements as a result of certain factors, as more fully
described in this section and elsewhere in this Report. We do not undertake to
update publicly any forward-looking statements for any reason, even if new
information becomes available or other events occur in the future.
We derive a significant portion of our total revenue from a few significant
customers, and our total revenue may decline significantly if any of these
customers cancels, reduces or delays purchases of our products or extracts
price concessions from us.
Our success depends on our continued ability to develop and maintain
relationships with a limited number of significant customers. We sell our
products into markets dominated by a relatively small number of systems
manufacturers, a fact that limits the number of our potential customers. Our
dependence on orders from a relatively small number of customers makes our
relationship with each customer critical to our business.
We do not have long-term sales contracts with our customers. Instead, sales
to our customers are made on the basis of individual purchase orders that our
customers may cancel or defer on short notice without significant penalty. In
the past, some of our major customers canceled, delayed or significantly
accelerated orders in response to changes in the manufacturing schedules for
their systems, and they are likely to do so in the future. Some of our
customers conduct their business by placing orders for comparable products
with more than one supplier and canceling all remaining orders once they have
received sufficient deliveries for their planned production. The reduction,
cancellation or delay of individual customer purchase orders would cause our
revenue to decline. Moreover, these uncertainties complicate our ability to
accurately plan our manufacturing schedule. Additionally, if any of our
customers cancel or defer orders, our operating expenses may increase as a
percentage of revenue.
In the past, our customers have sought price concessions from us, and they
are likely to continue to do so in the future. In addition, some of our
customers may shift their purchases of products from us to our competitors.
The loss of one or more of our significant customers, our inability to
successfully develop relationships with additional customers or future price
concessions could cause our revenue to decline significantly.
Our continued success in generating revenue depends on growth in construction
of fiber optic metropolitan area networks and high-speed premises networks.
Our fiber optic subsystems and modules are used primarily in metropolitan
area networks and high-speed premises networks. These markets are rapidly
evolving, and it is difficult to predict their potential size or future growth
rate. In addition, we are uncertain as to the extent to which fiber optic
technologies will be used in these markets. Our success in generating revenue
will depend on the growth of these markets and their adoption of fiber optic
technologies.
The current downturn in our industry have caused communications service
providers to reduced their capital spending on fiber optic equipment and
delayed the deployment of new and build-out of existing fiber optic networks.
As a result, our growth rate has been significantly lower than our historical
quarterly growth rate. For
13
example, during the third and fourth quarter of fiscal 2001, revenue decreased
17.9% and 62.3%, respectively, from the immediately preceding quarters
primarily due to the economic downturn in the communications industry.
As the result of currently unfavorable economic and market conditions, (a)
our revenue is declining, (b) we are unable to predict future revenue
accurately, and (c) we are currently unable to provide guidance for future
financial performance. The conditions contributing to this difficulty include:
. uncertainty regarding the capital spending plans of the major
telecommunications carriers, upon whom our customers and, ultimately we,
depend for revenue;
. the telecommunications carriers' current limited access to the capital
required for expansion;
. our customers decreasing their excess inventory levels, which, in turn,
reduces our revenue;
. lower near term revenue visibility; and
. general market and economic uncertainty.
Based on these and other factors, many of our major customers have reduced,
modified, cancelled or rescheduled orders for our products and have expressed
uncertainty as to their future requirements. As a result, our revenue in
future periods may continue to decline. In addition, our ability to meet
financial expectations for future periods may be harmed.
We are dependent on a limited number of suppliers for most of our key
components. If these suppliers are unable to meet our manufacturing
requirements, we may experience production delays leading to delays in
shipments, increased costs and cancellation of orders for our products.
We purchase several key components that we incorporate into our products
from a limited number of suppliers. We also purchase the majority of lasers
from Furukawa. We do not have long-term supply contracts with any of our key
suppliers. Our dependence on a small number of suppliers and our lack of long-
term supply contracts exposes us to several risks, including our potential
inability to obtain an adequate supply of quality components, price increases
and late deliveries. We have experienced shortages and delays in obtaining key
components in the past and expect to experience shortages and delays in the
future.
In the past, industry capacity has been constrained and some of our
component suppliers placed limits on the number of components sold to us. If
industry capacity becomes constrained in the future, our component suppliers
may place similar limits on us. We do not have any control over these limits,
and our suppliers may choose to allocate more of their production to our
competitors. In addition, our suppliers could discontinue the manufacture or
supply of these components at any time.
A disruption in, or termination of, our supply relationship with Furukawa or
any of our other key suppliers, or our inability to develop relationships with
new suppliers would interrupt and delay the manufacturing of our products
which could result in delays in our revenue or the cancellation of orders for
our products. We may not be able to identify and integrate alternative
suppliers in a timely fashion, or at all. Any transition to alternative
suppliers would likely result in delays in shipment, quality control issues
and increased expenses, any of which would limit our ability to deliver
products to our customers. Furthermore, if we are unable to identify an
alternative source of supply, we may have to redesign or modify our products,
which would cause delays in shipments, increase design and manufacturing costs
and require us to increase the prices of our products.
Our future operating results are likely to fluctuate from quarter to quarter,
and if we fail to meet the expectations of securities analysts or investors,
our stock price could decline significantly.
Our historical quarterly operating results have varied significantly, and
our future quarterly operating results are likely to continue to vary
significantly from period to period. As a result, we believe that period-to-
period
14
comparisons of our operating results should not be relied upon as an indicator
of our future performance. Some of the factors which could cause our operating
results to vary include:
. fluctuations in demand for, and sales of, our products, which is
dependent on the implementation of fiber optic networks;
. the timing of customer orders, particularly from our significant
customers;
. competitive factors, including introductions of new products, product
enhancements and the introduction of new technologies by our
competitors, the entry of new competitors into the fiber optic
subsystems and modules market and pricing pressures;
. our ability to control expenses;
. the mix of our products sold; and
. economic conditions specific to the communications and related
industries.
We incur expenses from time to time that may not generate revenue until
subsequent quarters. In addition, in connection with new product
introductions, we incur research and development expenses and sales and
marketing expenses that are not matched with revenue until a subsequent
quarter when the new product is introduced. We cannot assure you that our
expenditures on manufacturing capacity will generate increased revenue in
subsequent quarters. If growth in our revenue does not outpace the increase in
our expenses, our quarterly operating results may fall below expectations and
cause our stock price to decline significantly.
Due to these and other factors, we believe that our quarterly operating
results are not an indicator of our future performance. If our operating
results are below the expectations of public market analysts or investors in
future quarters, the trading price of our Class A common stock would be likely
to decrease significantly.
General economic factors could negatively impact our growth plan.
During our fiscal year ended September 30, 2001, unfavorable economic
conditions in the United States detrimentally affected the U.S. manufacturing
industry and sales of fiber optics equipment to service providers and
communication equipment companies. Announcements by fiber optics equipment
manufacturers and their customers during this period indicate that there is a
reduction in spending for fiber optic equipment as a result of the economic
slowdown and efforts to reduce existing inventories. Based on these and other
factors, some of our customers have reduced, modified, cancelled or
rescheduled orders for our products and have expressed uncertainty as to their
future requirements. In addition, the economic slowdown has required us to
aggressively manage our costs and expenses, including our July 2001
announcement of the elimination of approximately 110 jobs primarily in the
manufacturing area, and may require us to implement further cost management
procedures in the future. Our business, operating results and financial
condition will suffer if economic conditions in the United States worsen, the
fiber optics equipment market continues to slowdown, or if a wider or global
economic slowdown occurs.
If we do not develop and introduce new products with higher average selling
prices in a timely manner, the overall average selling prices of our products
will decrease.
The market for fiber optic subsystems and modules is characterized by
declining average selling prices for existing products due to increased
competition, the introduction of new products, product obsolescence and
increased unit volumes as manufacturers deploy new network equipment. We have
in the past experienced, and in the future may experience, period-to-period
fluctuations in operating results due to declines in our overall average
selling prices. We anticipate that the selling prices for our existing
products will decrease in the future in response to product introductions by
competitors or us, or other factors, including pressure from significant
customers for price concessions. Therefore, we must continue to develop and
introduce new products that can be sold at higher prices on a timely basis to
maintain our overall average selling prices. Failure to do so could cause our
revenue and gross margins to decline.
15
If our customers do not approve our manufacturing process and qualify our
products, we will lose significant customer sales and opportunities.
Customers generally will not purchase any of our products before they
qualify them and approve our manufacturing process and quality control system.
Our customers may require us to register under international quality
standards, such as ISO 9002. Delays in product qualification or loss of ISO
9002 certification may cause a product to be dropped from a long-term supply
program and result in a significant lost revenue opportunity. If particular
customers do not approve of our manufacturing process, we will lose the sales
opportunities with those customers.
If we fail to predict our manufacturing requirements accurately, we could
incur additional carrying costs and have excess and obsolete inventory or
experience manufacturing delays, which could cause us to lose orders or
customers.
We currently use historical data, a backlog of orders and estimates of
future requirements to determine our demand for components and materials. We
must accurately predict both the demand for our products and the lead-time
required to obtain the necessary components and materials. Lead times for
components and materials vary significantly, depending on factors such as the
specific supplier, the size of the order, contract terms and demand for each
component at a given time. We generally maintain excess inventory of parts
which increases our inventory carrying costs and periodically causes us to
have excess and obsolete inventory. However, if we were to underestimate our
purchasing requirements, manufacturing could be interrupted, resulting in
delays in shipments.
Our markets are highly competitive, some of our customers are also our
competitors, and our other customers may choose to purchase our competitors'
products rather than our products or develop internal capabilities to produce
their own fiber optic subsystems and modules.
The market for fiber optic subsystems and modules is highly competitive and
we expect competition to intensify in the future. Our primary competitors
include Agere Systems, Agilent Technologies, ExceLight Communications,
Finisar, Infineon Technologies, IBM, JDS Uniphase, Luminent, Stratos Lightwave
and Tyco International. We also face indirect competition from public and
private companies providing products that address the same fiber optic network
problems that our products address. The development of alternative solutions
to fiber optic transmission problems by our competitors, particularly systems
companies that also manufacture modules, such as Alcatel (via Alcatel
Optronics), Fujitsu, and Nortel Networks, could significantly limit our growth
and harm our competitive position.
Many of our current competitors and potential competitors have longer
operating histories and significantly greater financial, technical, sales and
marketing resources than we do. As a result, these competitors are able to
devote greater resources to the development, promotion, sale and support of
their products. In addition, our competitors that have large market
capitalizations or cash reserves are in a much better position to acquire
other companies in order to gain new technologies or products that may
displace our products. Any of these potential acquisitions could give our
competitors a strategic advantage. In addition, many of our competitors have
much greater brand name recognition, more extensive customer bases, more
developed distribution channels and broader product offerings than we do.
These companies can use their broader customer bases and product offerings and
adopt aggressive pricing policies to gain market share.
In addition, existing and potential customers, especially in Japan and other
international markets, may also become competitors. These customers have the
internal capabilities to integrate their operations by producing their own
optical subsystems and modules or by acquiring our competitors or the rights
to produce competitive products or technologies, which may allow them to
reduce their purchases or cease purchasing from us.
We expect our competitors to introduce new and improved products with lower
prices, and we will need to do the same to remain competitive. We may not be
able to compete successfully against either current or future competitors with
respect to new products. We believe that competitive pressures may result in
price reductions, reduced margins and our loss of market share.
16
Our sales cycle runs from our customers' initial design to production for
commercial sale. This cycle is long and unpredictable and may cause our
revenue and operating results to vary from our forecasts.
The period of time between our initial contact with a customer and the
receipt of a purchase order from that customer may span to more than a year
and varies by product and customer. During this time, customers may perform,
or require us to perform, extensive evaluation and qualification testing of
our products. Generally, they consider a wide range of issues before
purchasing our products, including interoperation with other subsystems and
components, product performance and reliability. We may incur substantial
sales and marketing expenses and expend significant management effort while
potential customers are qualifying our products. Even after incurring these
costs, we ultimately may not sell any or only small amounts of our products to
a potential customer. If sales forecasts to specific customers are not
realized, our revenue and results of operations may be negatively impacted.
If we do not achieve acceptable manufacturing yields in a cost-effective
manner, or we are required to develop new manufacturing processes to improve
our yields, our operating results would be impaired.
The manufacture of our products involves complex and precise processes. As a
result, it may be difficult to cost-effectively meet our production goals. In
addition, changes in our manufacturing processes or those of our suppliers, or
our suppliers' inadvertent use of defective materials, could significantly
reduce our manufacturing yields, increase our costs and reduce our product
shipments. To increase our gross margin, while offering products at prices
acceptable to customers, we will need to develop new manufacturing processes
and techniques that will involve higher levels of automation.
If we are unsuccessful in defending against Methode's lawsuit for patent
infringement, we may be required to pay significant monetary damages to
Methode and may be enjoined from manufacturing and selling some of our
products.
In October 1999, Methode Electronics, Inc. filed a lawsuit against Infineon
Technologies Corporation and us in the U.S. District Court for the Northern
District of California seeking unspecified damages, including monetary
damages, injunctive relief, attorneys' fees and costs arising from our alleged
infringement of five patents assigned to Methode. Two of the patents are
alleged to relate to the technology incorporated in our 1x9 pin configuration
products, such as our singlemode SONET/SDH transceiver products. The remaining
three patents are alleged to relate to technology incorporated in our gigabit
interface converter, or GBIC, products, such as our Gigabit Ethernet and Fibre
Channel products.
In 2000, Methode sought to amend its complaint to add Stratos Lightwave
Inc., a Methode spin-off and assignee of the patents-in-suit, as an additional
plaintiff and to allege that we infringe a sixth patent, which purportedly
relates to certain aspects of our GBIC products. Methode withdrew its motion
to amend with respect to the sixth patent, though Methode remains free to
reassert the claim at a later time, whether in the current action or in a
separate proceeding. The court later added Stratos as a plaintiff to the
lawsuit. For the fiscal year ended September 30, 2001, sales of our 1x9 pin
configuration products alleged to infringe the Methode patents accounted for
31.7% of our total revenue. Sales of our products alleged to infringe the
other Methode patents represented an immaterial amount of our total revenue
for the fiscal year ended September 30, 2001.
In recent discussions among the parties' counsel, Methode has indicated that
it believes our recently released Small Form Factor Pluggable, or SFP,
transceiver infringes one or more of Methode's patents, including the patents
at issue in the current action. Methode has also indicated that it believes
our Small Form Factor, or SFF, transceiver infringes Methode patents. While
Methode has filed actions against other manufacturers regarding such
transceivers, Methode has not filed any additional actions against us, nor has
Methode attempted to add SFPs, SFFs or any other transceivers as additional
accused devices in the current action. In the event that Methode filed a
lawsuit (or sought to amend its current lawsuit) and charged us with
infringement through the manufacture and sale of these transceivers, an
unfavorable resolution of such a lawsuit could have a material adverse impact
on our business.
17
Trial is scheduled to commence in September 2002. We intend to defend
ourselves vigorously in this lawsuit. The outcome of this lawsuit, however, is
uncertain. Our expenses and other resources expended on this lawsuit have been
greater in fiscal year end September 30, 2001 than in prior years. As this
lawsuit progresses, we expect to incur greater legal fees and expenses. In
addition, our defense of this lawsuit is expected to divert the efforts and
attention of our key management and technical personnel. As a result, our
defense of this lawsuit, regardless of its eventual outcome, will likely be
costly and time consuming. If Methode's patents are found to be valid and
enforceable and our products are found to infringe, we may be enjoined from
manufacturing or selling some of our products, we may be liable for
significant monetary damages and/or we may be required to obtain a license
from Methode to use its patented technology, any of which could disrupt our
ability to manufacture and sell our products. If we are required to obtain a
license to any of Methode's patents, such license may not be available from
Methode on commercially reasonable terms, if at all. For additional details
regarding this lawsuit, see "Legal Proceedings."
We could be subjected to additional litigation regarding intellectual property
rights, which may divert management attention, cause us to incur significant
costs or prevent us from selling our products.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights in the networking
technologies industry. Many companies aggressively use their patent portfolios
to bring infringement claims against competitors. As a result, we may be a
party to litigation or be involved in disputes over our alleged infringement
of others' intellectual property in the future, in addition to our current
dispute with Methode. These claims and any resulting lawsuit, if successful,
could subject us to significant liability for damages and prevent us from
making or selling some of our products. These lawsuits, regardless of their
merit, would likely be time-consuming and expensive to resolve and would
divert management's time and attention. Any potential intellectual property
litigation also could force us to do one or more of the following:
. stop selling, incorporating or using our products that use the infringed
intellectual property;
. obtain a license to make, sell or use the relevant technology from the
owner of the infringed intellectual property, which license may not be
available on commercially reasonable terms, if at all; or
. redesign the products to not use the infringed intellectual property,
which may not be technically or commercially feasible.
If we are forced to take any of these actions, we may be limited in our
ability to execute our business plan.
We may in the future initiate claims or litigation against third parties for
infringement of our proprietary rights. These claims could result in costly
litigation and the diversion of our technical and management personnel. In the
process of asserting our intellectual property rights, these rights could be
found to be invalid, unenforceable or not infringed. Failure to successfully
assert our intellectual property rights could result in our inability to
prevent our competitors from utilizing our proprietary rights.
If we are unable to protect our proprietary technology, this technology could
be misappropriated, which would make it difficult for us to compete in our
industry.
Our success and ability to compete is dependent in part on our proprietary
technology. We currently do not have any patents, and we have no pending
patent applications. We rely on a combination of copyright, trademark and
trade secret laws, as well as confidentiality agreements to establish and
protect our proprietary rights. Existing copyright, trademark and trade secret
laws afford only limited protection. In addition, the laws of some foreign
countries do not protect the unauthorized use of our proprietary technology
and processes to the same extent as do the laws of the United States, and
policing the unauthorized use of our products is difficult. Any infringement
of our proprietary rights could result in costly litigation, and any failure
to adequately protect our proprietary rights could result in our competitors
offering similar products, potentially resulting in the loss of some of our
competitive advantage and a decrease in our revenue.
18
If we are unable to generate adequate additional revenue as a result of the
planned expansion of our sales operations, our competitive position may be
harmed and our revenue or margins may decline.
Historically, we have relied primarily on a limited direct sales force,
supported by third party manufacturers' representatives and distributors, to
sell our products. Our sales strategy focuses primarily on developing and
expanding our direct sales force, manufacturers' representatives and
distributors. We will incur significant costs related to the expansion of our
sales operations. If the expansion of our sales operations does not generate
adequate additional revenue, the cost of any expansion may exceed the revenue
generated, and our margins may decline. To the extent we are unsuccessful in
expanding our direct sales force, we will likely be unable to compete
successfully against the significantly larger and well-funded sales and
marketing operations of many of our current or potential competitors. In
addition, if we fail to develop relationships with significant manufacturers'
representatives or distributors, or if these representatives or distributors
are not successful in their sales or marketing efforts, sales of our products
may decrease and our competitive position would be harmed. Our representatives
or distributors may not market our products effectively or may not continue to
devote the resources necessary to provide us with effective sales, marketing
and technical support. Our inability to effectively manage the expansion of
our domestic sales and support staff or maintain existing or establish new
relationships with manufacturer representatives and distributors would harm
our revenue and result in declining margins.
The market for our products is new and is characterized by rapid technological
changes and evolving industry standards. If we do not respond to the changes
in a timely manner, our products likely will not achieve market acceptance.
The market for our products is characterized by rapid technological change,
new and improved product introductions, changes in customer requirements and
evolving industry standards. Our future success will depend to a substantial
extent on our ability to develop, introduce and support cost-effective new
products and technology on a successful and timely basis. We plan to increase
our budget for research and development of new products and technology. Since
these costs are expensed as incurred, we expect a negative impact on our
reported net income. If we fail to develop and deploy new cost-effective
products and technologies or enhancements of existing products on a timely
basis, or if we experience delays in the development, introduction or
enhancement of our products and technologies, our products will no longer be
competitive and our revenue will decline.
The development of new, technologically advanced products is a complex and
uncertain process requiring high levels of innovation and highly skilled
engineering and development personnel, as well as the accurate anticipation of
technological and market trends. We cannot assure you that we will be able to
identify, develop, manufacture, market or support new or enhanced products on
a timely basis, if at all. Furthermore, we cannot assure you that our new
products will gain market acceptance or that we will be able to respond
effectively to product announcements by competitors, technological changes or
emerging industry standards. Our failure to respond to product announcements,
technological changes or industry changes in standards would likely prevent
our products from gaining market acceptance and harm our competitive position.
Recent terrorist activities and resulting military and other actions could
adversely affect our business.
Recent terrorist attacks in the United States, as well as continued threats
of terrorism within the United States and abroad and current and future
military response to them have created many economic and political
uncertainties that make it extremely difficult for us, our customers and our
suppliers to accurately forecast and plan future business activities. This
reduced predictability challenges our ability to operate profitably or to grow
our business. In particular, it is difficult to develop and implement
strategies, sustainable business models and efficient operations, and
effectively manage contract manufacturing and supply chain relationships. In
addition, the continued threats of terrorism and the heightened security
measures in response to such threats have and may continue to cause
significant disruption to commerce throughout the world. Disruption in air
transportation in response to these threats or future attacks may result in
transportation and supply-chain disruptions, increase our costs for both
receipt of inventory and shipment of products to our customers, and cause
customers to defer their
19
purchasing decisions. Disruptions in commerce could also cause consumer
confidence and spending to decrease or result in increased volatility in the
U.S. and worldwide financial markets and economy. They also could result in
economic recession in the U.S. or abroad. Any of these occurrences could have
a significant impact on our operating results, revenues and costs and may
result in the volatility of the market price for our Class A common stock and
on the future price of our Class A common stock.
Our success depends on our key personnel, including our executive officers,
the loss of any of whom could harm our business.
Our success depends on the continued contributions of our senior management
and other key research and development, sales and marketing and operations
personnel, including Muoi Van Tran, our Chief Executive Officer and President,
Susie Nemeti, our Chief Financial Officer and Vice President of Finance and
Administration, and Mohammad Ghorbanali, our Chief Operating Officer and Vice
President of Technical Operations. Competition for employees in our industry
is intense. We do not have life insurance policies covering any of our
executives. There can be no assurance that we will be successful in retaining
such key personnel, or that we will be successful in hiring replacements or
additional key personnel. Our loss of any key employee, the failure of any key
employee to perform in his or her current position, or the inability of our
officers and key employees to expand, train and manage our employee base would
prevent us from executing our growth strategy. See "Management."
We will need to attract and retain highly qualified managers, sales and
marketing and technical support personnel. We have had difficulty hiring the
necessary engineering, sales and marketing and management personnel in the
past. If we fail to hire and retain qualified personnel when needed, our
product development efforts and customer relations will suffer. Our key
management personnel have limited experience in managing the growth of
technologically complex businesses in a rapidly evolving environment. If we
are unable to manage our growth effectively, we will incur additional expenses
which will negatively impact our operating results.
Our products may have defects that are not detected until full deployment of a
customer's system. Any of these defects could result in a loss of customers,
damage to our reputation and substantial costs.
We design our products for large and complex fiber optic networks, and our
products must be compatible with other components of the network system, both
current and future. We have experienced in the past, and may continue to
experience in the future, defects in our products. Defects in our products or
incompatibilities in our products may appear only when deployed in networks
for an extended period of time. In addition, our products may fail to meet our
customers' design specifications, or our customers may change their design
specifications after the production of our product. A failure to meet our
customers' design specification often results in a loss of the sale due to the
length of time required to redesign the product. We may also experience
defects in third party components that we incorporate into our products. We
have experienced the following due to our inability to detect or fix errors in
the past:
. increased costs associated with the replacement of defective products,
redesign of products to meet customer design specification and/or refund
of the purchase price;
. diversion of development resources; and
. increased service and warranty costs.
Our products and the systems into which our products are incorporated must
comply with domestic and international governmental regulations, and if our
products do not meet these regulations, our ability to sell our products will
be restricted.
Our products are subject to various regulations of U.S. and foreign
governmental authorities principally in the areas of radio frequency emission
standards and eye safety. Radio frequency emission standards govern allowable
radio interference with other services. Eye safety standards govern the
labeling and certification of laser products to ensure that they are used in a
way that does not create a hazard to the human eye. Our products and the
systems into which they are incorporated must also comply with international
standards and governmental standards of the foreign countries where our
products are used. Our inability, or the inability of
20
our customers, to comply with existing or evolving standards established by
regulatory authorities, or to obtain timely domestic or foreign regulatory
approvals or certificates will restrict our ability to sell our products.
We are subject to environmental laws and other legal requirements that have
the potential to subject us to substantial liability and increase our cost of
doing business.
Our properties and business operations are subject to a wide variety of
federal, state and local environmental, health and safety laws and other legal
requirements, including those relating to the storage, use, discharge and
disposal of toxic, volatile or otherwise hazardous substances. We may be
required to incur substantial costs to comply with current or future legal
requirements. In addition, if we fail to obtain required permits or otherwise
fail to operate within these or future legal requirements, we may be required
to pay substantial penalties, suspend our operations or make costly changes to
our manufacturing processes or facilities. We believe our properties and
business operations are in compliance with applicable environmental laws. We
do not anticipate any material capital expenditures for environmental control
facilities for the 2002 fiscal year.
We face risks associated with our international operations that could prevent
us from marketing and distributing our products internationally.
Historically, approximately 80% of our sales have been in North America, and
we have limited experience in marketing and distributing our products
internationally. We intend to expand our international operations in the
future. Significant management attention and financial resources are needed to
develop our international sales, support and distribution channels and
manufacturing. We may not be able to establish or maintain international
market demand for our products.
In addition, international operations are subject to other risks, including:
. greater difficulty in accounts receivable collection and longer
collection periods;
. difficulties and costs of staffing and managing foreign operations with
personnel who have expertise in fiber optic technology;
. unexpected changes in regulatory or certification requirements for
optical networks; and
. political or economic instability.
A portion of our international revenue and expenses may be denominated in
foreign currencies in the future. Accordingly, we could experience the risks
of fluctuating currencies and may choose to engage in currency hedging
activities.
We rely on a continuous power supply to conduct our operations, and
California's current energy crisis could disrupt our operations and increase
our expenses.
All of our manufacturing operations are located in our headquarters in
Chatsworth, California. California is in the midst of an energy crisis that
could disrupt our operations and increase our expenses. In the event power
reserves for the State of California fall to a critically low level,
California has on some occasions implemented, and may in the future continue
to implement, rolling power blackouts throughout California. If blackouts
interrupt our power supply, we would be temporarily unable to continue
operations. Any such interruption in our ability to continue operations would
delay the manufacture and development of our products, disrupt communications
with our customers and suppliers and delay product shipment. Power
interruptions could also damage our reputation and could result in lost
revenue. Any loss of power could have a material adverse effect on our
business, operating results and financial condition. Furthermore, shortages in
wholesale electricity supplies have caused power prices to increase. If
electricity prices continue to increase and we are unable to conserve our
electricity usage, our operating expenses will likely increase, which will
have a negative effect on our operating results.
21
Disruption of our operations at our Chatsworth, California manufacturing
facility could require us to lease alternative manufacturing facilities or
limit our manufacturing operations.
All of our manufacturing operations are conducted in our Chatsworth,
California headquarters. Due to this geographic concentration, a disruption of
our manufacturing operations, resulting from sustained process abnormalities,
human error, government intervention or natural disasters, such as
earthquakes, fires or floods, or other causes, could require us to cease or
limit our manufacturing operations. See "Business--Manufacturing" and
"Properties."
Our limited experience in acquiring other businesses, product lines and
technologies may make it difficult for us to overcome problems encountered in
connection with any acquisition we may undertake.
We expect to review opportunities to buy other businesses, products or
technologies that would enhance our technical capabilities, complement our
current products or expand the breadth of our markets or which may otherwise
offer growth opportunities. Our acquisition of businesses or technologies will
require significant commitment of resources. We may be required to pay for any
acquisition with cash, but we cannot be certain that additional capital will
be available to us on favorable terms, if at all. In lieu of paying cash, we
could issue stock as consideration for an acquisition that would dilute
existing stockholders' percentage ownership, incur substantial debt or assume
contingent liabilities. We have no experience in acquiring other businesses
and technologies. Potential acquisitions also involve numerous risks,
including:
. problems assimilating the purchased operations, technologies or
products;
. unanticipated costs associated with the acquisition;
. diversion of management's attention from our core business;
. adverse effects on existing business relationships with suppliers and
customers;
. risks associated with entering markets in which we have no or limited
prior experience; and
. potential loss of key employees of purchased organizations.
We have business conflicts of interest with Furukawa, the resolution of which
may not be as favorable to us as if we were dealing with an unaffiliated third
party.
We have historically relied on Furukawa's research and development
capabilities to provide us with technologically advanced lasers and fiber
optic components which we purchase from Furukawa for inclusion in our
products, and we expect to continue to rely on Furukawa in the future. We
currently purchase the majority of lasers from Furukawa. We currently have no
written agreements with Furukawa with respect to our research and development
and supply relationship. We cannot assure you that Furukawa will continue to
provide services and components to us, and if not, whether or on what terms we
could find adequate alternative sources for these services and components. We
believe that our past business dealings with Furukawa and its subsidiaries and
affiliates were on terms that were no less favorable than terms that would be
available from third parties for similar transactions. We intend to continue
to maintain our relationship with Furukawa and Furukawa will continue to
control us. The terms of future transactions with Furukawa may or may not be
comparable to those that would be available from unaffiliated third parties.
See "Related party transactions."
Conflicts of interest may arise between Furukawa and us in a number of
areas, including the nature and quality of services rendered by Furukawa to
us, potential competitive business activities, sales or distributions by
Furukawa of all or any portion of its ownership interest in us, or Furukawa's
ability to control our management and affairs. It is possible that business
decisions made by management that are in the best interest of our stockholders
may conflict with Furukawa's interests. For example, we may decide to enter
into or acquire a line of business competitive with Furukawa, or Furukawa may
decide to enter into or acquire a line of business competitive with us. Any of
these events may alter or eliminate our ability to rely on Furukawa to supply
key components to us in the future, increase our costs of producing our
products and result in increased competition in our markets. We cannot assure
you that we will be able to resolve any conflicts we may have with Furukawa
or, if we are able to do so, that the resolution will be favorable to us.
22
Furukawa will control the outcome of stockholder voting and there may be an
adverse effect on the price of our Class A common stock due to disparate
voting rights of our Class A common stock and our Class B common stock.
Furukawa beneficially owns all of our outstanding shares of Class B common
stock, which as of December 5, 2001 represented 94.0% voting control over all
stockholder issues. The holders of our Class A common stock and Class B common
stock have identical rights except that holders of our Class A common stock
are entitled to one vote per share while holders of our Class B common stock
are entitled to ten votes per share on matters to be voted on by stockholders.
The differential in the voting rights of our Class A common stock and Class B
common stock could adversely affect the price of our Class A common stock to
the extent that investors or any potential future purchaser of our shares of
Class A common stock give greater value to the superior voting rights of our
Class B common stock. Each share of our Class B common stock will
automatically convert into one share of Class A common stock if it is
transferred to any entity, other than an entity controlling, controlled by or
under common control with Furukawa. In addition, our Class B common stock will
automatically convert into shares of our Class A common stock if the total
number of outstanding shares of Class B common stock falls below 20% of total
number of outstanding shares of our common stock. As long as Furukawa has a
controlling interest, it will continue to be able to elect our entire board of
directors and generally be able to determine the outcome of all corporate
actions requiring stockholder approval. As a result, Furukawa will be in a
position to continue to control all matters affecting us, including:
. a change of control, including a merger;
. our acquisition or disposition of assets;
. our future issuances of common stock or other securities;
. our incurrence of debt; and
. our payment of dividends on our common stock.
Three members of our board of directors are also executives of Furukawa.
These individuals have obligations to both our company and Furukawa and may
have conflicts of interest with respect to matters potentially or actually
involving or affecting us, such as acquisitions and other corporate
opportunities that may be suitable for both Furukawa and us.
ITEM 2. PROPERTIES
Our corporate headquarters, manufacturing, research and development and
sales operations are located in Chatsworth, California, where we own and
occupy a building of approximately 65,000 square feet. We purchased the
property in July 1999 with the proceeds of a $3.3 million term loan that
matures in July 2006. The term loan bears interest on amounts outstanding at a
per annum rate equal to LIBOR plus 1.80%. The term loan and a revolving credit
facility are secured by all of our assets. In June 2001, we acquired a 145,720
square foot building in Woodland Hills, California for $18,750,000. The
purchase price was paid from our existing cash on-hand. We have not occupied
this building and are currently leasing an aggregate of 73,720 square feet of
this building to two unrelated parties. In addition, we lease small sales
facilities in Franklin, Massachusetts, Richardson, Texas, Nepean, Canada and
Bury St. Edmunds, England. The lease for Franklin, Massachusetts and
Richardson, Texas are on a month-to-month basis. Our leases for our facilities
in Nepean, Canada and Bury St. Edmunds, England expire in January 2002 and
January 2005, respectively.
We believe that our existing space is adequate for our current operations.
We believe that suitable replacement and additional spaces, if needed, will be
available in the future on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
On October 15, 1999, Methode Electronics, Inc. filed a lawsuit against
Infineon Technologies Corporation and us in the United States District Court
for the Northern District of California, seeking unspecified damages,
including monetary damages, injunctive relief, attorneys' fees and costs
arising from our alleged infringement of
23
some claims contained in Methode's U.S. Patents Nos. 5,528,408, 5,717,533,
5,734,558, 5,864,468 and 5,879,173. Methode alleges that the '408 and '468
Patents relate to technology incorporated in our 1x9 pin configuration
products, such as our singlemode SONET/SDH transceivers products. These
products combine fiber optic transmitters and receivers in one module that
conforms to the internationally agreed SONET/SDH telecommunications standard
protocol. Methode alleges that the '533, '558 and '173 Patents, or GBIC
Patents, relate to the technology incorporated in our gigabit interface
converter, or GBIC, products, such as our Gigabit Ethernet and Fibre Channel
products. Our GBIC products are a type of transceiver.
On December 17, 1999, we filed an answer to Methode's complaint denying its
claims of infringement and asserting a number of defenses, including non-
infringement and invalidity of the asserted patents. On June 27, 2000, Methode
filed a motion for leave to amend its complaint to add Stratos Lightwave,
Inc., a Methode spin-off and assignee of the patents-in-suit, as an additional
plaintiff and to allege that certain aspects of our GBIC products infringe
U.S. Reissue Patent No. 36,820 (a reissue of U.S. Patent No. 5,546,281). The
court has now added Stratos as a plaintiff to the lawsuit. Methode withdrew
its motion to amend with respect to the RE '820 Patent, although Methode and
Stratos may later seek to amend the complaint again to allege infringement of
the claims of the RE '820 Patent, or they may later file a separate proceeding
against us alleging infringement of the reissued patent's claims. For the year
ended September 30, 2001, sales of our 1x9 pin configuration products alleged
to infringe the '408 and '468 Patents accounted for 31.7% of our total
revenue. For the year ended September 30, 2001, sales of our GBIC products
alleged to infringe the '533, '558, and '173 Patents (and RE '820 Patent)
represented an immaterial amount of our total revenue.
The court granted a motion by us and Infineon to stay that part of the case
relating to the claims involving the '408 and '468 Patents, and our 1x9 pin
configuration products, pending the completion of the Patent and Trademark
Office's re-examination of the '408 Patent. In the reexamination, Methode
requested that the Patent and Trademark Office reexamine the claims of the
'408 Patent in view of prior art that was not considered by the Patent and
Trademark Office prior to the patent's issuance. In November 2000, the Patent
and Trademark Office issued a final office action rejecting all claims of the
'408 Patent. Stratos, as assignee of the '408 Patent, has appealed the final
rejection to the Patent and Trademark Office's Board of Patent Appeals. That
part of the lawsuit remains stayed.
The parties have exchanged extensive "Initial Disclosures" and supplemental
disclosures of information mandated by the court's local rules. The parties
have also conducted and continue to conduct formal discovery regarding the
issues in the active part of the case. On June 22, 2001, the court entered an
Order Re Claim Construction, in which the court defined three GBIC Patent
claim terms disputed by the parties. The parties have agreed upon the
interpretation of the other GBIC Patent claim terms at issue. Under the
court's current case management schedule, discovery in the case will remain
open until April 2002.
In recent discussions among the parties' counsel, Methode has indicated that
it believes our recently released Small Form Factor Pluggable, or SFP,
transceiver infringes one or more of Methode's patents, including the patents
at issue in the current action. Methode has also indicated that it believes
our Small Form Factor, or SFF, transceiver infringes Methode patents. While
Methode has filed actions against other manufacturers regarding such
transceivers, Methode has not filed any additional actions against us, nor has
Methode attempted to add SFPs, SFFs or any other transceivers as additional
accused devices in the current action. Unless the current case terminates
through dispositive motions or through settlement, trial is scheduled to
commence in September 2002.
We intend to defend ourselves vigorously in this lawsuit. However, the
outcome of this lawsuit is uncertain. Our defense of this lawsuit, regardless
of its eventual outcome, will likely be costly and time consuming. We expect
to incur greater legal fees and expenses in connection with this lawsuit. If
the Methode/Stratos patents are found to be valid and enforceable and our
products are found to infringe, we may be enjoined from manufacturing or
selling some of our products, we may be liable for significant monetary
damages, and we may have to obtain a license from Methode and Stratos to use
the patented technology, any of which could harm our business. If we are
required to obtain a license to any of the Methode/Stratos patents, such a
license may not be available from them on commercially reasonable terms, if at
all. See "Risk Factors--If we are unsuccessful in
24
defending against Methode's and Stratos's lawsuit for patent infringement, we
may be required to pay significant monetary damages to Methode and may be
enjoined from manufacturing and selling some of our products."
We are not currently involved in any other material legal proceedings, nor
have we been involved in any such proceedings that has had or may have a
significant effect on our company. We are not aware of any other material
legal proceedings threatened or pending against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
25
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Market Information
Our Class A common stock has traded on The Nasdaq National Market under the
symbol "OCPI" since November 3, 2000. The following table sets forth the range
of high and low intra-day sales prices (rounded to the nearest cent) reported
on The Nasdaq National Market for our Class A common stock for the periods
indicated.
Price range
of Common
Stock
------------
High Low
------ -----
Fiscal Year Ended September 30, 2001:
First Quarter (November 3, 2000 through December 31, 2000)........ $23.00 $9.00
Second Quarter.................................................... $21.00 $6.28
Third Quarter..................................................... $16.49 $5.63
Fourth Quarter.................................................... $11.00 $1.92
Recent Share Prices
The following table sets forth the closing sales prices per share of our
Class A common stock on The Nasdaq National Market on (i) September 28, 2001
and (ii) December 5, 2001. Because the market price of our Class A common
stock is subject to fluctuation, the market value of the shares of our Class A
common stock may increase or decrease.
Closing
Price
-------
September 28, 2001...................................................... $2.32
December 5, 2001........................................................ $3.91
Holders
As of December 5, 2001, there were 79 stockholders of record who held shares
of our Class A common stock.
Dividend Policy
We have not declared or paid any cash dividends on our capital stock since
our inception and we intend to retain future earnings, if any, for use in the
operation and expansion of our business and do not anticipate paying cash
dividends in the foreseeable future.
Recent Sales of Unregistered Securities
None.
Use of Proceeds from Sales of Registered Securities
On November 3, 2000, we completed an initial public offering of our Class A
common stock pursuant to our Registration Statement on Form S-1 (File No. 383-
44862) that was declared effective by the Securities Exchange Commission on
November 2, 2000. There has been no material change with respect to our use of
proceeds from our initial public offering to the information discussed on our
annual Report on Form 10-K for the year ended September 30, 2000.
26
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with, and are qualified by reference to, our consolidated
financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The selected
income statement data for the three fiscal years ended September 30, 2001,
2000 and 1999 and the selected balance sheet data as of September 30, 2001 and
2000 are derived from, and qualified by reference to, the audited consolidated
financial statements included elsewhere in this Form 10-K. The selected income
statement data for the fiscal years ended September 30, 1998 and 1997 and the
selected balance sheet data as of September 30, 1999, 1998 and 1997 are
derived from audited financial statements not included in this Form 10-K.
Fiscal years ended September 30
-----------------------------------------
1997 1998 1999 2000 2001
------- ------- ------- -------- --------
(In thousands, except per share data)
Income statement data
Revenue.............................. $10,126 $19,620 $36,036 $101,867 $144,012
Cost of revenue...................... 5,797 11,086 20,860 50,326 94,684
------- ------- ------- -------- --------
Gross profit......................... 4,329 8,534 15,176 51,541 49,328
Operating Expenses:
Research and development........... 465 779 1,134 2,527 2,958
Sales and marketing................ 563 999 1,364 2,943 3,799
General and administrative......... 369 712 1,065 3,877 4,553
------- ------- ------- -------- --------
Total operating expenses......... 1,397 2,490 3,563 9,347 11,310
Income from operations............... 2,932 6,044 11,613 42,194 38,018
Other income (expenses), net......... 62 119 116 305 6,081
------- ------- ------- -------- --------
Income before income taxes........... 2,994 6,163 11,729 42,499 44,099
Income taxes......................... 1,205 2,492 4,693 17,319 17,655
------- ------- ------- -------- --------
Net income........................... $ 1,789 $ 3,671 $ 7,036 $ 25,180 $ 26,444
Earnings per share:
Basic.............................. $ 0.06 $ 0.13 $ 0.26 $ 0.91 $ 0.26
Diluted............................ $ 0.02 $ 0.04 $ 0.07 $ 0.25 $ 0.24
Shares outstanding:
Basic.............................. 27,321 27,321 27,348 27,547 100,263
Diluted............................ 9,842 100,494 101,132 102,500 111,430
September 30
-----------------------------------------
1997 1998 1999 2000 2001
------- ------- ------- -------- --------
(In thousands)
Balance sheet data
Cash and cash equivalents............ 1,661 1,863 2,447 3,202 62,529
Working capital...................... 3,971 7,214 11,970 34,078 166,416
Total assets......................... 5,970 11,661 26,149 50,426 204,268
Long-term portion of debt............ 2,750 2,296 1,825
Stockholders' equity................. 4,384 8,055 15,096 40,373 194,713
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with our financial statements and the
related notes to such financial statements included elsewhere in this Report
beginning on page F-1. The following discussion contains forward-looking
statements that involve risks and uncertainties. The statements are based on
current expectations and actual results could differ materially from
27
those discussed herein. Factors that could cause or contribute to the
differences are discussed in "Business--Risk Factors" and elsewhere in this
Report.
Overview
We design, manufacture and sell a comprehensive line of high performance,
highly reliable fiber optic subsystems and modules for fiber optic
transmission systems used to address the bandwidth limitations in metropolitan
area networks and high-speed premises networks. Our subsystems and modules
include optical transmitters, receivers, transceivers and transponders that
convert electronic signals into optical signals and back to electronic
signals, enabling high-speed communication of voice and data traffic over
public and private networks. We began our operations and shipped our first
products in November of 1991 and have been profitable every year since our
inception.
Furukawa beneficially owns all of our outstanding Class B common stock,
representing 61.1% of our outstanding shares of common stock and 94.0% of the
combined voting power of all of our outstanding common stock. Since our
inception, we have purchased substantially all of our lasers and the majority
of our other fiber optic components from Furukawa. We have relied on
Furukawa's research and development capabilities to provide us with
technologically advanced lasers and fiber optic components which we purchase
from Furukawa for inclusion in our products. We currently purchase the
majority of lasers from Furukawa using short-term purchase orders.
We operate in one industry segment, the design and manufacture of fiber
optic subsystems and modules. We sell our products to fiber optic
communication equipment manufacturers, directly and through contract
manufacturers who incorporate them into systems they assemble for equipment
manufacturers. We define our customers as equipment manufacturers who have
purchased our products directly or ordered our products for incorporation into
systems produced by contract manufacturers. We recognize revenue upon product
shipment, and sales returns and allowances have been insignificant. For the
fiscal year ended September 30, 2001, our 10 largest customers accounted for
approximately 74.2% of our total revenue, with Alcatel and Cisco Systems
accounting for approximately 20.9% and 19.8% of our total revenue,
respectively. No other customer accounted for more than 10.0% of our total
revenue for the fiscal year ended September 30, 2001. Although our revenue
from sales to our other customers continues to increase, we expect that
significant customer concentration will continue for the foreseeable future.
Our sales are made on a purchase order basis rather than by long-term purchase
commitments. Our customers may cancel or defer purchase orders without penalty
on short notice.
In October 1999, Methode Electronics, Inc. filed a lawsuit against Infineon
Technologies Corporation and us seeking unspecified damages, including
monetary damages, injunctive relief, attorneys' fees and costs arising from
our alleged infringement of some of the claims contained in patents assigned
to Methode, including patents relating to our 1x9 pin configuration products.
After Methode initiated the lawsuit, it assigned to Stratos Lightwave, Inc., a
Methode spin-off, all of Methode's rights, title and interest in the patent at
issue. The court has added Stratos as a plaintiff to the lawsuit. The parties
have exchanged extensive "Initial Disclosures" and supplemental disclosures of
information mandated by the court's local rules. Unless the case terminates
through dispositive motions or through settlement, trial is scheduled to
commence in September 2002. Although our expenses and other resources expended
on this lawsuit have been greater in fiscal year ended September 30, 2001 than
in prior years, the lawsuit has not had a material effect on our business
operations. As the lawsuit progresses, we expect to incur greater legal fees
and expenses. In addition, we expect that the defense of this lawsuit will
divert the efforts and attention of our key management and technical
personnel. For the fiscal year ended September 30, 2001, sales of our 1x9
products alleged to infringe the Methode/Stratos patents accounted for
approximately 31.7% of our total revenue. Sales of our other products alleged
to infringe the Methode patents represented an immaterial amount of our total
revenue for the fiscal year ended September 30, 2001. See "Legal Proceedings."
During the fiscal year ended September 30, 2001, the telecommunications
sector, and in particular the fiber optic networking sector, suffered a severe
downturn. System providers are scaling back on deployment and have
dramatically slowed their purchases of systems from equipment manufacturers.
As a result, equipment
28
manufacturers have also slowed purchases of components and modules from our
competitors and from us. Moreover, as equipment manufacturers' sales declined,
they have relied on their excess component inventories to meet reduced demand
and have moved to reduce their overall component and module inventory levels.
Consequently, the slowdown continues to have a negative impact on our business
as we face declining sales as the result of our customers' declining business
and the resulting adjustment to their inventory levels.
The average selling prices of our products generally decrease as the
products mature from factors such as increased competition, the introduction
of new products and increased unit volumes. We anticipate that average selling
prices of our existing products will continue to decline in future periods
although the timing and degree of the declines cannot be predicted with any
certainty. We must continue to develop and introduce new products that
incorporate features that can be sold at higher average selling prices on a
timely basis.
Our cost of revenue consists principally of materials, as well as salaries
and related expenses for manufacturing personnel, manufacturing overhead and
provisions for excess and obsolete inventory. We purchase several key
components for our products from a limited number of suppliers.
Our research and development expenses consist primarily of salaries and
related expenses for design engineers and other technical personnel, cost of
developing prototypes, fees paid to consultants and depreciation of test and
prototyping equipment. Our research and development expenses also consist of
materials and overhead costs related to major product development projects. We
charge all research and development expenses to operations as incurred. We
believe that continued investment in research and development is critical to
our future success. Accordingly, we intend to expand our internal research and
development capabilities in the future to develop new products. As a result,
we expect that our research and development expenses in absolute dollar
amounts and as a percentage of revenue will increase significantly in future
periods.
Sales and marketing expenses consist primarily of personnel costs,
commissions paid to independent manufacturers' representatives, product
marketing and promotion costs. We intend to substantially expand our sales and
marketing operations and efforts, both domestically and internationally, in
order to increase sales and market awareness of our products. In December 1999
we opened a sales office in Franklin, Massachusetts, in July 2000 we opened
sales offices in Bury St. Edmunds, England and Richardson, Texas and in May
2001 we opened a sales office in Ottawa, Canada. We also intend to open an
additional sales office in San Jose, California. We believe that investment in
sales and marketing is critical to our success and expect these expenses to
increase in the future.
General and administrative expenses consist primarily of salaries and
related expenses for our administrative, finance and human resources
personnel, professional fees and other corporate expenses. We expect that, in
support of our operations as a public company, general and administrative
expenses will continue to increase particularly due to the recent rise in our
directors and officers insurance premiums as a result of the current downturn
in the equity markets. General and administrative expenses are also likely to
be affected in future periods by significant legal fees, stock compensation
and expenses incurred in connection with pending litigation.
29
Results of Operations
The following table sets forth income statement data for the periods
indicated as a percentage of revenue:
Fiscal years
ended
September 30,
-------------------
1999 2000 2001
----- ----- -----
Revenue.................................................... 100.0% 100.0% 100.0%
Cost of revenue............................................ 57.9 49.4 65.6
Gross Profit............................................... 42.1 50.6 34.4
Operating Expenses:
Research and development................................. 3.1 2.5 2.1
Sales and marketing...................................... 3.8 2.9 2.6
General and administrative............................... 3.0 3.8 3.2
Total operating expenses................................... 9.9 9.2 7.9
Income from operations..................................... 32.2 41.4 26.5
Other income............................................... 0.3 0.3 4.2
Income before income taxes................................. 32.5 41.7 30.7
Income taxes............................................... 13.0 17.0 12.3
Net income............................................. 19.5% 24.7% 18.4%
Fiscal years ended September 30, 2001 and 2000
Revenue--Revenue increased 41.4% to $144.0 million in the fiscal year ended
September 30, 2001 from $101.9 million in the fiscal year ended September 30,
2000. This increase was due substantially to an increase in demand from our
existing customers and, to a lesser extent, to demand from new customers and
from revenue generated by newer products with higher average selling prices,
such as our PTC transponder products. Sales of our products for metropolitan
area networks increased to 91% of revenue for the fiscal year ended September
30, 2001 from 84.3% of revenue for the fiscal year ended September 30, 2000.
We do not expect that our rate of year-to-year growth in revenue will be
sustainable in future periods, as the average selling prices for existing
products may decline in response to product introductions by competitors or
us, or other factors, including pressure from significant customers for price
concessions and reductions in spending for fiber optic equipment as a result
of the economic slowdown. We believe that the increase in customer demand for
our products in recent years reflects increased demand for components due to
growth in the deployment of fiber optic networks worldwide.
During the fiscal year ended September 30, 2001, the telecommunications
sector, and in particular the fiber optic networking sector, suffered a severe
downturn. System providers are scaling back on deployment and have
dramatically slowed their purchases of systems from equipment manufacturers.
As a result, equipment manufacturers have also slowed purchases of components
and modules from our competitors and from us. Moreover, as equipment
manufacturers' sales declined, they have relied on their excess component
inventories to meet reduced demand and have moved to reduce their overall
component and module inventory levels. Consequently, the slowdown continues to
have a negative impact on our business as we face declining sales as the
result of our customers' declining business and the resulting adjustment to
their inventory levels.
Cost of Revenue--Cost of revenue increased 88.1% to $94.7 million in the
fiscal year ended September 30, 2001 from $50.3 million in the fiscal year
ended September 30, 2000. Cost of revenue for the fiscal year ended September
30, 2001 includes charges related to the write down of excess inventory of
$18.1 million. Gross margin decreased to 34.4% from 50.6% during this period.
The decrease in gross margin was due to a reduction in average selling prices
and to the write down of excess inventory. We expect continued pricing
pressure to have an unfavorable impact on gross margins in future periods as
the average selling prices for existing products are expected to decline in
response to product introductions by competitors and pressure from significant
customers for price concessions.
30
Research and Development--Research and development expenses increased 17.1%
to $3.0 million in the fiscal year ended September 30, 2001 from $2.5 million
in the fiscal year ended September 30, 2000. This increase was primarily due
to increased supplies and equipment resulting from an increase in engineers
hired during this period. Research and development as a percentage of revenue
decreased to 2.1% from 2.5% over this period because of a significant growth
in revenue. We expect research and development expenses to increase as a
percentage of revenue as we expand our research and development efforts.
Sales and Marketing--Sales and marketing expenses increased 29.1% to $3.8
million in the fiscal year ended September 30, 2001 from $2.9 million in the
fiscal year ended September 30, 2000. This increase was due to increased
commissions paid to independent manufacturers' representatives as a result of
an increase in the sales of our high-performance subsystems and modules and an
increase in advertising. Sales and marketing expenses as a percentage of
revenue decreased to 2.6% from 2.9% over this period because of a significant
growth in revenue. We expect that sales and marketing expenses will increase
as a percentage of revenue as we expand our sales and marketing efforts.
General and Administrative--General and administrative expenses increased
17.4% to $4.6 million in the fiscal year ended September 30, 2001 from $3.9
million in the fiscal year ended September 30, 2000. This increase was the
result of an increase in legal and other professional fees and an increase in
insurance expense resulting from being a public company. General and
administrative expenses are likely to be affected in future periods by
significant legal fees, stock compensation and expenses incurred with pending
litigation.
Income Taxes--The provision for income taxes increased 1.9% to $17.7 million
in the fiscal year ended September 30, 2001, based on an effective tax rate of
40.0%, from $17.3 million in the fiscal year ended September 30, 2000, based
on an effective tax rate of 40.8%.
Fiscal years ended September 30, 2000 and 1999
Revenue--Revenue increased 182.7% to $101.9 million in the fiscal year ended
September 30, 2000 from $36.0 million in the fiscal year ended September 30,
1999. This increase was due substantially to an increase in demand from our
existing customers and, to a lesser extent, to an increase in the percentage
of our revenue represented by newer products with higher average selling
prices, such as our OC-3, OC-12 and OC-48 transceiver products. Sales of our
products for metropolitan area networks increased to 84.3% of revenue for the
fiscal year ended September 30, 2000 from 60.5% of revenue for the fiscal year
ended September 30, 1999. We believe that the increase in customer demand for
our products in recent years reflects increased demand for components due to
growth in the deployment of fiber optic networks worldwide.
Cost of Revenue--Cost of revenue increased 141.3% to $50.3 million in the
fiscal year ended September 30, 2000 from $20.9 million in the fiscal year
ended September 30, 1999. Gross margin increased to 50.6% from 42.1% during
this period. The increase in gross margin was due to a decrease in labor costs
as a percentage of revenue due to higher productivity in our new facility,
lower component costs as a percentage of revenue due to higher volume
purchases and a decrease in overhead as a percentage of revenue. Provisions
for obsolete inventory increased during this period as we increased inventory
to maintain a supply of components.
Research and Development--Research and development expenses increased 122.8%
to $2.5 million in the fiscal year ended September 30, 2000 from $1.1 million
in the fiscal year ended September 30, 1999. This increase was primarily due
to increased recruiting and hiring of engineering personnel, including
expenses related to employee benefits and bonuses. We also incurred
development costs of $84,000 paid to Furukawa for the automation of our
product testing procedure. Research and development as a percentage of revenue
decreased to 2.5% from 3.1% over this period because of a significant growth
in revenue. We expect research and development expenses to increase
significantly as a percentage of revenue as we expand our research and
development efforts.
Sales and Marketing--Sales and marketing expenses increased 115.7% to $3.0
million in the fiscal year ended September 30, 2000 from $1.4 million in the
fiscal year ended September 30, 1999. This increase was due
31
to increased employee benefits and bonuses, including commissions paid to
independent manufacturers' representatives as a result of an increase in the
sales of our high-performance subsystems and modules and the addition of a
sales office in Franklin, Massachusetts. Sales and marketing expenses as a
percentage of revenue decreased to 2.9% from 3.8% over this period because of
a significant growth in revenue.
General and Administrative--General and administrative expenses increased
264.0% to $3.9 million in the fiscal year ended September 30, 2000 from $1.1
million in the fiscal year ended September 30, 1999. This increase was the
result of an increase in employee benefits and bonuses, an increase in legal
and other professional fees and an increase in reserves to provide for
uncollectible receivables. We expect the dollar level of these costs to
increase as a result of increased legal fees, accounting costs and other costs
associated with being a public company.
Income Taxes--The provision for income taxes increased 269.0% to $17.3
million in the fiscal year ended September 30, 2000, based on an effective tax
rate of 40.8%, from $4.7 million in the fiscal year ended September 30, 1999,
based on an effective tax rate of 40.0%.
32
Quarterly Results
The following table sets forth some of our selected financial information
for our eight most recent fiscal quarters. In the opinion of our management,
this unaudited financial information has been prepared on the same basis as
the audited financial information, and includes all adjustments, consisting
only of normal recurring adjustments, necessary to present this information
fairly when read in conjunction with our financial statements and the related
notes contained elsewhere in this Report. These operating results are not
necessarily indicative of results of any future period.
Three-Month Period Ended
--------------------------------------------------------------------------------
Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30, Sept. 30,
1999 2000 2000 2000 2000 2001 2001 2001
-------- -------- -------- --------- -------- -------- -------- ---------
(In thousands, except per share data)
Revenue................. $ 14,785 $ 25,279 $ 28,997 $ 32,806 $ 41,853 $ 47,944 $ 39,364 $ 14,851
Cost of revenue......... 7,911 12,958 13,715 15,742 21,986 26,588 26,296 19,814
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit (loss)..... 6,874 12,321 15,282 17,064 19,867 21,356 13,068 (4,963)
Operating Expenses:
Research and
development........... 406 516 734 871 676 845 780 657
Sales and marketing.... 510 685 785 963 1,290 1,217 1,070 222
General and
administrative........ 471 919 1,392 1,095 1,011 940 1,589 1,013
-------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 1,387 2,120 2,911 2,929 2,977 3,002 3,439 1,892
Income (loss) from
operations............. 5,487 10,201 12,371 14,135 16,890 18,354 9,629 (6,855)
Other income............ 19 35 83 168 1,145 1,724 1,913 1,299
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before
income taxes........... 5,506 10,236 12,454 14,303 18,035 20,078 11,542 (5,556)
Income tax provision
(benefit).............. 2,244 4,171 5,075 5,829 7,214 8,031 4,617 (2,207)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss)....... $ 3,262 $ 6,065 $ 7,379 $ 8,474 $ 10,821 $ 12,047 $ 6,925 $ (3,349)
======== ======== ======== ======== ======== ======== ======== ========
Earnings (loss) per
share:
Basic.................. $ 0.12 $ 0.22 $ 0.27 $ 0.30 $ 0.14 $ 0.11 $ 0.06 $ (0.03)
Diluted................ $ 0.03 $ 0.06 $ 0.07 $ 0.09 $ 0.10 $ 0.11 $ 0.06 $ (0.03)
Shares outstanding:
Basic.................. 27,401 27,401 27,515 27,871 78,039 107,439 107,613 107,967
Diluted................ 103,022 103,022 103,864 100,092 107,838 112,754 112,613 107,967
As a percentage of
revenue:
Revenue................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue......... 53.5 51.3 47.3 48.0 52.5 55.5 66.8 133.4
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit (loss)..... 46.5 48.7 52.7 52.0 47.5 44.5 33.2 (33.4)
Operating Expenses:
Research and
development........... 2.7 2.0 2.5 2.7 1.6 1.8 2.0 4.4
Sales and marketing.... 3.4 2.7 2.7 2.9 3.1 2.5 2.7 1.5
General and
administrative........ 3.2 3.6 4.8 3.3 2.4 2.0 4.0 6.8
-------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 9.3 8.3 10.0 8.9 7.1 6.3 8.7 12.7
Income (loss) from
operations............. 37.2 40.4 42.7 43.1 40.4 38.2 24.5 (46.1)
Other income............ 0.1 0.1 0.3 0.5 2.7 3.6 4.9 8.7
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before
income taxes........... 37.3 40.5 43.0 43.6 43.1 41.8 29.4 (37.4)
Income taxes (benefit).. 15.2 16.5 17.5 17.8 17.2 16.7 11.7 (14.8)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss)....... 22.1% 24.0% 25.5% 25.8% 25.9% 25.1% 17.7% (22.6)%
The quarterly operating results reflect revenue growth through the quarters
ended December 31 and March 31, 2001 and decreases in revenue for the quarters
ended June 30 and September 30, 2001 as compared with their immediate prior
quarter. Revenue increased 27.6% and 14.6% in the quarters ended December 31
and March 31, 2001, respectively, compared to the previous quarter due to
increased sales to new and existing customers. New and existing customer
purchases were primarily the result of the growth in the deployment of fiber
optic networks worldwide. Revenue decreased 17.9% and 62.3% in the quarters
ended June 30 and September 30, 2001, respectively, compared to the previous
quarter, due to a general economic downturn, which has caused system providers
to scale back on deployment fiber optic networks. This downturn has resulted
in the
33
reduction by our customers and equipment manufacturers of their purchases of
components and modules that we provide.
The quarterly operating results reflect an increase in the cost of revenue
for the first two quarters and a decrease for the third and fourth quarters of
fiscal year end 2001, as compared with their immediate prior quarter. Cost of
revenue ranged from between 47.3% and 55.5% of revenue for the four quarters
of fiscal year end 2000 and the first two quarters of fiscal year end 2001.
Cost of revenue as a percent of revenue in the third and fourth quarters of
fiscal year end 2001 was 66.8% and 133.4%, respectively. The increase in the
third and fourth quarters of fiscal year end 2001 as a percent of revenue over
the prior six quarters was the result of charges related to the write down of
excess inventory of $5.6 million and $12.1 million, respectively. Excluding
the charges related to the inventory write downs, we expect cost of revenue to
continue to increase as a percentage of revenue as the average selling prices
for existing products are expected to decline in response to product
introductions by competitors and pressure from significant customers for price
concessions.
Research and development expenses reflected in our quarterly operating
results range between 1.6% and 2.7% of revenue for the four quarters of fiscal
year end 2000 and the first three quarters of fiscal year end 2001. Research
and development expenses in the fourth quarter ended September 30, 2001 was
4.4% of revenue. The increase in research and development expense as a percent
of revenue in the fourth quarter of fiscal year end 2001 was the result of a
62.3% decrease in revenue compared to the prior quarter. Although we
anticipate that the current economic environment will continue to have a
negative impact on our business, we intend to expand our research and
development capabilities to develop new products and strengthen our position
to take advantage of the opportunities when the market recovers. As a result,
we expect that our research and development expenses will increase in absolute
dollar amounts and as a percentage of revenue.
Sales and marketing expenses ranged between 2.5% and 3.4% of revenue for the
four quarters of fiscal year end 2000 and the first three quarters of fiscal
year end 2001. Sales and marketing expenses in the fourth quarter of fiscal
year end 2001 was 1.5% of revenue. The decrease in sales and marketing
expenses as a percentage of revenue in the fourth quarter of fiscal year end
2001 was the result of the decrease in commissions paid to independent
manufacturers' representatives. Because of our plans to expand our sales and
marketing operations, we expect our sales and marketing expenses to increase
in future periods.
General and administrative expenses ranged between 2.0% and 4.8% of revenue
for the four quarters of fiscal year end 2000 and the first three quarters of
fiscal year end 2001. General and administrative expenses in the fourth
quarter of fiscal year end 2001 was 6.8% of revenue. The increase in general
and administrative expenses as a percent of revenue in the fourth quarter of
fiscal year end 2001 was the result of a 62.3% decrease in revenue compared to
the prior quarter. We expect the dollar level of these costs to increase as a
result of increased legal fees, accounting costs and other costs associated
with being a public company.
Our historical operating results have varied significantly, and our future
quarterly operating results are likely to continue to vary significantly from
period-to-period. We believe that period-to-period comparisons of operating
results should not be relied upon as an indicator of our future performance.
Some of the factors which could cause our operating results to vary include
fluctuations in the demand for and sales of our products, the timing of
customer orders, the cancellation of existing orders, competitive factors such
as introductions of new products, our ability to develop, introduce and
manufacture new products in a timely manner, our ability to control expenses,
the availability of components for our products, the mix of our products sold,
changes in industry standards and general economic conditions in the
communications and related industries.
34
The following table sets forth revenue attributable to each of our product
groups as a percentage of revenue for the periods presented.
Fiscal years
ended
September 30,
-------------------
1999 2000 2001
----- ----- -----
Receivers.................................................. 16.4% 15.2% 12.1%
Transceivers............................................... 70.0 73.4 72.3
Transmitters............................................... 11.5 9.9 10.5
Other...................................................... 2.1 1.5 5.1
----- ----- -----
Revenue.................................................... 100.0% 100.0% 100.0%
We believe the increase in the percentage of sales attributable to our
transceiver products during the periods reflected in the table above reflects
an overall increase in customer demand for products designed with higher
levels of integration, such as transceivers.
Liquidity and Capital Resources
As of September 30, 2001, our primary source of liquidity was our cash and
cash equivalents balance of $62.5 million and $76.1 million of marketable
securities which consist primarily of United States treasury notes and
treasury bonds. Our unused revolving line of credit totaling approximately
$1.0 million provided an additional source of liquidity. Since inception, we
have financed our operations primarily with cash generated from operations.
Additional financing has been generated through lines of credit and term
loans. As of September 30, 2001, our working capital was $166.4 million with a
current ratio of 23:1. As of September 30, 2000, our working capital was $34.1
million with a current ratio of 3:1. Because of our low debt balances, we
believe that additional cash could be borrowed if necessary; however, cash
flow from operations, cash and cash equivalents, marketable securities and
existing loan facilities are expected to be sufficient to fund operations for
the next 12 months.
As of September 30, 2001, we had a $2.3 million balance outstanding under
our term loan and no balance outstanding under our $1.0 million revolving line
of credit. The term loan and the revolving credit facility bear interest on
amounts outstanding at various time intervals and the market rates based on
our election at a per annum rate equal to either (a) the prime rate or (b)
LIBOR plus 1.8%. The term loan matures July 2006, and the proceeds of the term
loan were used to purchase our primary corporate and manufacturing facility in
Chatsworth, California. The revolving credit facility can be used to fund
working capital requirements.
The term loan and our revolving credit facility contain customary covenants,
including covenants limiting indebtedness and the disposition of assets. To
secure our payment and performance obligations under the term loan we have
pledged all of our assets as collateral. The term loan and the revolving
credit facility also require that we comply with financial covenants, which
require us to maintain our tangible net worth, cash position and revenue at
specified levels. Our need to comply with these covenants does not materially
affect the operation of our business.
We have committed to make capital expenditures totaling $700,000, primarily
to purchase additional production equipment to continue our manufacturing
capacity expansion.
During the fiscal year ended September 30, 2001, we generated cash flow from
operations of $28.1 million. The increase in cash generated by operating
activities during this period was caused by increases in income and a decrease
in accounts receivables, partially offset by increases in income tax benefits
and other current assets and decreases accounts payable and accounts payable
to related parties. For the years ended September 30, 2000 and 1999, we
generated net cash flow from operations of $12.9 million and $2.2 million,
respectively. The increase in cash generated by operations between the years
ended September 30, 2000 and 1999 was caused by increased income, partially
offset by increases in accounts receivable and inventory.
35
During the fiscal year ended September 30, 2001 and September 30, 2000, cash
used in investing activities was $90.7 million and $11.8 million,
respectively. The majority of cash used in investing activities was for the
net purchase of marketable securities, the June, 2001 purchase of a 145,720
square foot building in Woodland Hills, California for $18.8 million and
capital expenditures for the purchase of property, plant and equipment to
expand and automate our manufacturing facility.
On November 3, 2000, we completed an initial public offering of our Class A
Common Stock. All 12,075,000 shares of Class A Common Stock registered under
the Registration Statement were sold at a price of $11.00 per share, which
amount includes exercise of the underwriters' over-allotment option of
1,575,000 shares. After deducting the underwriting discounts and commissions
and the offering expenses we received net proceeds from the initial public
offering of approximately $122.1 million.
Inflation
Inflation has not had a material adverse effect on our results of
operations, however, our results of operations may be materially and adversely
affected by inflation in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are currently exposed to interest rate risk on our existing term loan and
revolving credit facility and on our investment portfolio. Our variable rate
debt consists of term loan borrowing of $2.3 million. To date we have not
utilized our floating rate debt under the revolving credit facility. The
primary objective of our investment activities is to preserve capital. We have
not used derivative financial instruments in our investment portfolio. Our
cash and cash equivalents includes $62.2 million invested in money market and
other interest bearing accounts. In addition, we have $76.1 million invested
in marketable securities, which represents investments in United States
treasury notes and treasury bonds.
As of September 30, 2001, our investment in marketable securities had a
weighted-average time to maturity of approximately 167 days. Marketable
securities represent United States treasury notes and treasury bonds with a
maturity of greater than three months. These securities are classified as held
to maturity because we have the intention and ability to hold the securities
to maturity. Gross unrealized gains and losses on held-to-maturity marketable
securities have historically not been material. Maturities on held-to-maturity
marketable debt securities range from three months to two years.
If interest rates were to increase or decrease 1%, the result would be an
annual increase or decrease of interest expense of approximately $23,000 on
our term loan and an annual increase or decrease of interest income of $1.4
million on our investment portfolio. However, due to the uncertainty of the
actions that would be taken and their possible effects, this analysis assumes
no such action. Further, this analysis does not consider the effect of the
change in the level of overall economic activity that could exist in such an
environment.
Sales to foreign customers are denominated in U.S. dollars and as such we
have no foreign currency fluctuation risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Optical Communication Products, Inc. financial statements, schedule and
supplementary data, as listed under Item 14, appear in a separate section of
this Report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is included in the Proposal One:
Elections of Directors, Management, and Section 16(a) Beneficial Ownership
Reporting Compliance sections of our Proxy Statement to be filed in connection
with our 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is included in the Executive
Compensation and Related Information sections of the our Proxy Statement to be
filed in connection with our 2002 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is included in the Security Ownership
of Certain Beneficial Owners and Management section of our Proxy Statement to
be filed in connection with the our 2002 Annual Meeting of Stockholders and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is included in the Compensation
Committee Interlocks and Insider Participation and Certain Transactions
sections of our Proxy Statement to be filed in connection with the our 2002
Annual Meeting of Stockholders and is incorporated herein by reference.
37
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K
(a) Documents filed as part of this Report:
1. Financial Statements. The following financial statements of Optical
Communication Products, Inc. are included in a separate section of this
Annual Report on Form 10-K commencing on the pages referenced below:
Page
----
Optical Communication Products Financial Statements
Independent Auditors' Report........................................ F-2
Balance Sheets at September 30, 2000 and 2001....................... F-3
Statements of Income for each of the three years in the period ended
September 30, 2001................................................. F-4
Statements of Stockholders' Equity for each of the three years in
the period ended September 30, 2001................................ F-5
Statements of Cash Flows for each of the three years in the period
ended September 30, 2001........................................... F-6
Notes to Financial Statements....................................... F-7
2. Financial Statement Schedule. The following financial statement
schedule of Optical Communication Products, Inc. is included in a separate
section of this Annual Report on Form 10-K commencing on the pages
referenced below. All other schedules have been omitted because they are
not applicable, not required, or the information is included in the
financial statements or notes thereto.
Schedule II--Valuation and Qualifying Accounts
For the Year Ended September 30, 1999, 2000 and 2001
Additions
charged
Balance to
at beginning expense Deductions- Balance at end
Description Period of period ($) ($) recoveries ($) of period ($)
- ----------- ------ ------------- --------- -------------- --------------
Allowance for Doubtful
Accounts............... 1999 52,000 267,000 (22,000) 297,000
2000 297,000 1,480,000 -- 1,777,000
2001 1,777,000 1,200,000 (1,821,000) 1,156,000
Warranty Reserve........ 1999 140,000 133,000 (20,000) 253,000
2000 253,000 173,000 (19,000) 407,000
2001 407,000 451,000 (120,000) 738,000
38
3. Exhibits. The following Exhibits are attached hereto and incorporated
herein by reference:
Number Description
------ -----------
3.1* Amended and Restated Certificate of Incorporation
3.2* Bylaws
4.1 See Exhibits 3.1 and 3.2 for provisions of the Certificate of
Incorporation and Bylaws for the Registrant defining the rights of
holders of common stock of the Registrant
4.2* Specimen Stock Certificate
4.3 * Standstill and Registration Rights Agreement, dated as of October 26,
2000, by and between the Registrant and The Furukawa Electric Co., Ltd.
10.1* 2000 Stock Incentive Plan
10.2* Employee Stock Purchase Plan
10.3* Form of Indemnification Agreement
10.5* Employment Agreement, dated November 1, 1999, by and between the
Registrant and Muoi Van Tran, as currently in effect
10.6* Employment Agreement, dated November 1, 1999, by and between the
Registrant and Mohammad Ghorbanali, as currently in effect
10.7* Employment Agreement, dated November 1, 1999, by and between the
Registrant and Susie L. Nemeti, as currently in effect
10.8* Form of Stock Option Agreement, dated August 29, 2000, by and between
the Registrant and each of Muoi Van Tran, Mohammad Ghorbanali and Susie
L. Nemeti (including a schedule of substantially identical terms)
10.9* Form of Stock Option Agreement, dated June 28, 1993, by and between the
Registrant and each of Muoi Van Tran, Mohammad Ghorbanali and Susie L.
Nemeti (including a schedule of substantially identical terms)
21.1* List of Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
- --------
* This exhibit was previously filed as an exhibit to the Company's
Registration Statement on Form S-1 declared effective November 2, 2000
(File No. 333-44862) under the same exhibit number, and is incorporated by
reference herein.
(b) Reports on Form 8K:
None.
(c) Exhibit Index:
See Exhibit index.
(d) Financial Statement Schedule:
See Financial statement schedule set forth in (a)(2) above
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Chatsworth, State of California, on the 19th day of
December, 2001.
Optical Communication Products, Inc.
/s/ Muoi Van Tran
By: _________________________________
Name:Muoi Van Tran
Title:President and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint Muoi Van Tran and Susie L. Nemeti his true and lawful attorney-in-fact
and agent, with full power of substitution and resubstitution, for him and in
his name, place and stead, in any and all capacities, to sign any and all
amendments to this Report, and to file the same, with exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent, full power and
authority to do and perform each and every act and thing requisite or
necessary to be done in connection therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming
all that said attorney-in-fact and agent, or his substitute or substitutes,
may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons in the capacities and on the
dates indicated:
Signature Title Date
--------- ----- ----
/s/ Muoi Van Tran Chairman of the Board of December 19, 2001
______________________________________ Directors, Chief
Muoi Van Tran Executive Officer and
President (principal
executive officer)
/s/ Susie L. Nemeti Chief Financial Officer December 20, 2001
______________________________________ (principal financial and
Susie L. Nemeti accounting officer)
/s/ Masato Sakamoto Director December 18, 2001
______________________________________
Masato Sakamoto
/s/ Kunihiro Matsubara Director December 17, 2001
______________________________________
Kunihiro Matsubara
/s/ Yoshihisa Okada Director December 17, 2001
______________________________________
Yoshihisa Okada
/s/ Stewart D. Personick Director December 16, 2001
______________________________________
Stewart D. Personick
40
Signature Title Date
--------- ----- ----
/s/ Masao Konomi Director December 16, 2001
______________________________________
Masao Konomi
/s/ John Lemasters Director December 16, 2001
______________________________________
John Lemasters
41
OPTICAL COMMUNICATION PRODUCTS, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report............................................. F-2
Balance Sheets at September 30, 2000 and 2001............................ F-3
Statements of Income for each of the three years in the period ended
September 30, 2001...................................................... F-4
Statements of Stockholders' Equity for each of the three years in the
period ended September 30, 2001......................................... F-5
Statements of Cash Flows for each of the three years in the period ended
September 30, 2001...................................................... F-6
Notes to Financial Statements............................................ F-7
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Optical Communication Products, Inc.:
We have audited the accompanying balance sheets of Optical Communication
Products, Inc. (the "Company") as of September 30, 2000 and 2001, and the
related statements of income, stockholders' equity, and cash flows for each of
the three years in the period ended September 30, 2001. Our audits also
included the financial statement schedule listed in the Index at Item 14.
These financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and financial statement schedule based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of September 30, 2000 and
2001, and the results of its operations and its cash flows for each of the
three years in the period ended September 30, 2001, in conformity with
accounting principles generally accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
Deloitte & Touche LLP
Los Angeles, California
November 14, 2001
F-2
OPTICAL COMMUNICATION PRODUCTS, INC.
BALANCE SHEETS
September 30, 2000 and 2001
September 30,
----------------
2000 2001
------- --------
(in thousands,
except share and
per share
amounts)
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................... $ 3,202 $ 62,529
Marketable securities....................................... 9,280 76,102
Accounts receivable less allowance for doubtful accounts of
$1,777 and $1,156 in 2000 and 2001, respectively........... 20,031 8,004
Inventories................................................. 16,018 15,852
Deferred income taxes....................................... 1,808 9,296
Prepaid expenses and other current assets................... 87 2,306
------- --------
Total current assets...................................... 50,426 174,089
PROPERTY, PLANT, AND EQUIPMENT, Net........................... 8,190 30,179
OTHER ASSETS.................................................. 460
------- --------
TOTAL......................................................... $59,076 $204,268
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt........................... $ 471 $ 471
Accounts payable............................................ 4,036 1,365
Accounts payable to related parties......................... 5,175 1,260
Accrued bonus............................................... 3,042 1,900
Other accrued expenses...................................... 2,057 2,249
Income taxes payable........................................ 1,567 428
------- --------
Total current liabilities................................. 16,348 7,673
------- --------
LONG-TERM DEBT................................................ 2,296 1,825
------- --------
DEFERRED INCOME TAXES......................................... 59 57
------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, no par value; 70,000,000 shares authorized,
66,000,000 shares issued and outstanding at September 30,
2000....................................................... 1,650
Common stock, no par value; 150,000,000 shares authorized;
27,871,440 shares issued and outstanding at September 30,
2000....................................................... 269
Class A common stock, $0.001 par value; 200,000,000 shares
authorized, 42,006,602 shares issued and outstanding at
September 30, 2001......................................... 42
Class B common stock $0.001 par value; 66,000,000 shares
authorized, 66,000,000 shares issued and outstanding at
September 30, 2001......................................... 66
Additional paid-in capital.................................. 129,707
Retained earnings........................................... 38,454 64,898
------- --------
Total stockholders' equity................................ 40,373 194,713
------- --------
TOTAL......................................................... $59,076 $204,268
======= ========
See notes to financial statements.
F-3
OPTICAL COMMUNICATION PRODUCTS, INC.
STATEMENTS OF INCOME
Years Ended September 30, 1999, 2000, and 2001
1999 2000 2001
------- -------- --------
(in thousands, except per
share amounts)
REVENUE............................................ $36,036 $101,867 $144,012
COST OF REVENUE.................................... 20,860 50,326 94,684
------- -------- --------
GROSS PROFIT....................................... 15,176 51,541 49,328
------- -------- --------
EXPENSES:
Research and development......................... 1,134 2,527 2,958
Selling and marketing............................ 1,364 2,943 3,799
General and administrative....................... 1,065 3,877 4,553
------- -------- --------
Total expenses................................. 3,563 9,347 11,310
------- -------- --------
INCOME FROM OPERATIONS............................. 11,613 42,194 38,018
------- -------- --------
OTHER INCOME (EXPENSE):
Interest income.................................. 149 410 6,006
Interest expense................................. (60) (249) (180)
Other income..................................... 27 144 255
------- -------- --------
OTHER INCOME, Net.................................. 116 305 6,081
------- -------- --------
INCOME BEFORE INCOME TAXES......................... 11,729 42,499 44,099
INCOME TAXES....................................... 4,693 17,319 17,655
------- -------- --------
NET INCOME......................................... $ 7,036 $ 25,180 $ 26,444
======= ======== ========
BASIC EARNINGS PER SHARE........................... $ 0.26 $ 0.91 $ 0.26
DILUTED EARNINGS PER SHARE......................... $ 0.07 $ 0.25 $ 0.24
BASIC SHARES OUTSTANDING........................... 27,348 27,547 100,263
DILUTED SHARES OUTSTANDING......................... 101,132 102,500 111,430
See notes to financial statements.
F-4
OPTICAL COMMUNICATION PRODUCTS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1999, 2000, and 2001
Preferred Stock Common Stock Additional
-------------------- ------------------ Paid-in Retained
Shares Amount Shares Amount Capital Earnings Total
----------- ------- ----------- ------ ---------- -------- --------
(in thousands, except share data)
BALANCE, OCTOBER 1,
1998................... 66,000,000 $ 1,650 27,321,440 $ 167 $ -- $ 6,238 $ 8,055
Net income............ 7,036 7,036
Exercise of stock
options.............. 80,000 5 5
----------- ------- ----------- ----- -------- ------- --------
BALANCE, SEPTEMBER 30,
1999................... 66,000,000 1,650 27,401,440 172 13,274 15,096
Net income............ 25,180 25,180
Exercise of stock
options.............. 470,000 97 97
----------- ------- ----------- ----- -------- ------- --------
BALANCE, SEPTEMBER 30,
2000................... 66,000,000 1,650 27,871,440 269 38,454 40,373
Net income............ 26,444 26,444
Issuance of common
stock from initial
public offering...... 12,075,000 12 122,067 122,079
Conversion of
preferred stock to
class B common stock
with a $0.001 par
value................ (66,000,000) (1,650) 66,000,000 66 1,584
Conversion of common
stock with no par
value to class A
common stock with
$0.001 par value..... (241) 241
Issuance of common
stock for exercise of
stock options and
employee stock
purchase plan........ 2,060,162 2 348 350
Tax benefit from
exercise of non-
qualified stock
options.............. 5,467 5,467
----------- ------- ----------- ----- -------- ------- --------
BALANCE, SEPTEMBER 30,
2001................... -- $ -- 108,006,602 $ 108 $129,707 $64,898 $194,713
=========== ======= =========== ===== ======== ======= ========
See notes to financial statements.
F-5
OPTICAL COMMUNICATION PRODUCTS, INC.
STATEMENTS OF CASH FLOWS
Years Ended September 30, 1999, 2000, and 2001
1999 2000 2001
------- ------- --------
(in thousands)
OPERATING ACTIVITIES:
Net income........................................ $ 7,036 $25,180 $ 26,444
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation..................................... 305 722 1,429
Amortization of premium on marketable
securities...................................... 467
Tax benefit from exercise of non-qualified stock
options......................................... 5,467
Changes in operating assets and liabilities:
Accounts receivable, net........................ (4,010) (11,846) 12,027
Inventories..................................... (4,924) (7,710) 166
Deferred income taxes........................... (348) (1,180) (7,490)
Prepaid expense and other current assets........ 1 (6) (2,219)
Other assets.................................... (10) (431) 460
Accounts payable................................ 1,645 1,898 (2,671)
Accounts payable to related parties............. 1,318 1,991 (3,915)
Accrued bonuses................................. 508 2,004 (1,142)
Other accrued expenses.......................... 436 932 192
Income taxes payable............................ 279 1,313 (1,139)
------- ------- --------
Net cash provided by operating activities...... 2,236 12,867 28,076
------- ------- --------
INVESTING ACTIVITIES:
Purchase of marketable securities................. (1,508) (12,783) (161,789)
Maturities of marketable securities............... 2,000 4,000 94,500
Purchase of property, plant and equipment......... (5,370) (2,972) (23,418)
------- ------- --------
Net cash used in investing activities.......... (4,878) (11,755) (90,707)
------- ------- --------
FINANCING ACTIVITIES:
Proceeds from long-term debt...................... 3,300
Principal payments on long-term debt.............. (79) (454) (471)
Proceeds from Initial Public Offering............. 122,079
Issuance of common stock.......................... 5 97 350
------- ------- --------
Net cash provided by (used in) financing
activities.................................... 3,226 (357) 121,958
------- ------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS.......... 584 755 59,327
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR....... 1,863 2,447 3,202
------- ------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR............. $ 2,447 $ 3,202 $ 62,529
======= ======= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest......................................... $ 48 $ 239 $ 185
Income taxes..................................... $ 4,710 $17,158 $ 20,803
See notes to financial statements.
F-6
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS
1. GENERAL INFORMATION
The accompanying financial statements of Optical Communication Products,
Inc., a Delaware corporation (the "Company") reflect the results of its
operations for the years ended September 30, 1999, 2000 and 2001. The
Company's operations are primarily located in Chatsworth, California. The
Company is a majority-owned subsidiary of Furukawa Electric Company, Ltd. of
Japan ("Furukawa"). Furukawa beneficially owns 61.1% of the Company's capital
stock at September 30, 2001, which accounts for 94.0% of the combined voting
power of all of our outstanding common stock.
Operations--The Company operates in one industry segment, which includes the
design and manufacture of fiber optic components. The Company's products
consist of optical transmitters, receivers, transceivers and transponders,
which convert electronic signals into optical signals and back to electronic
signals. Many of the Company's major customers purchase through contract
manufacturers. Contract manufacturers purchase on behalf of the Company's
major customers and to their specifications. Revenue from the Company's two
largest direct sale customers, which could be either contract manufacturers or
major end-user customers, amounted to 12.7% and 10.5% for the year ended
September 30, 2001. Revenue from the Company's three largest direct sale
customers amounted to 23.8%, 15.3% and 12.1% for 2000. Revenue from one direct
sale customer amounted to 10.8% for 1999.
2. SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents--Cash and cash equivalents include unrestricted
deposits and short-term investments with an original maturity of three months
or less.
Marketable Securities--Marketable securities represent United States
treasury notes and treasury bonds with a maturity of greater than three
months. These securities are classified as held to maturity because the
Company has the intent and ability to hold the securities to maturity. Gross
unrealized gains and losses on held-to-maturity marketable securities have
historically not been material. Maturities on held-to-maturity marketable debt
securities range from three months to two years.
Inventories--Inventories are stated at the lower of cost or net realizable
value. Cost is determined using the first-in, first-out method.
Property, Plant and Equipment--Property, plant and equipment are recorded at
cost. Provision for depreciation has been made based upon the estimated useful
lives of the assets, which range from three to thirty-nine years, using the
straight-line method.
Impairment of Long-Lived Assets--The Company evaluates long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may no longer be recoverable. If the estimated
future cash flows (undiscounted and without interest charges) from the use of
an asset are less than the carrying value, a write-down would be recorded to
reduce the related asset to its estimated fair value. For purposes of
estimating future cash flows from impaired assets, the Company groups assets
at the lowest level for which there are identifiable cash flows that are
largely independent of the cash flows of other groups of assets. There have
been no impairment charges recorded by the Company.
Income Taxes--Income taxes are provided for taxes currently payable or
refundable, and deferred income taxes arising from future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. Deferred income tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. Deferred income tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to
F-7
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
be recovered or settled. Valuation allowances are established when necessary
to reduce deferred income tax assets to the amounts expected to be realized.
Earnings per Share--Basic earnings per share are computed using the
weighted-average number of common shares outstanding during the period.
Diluted earnings per share are computed using the weighted-average number of
common shares and dilutive potential common shares outstanding during the
period, using the as-if-converted method for the Company's preferred shares
and the treasury stock method for stock options.
Revenue Recognition--The Company recognizes revenue from product sales upon
shipment, as shipments are FOB shipping point, assuming collectibility of the
resulting receivable is probable. Sales returns and warranty claims are not
material.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
which summarizes views of the Commission staff in applying accounting
principles generally accepted in the United States of America to revenue
recognition in financial statements. The company believes that its current
revenue recognition policies comply with this bulletin.
Research and Development Costs--Costs associated with the development of new
products are charged to expense when incurred.
Common Stock--At September 30, 2001, the Company had two classes of common
stock with a par value of $0.001 per share. Holders of Class A common stock
generally have identical rights to holders of Class B common stock, except
that holders of Class A common stock are entitled to one vote per share while
holders of Class B common stock are entitled to ten votes per share on matters
submitted to a vote of the stockholders. Furukawa owns all 66,000,000 shares
of the Company's outstanding Class B common stock.
Use of Estimates in the Preparation of the Financial Statements--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 amounts reported therein. Due to the
inherent uncertainty involved in making estimates, actual results reported in
future periods may differ from those estimates.
Fair Value of Financial Instruments--The recorded values of marketable
securities, accounts receivable, accounts payable and accrued expenses
approximate their fair values based on their short-term nature. The recorded
value of long-term debt and other liabilities approximate fair value, as
interest is tied to market rates.
Concentration of Credit Risk--Financial instruments that potentially subject
the Company to concentrations of credit risk consist primarily of cash and
cash equivalents, placed with high credit quality institutions, and accounts
receivable. The Company sells products and extends credit to customers,
primarily in the United States, and periodically monitors its exposure to
credit losses, and maintains allowances for anticipated losses. Accounts
receivable from the Company's three largest customers amounted to $1,153,000,
$882,000 and $694,000 at September 30, 2001, respectively. Accounts receivable
from the Company's largest customer amounted to $3,340,000 at September 30,
2000.
Segment Reporting--Statement of Financial Accounting Standards ("SFAS") No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for the manner in which public companies report
information about operating segments in annual and interim financial
statements. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The method
for determining what information to report is based on the way management
organizes the operating segments within a Company for making operating
decisions and assessing financial performance.
F-8
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company's chief executive officer ("CEO") and chief financial officer
("CFO") are its chief operating decision makers. The financial information the
CEO and CFO review is identical to the information presented in the
accompanying financial statements. The Company has determined that it operates
in one reportable segment, which includes the design and manufacture of fiber
optic components. The Company does not have foreign operations.
3. INVENTORIES
Inventories consist of the following:
September 30,
---------------
2000 2001
------- -------
(in thousands)
Raw materials................................................ $ 6,571 $10,865
Work-in-process.............................................. 9,019 1,593
Finished goods............................................... 428 3,394
------- -------
Total........................................................ $16,018 $15,852
======= =======
During fiscal year 2001, the Company recorded write-downs of excess
inventory of $18.1 million, which includes $12.1 million recorded in the
fourth quarter.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
September 30,
-------------- Useful
2000 2001 Lives
------ ------- --------
(in thousands)
Land................................................. $1,345 $ 8,074
Buildings............................................ 3,801 15,961 39 years
Machinery and equipment.............................. 4,045 8,277 5 years
Furniture and fixtures............................... 168 230 5 years
Computer hardware and software....................... 368 602 3 years
------ -------
9,727 33,144
Less accumulated depreciation........................ 1,537 2,965
------ -------
Total................................................ $8,190 $30,179
====== =======
On June 8, 2001, the Company purchased land and a 145,720 square foot
building in Woodland Hills, California for the purchase price of $18,750,000.
As of September 30, 2001, the Company leased a portion of the Woodland Hills
building to various other parties. Rental income from these leases was
$147,100 for the fiscal year ended September 30, 2001.
5. LONG-TERM DEBT
On July 15, 1999, the Company entered into a term loan for $3.3 million and
a revolving credit facility agreement with Manufacturer's Bank. The term loan
was used to fund the purchase of the Company's land and building located in
Chatsworth, California. The credit limit of the revolving credit facility is
$1.0 million. The term loan and the revolving credit facility bear interest on
amounts outstanding at various time intervals based on the Company's election
at a per annum rate equal to either (a) the prime rate or (b) LIBOR plus
1.80%. The term loan and the revolving credit facility are secured by all of
the Company's assets. The term loan is paid in
F-9
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
monthly installments and matures on July 15, 2006 and revolving credit
facility expires on July 3, 2002. No amounts have been borrowed against the
revolving credit facility. The term loan and the revolving credit facility
also require compliance with specified financial covenants, including interest
coverage ratios and indebtedness to total capital ratios and other covenants.
Long-term debt at September 30, 2000 and 2001 consists of the following:
2000 2001
------ ------
(in
thousands)
Term loan due July, 2006 (4.95% at September 30, 2001)........ $2,767 $2,296
Less current portion.......................................... 471 471
------ ------
Long-term debt, less current portion.......................... $2,296 $1,825
====== ======
Long-term debt maturities as of September 30, 2001 consist of the following:
(in thousands)
Fiscal 2002................................................... $ 471
Fiscal 2003................................................... 471
Fiscal 2004................................................... 471
Fiscal 2005................................................... 471
Fiscal 2006................................................... 412
------
$2,296
======
6. EARNINGS PER SHARE
The following is a calculation of basic and diluted earnings per share
("EPS"):
Year Ended September 30,
--------------------------
1999 2000 2001
-------- -------- --------
(in thousands, except per
share data)
Weighted average common shares outstanding...... 27,348 27,547 100,263
-------- -------- --------
Basic EPS....................................... $ 0.26 $ 0.91 $ 0.26
======== ======== ========
Diluted EPS:
Net income.................................... $ 7,036 $ 25,180 $ 26,444
Preferred stock dividends..................... -- -- --
-------- -------- --------
Income attributable to common stockholders...... $ 7,036 $ 25,180 $ 26,444
======== ======== ========
Weighted average common shares outstanding...... 27,348 27,547 100,263
Convertible preferred stock..................... 66,000 66,000 6,148
Common stock options............................ 7,784 8,953 5,019
-------- -------- --------
Diluted shares outstanding...................... 101,132 102,500 111,430
======== ======== ========
Diluted EPS..................................... $ 0.07 $ 0.25 $ 0.24
======== ======== ========
7. COMMITMENTS AND CONTINGENCIES
Operating Leases--The Company leases certain facilities. Lease payments are
made monthly. The Company's leases are renewable either monthly or annually.
Rent expense for these leases for the years ended
F-10
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
September 30, 1999, 2000 and 2001 was $105,000, $13,000 and $38,000,
respectively. The Company rented its operating facilities in Chatsworth,
California prior to purchasing the land and building in fiscal year 1999.
Legal Proceedings--The Company is involved in litigation arising in the
ordinary course of its business. On October 15, 1999, Methode Electronics,
Inc. ("Methode") filed a lawsuit against the Company and Infineon Technologies
Corporation in the United States District Court for the Northern District of
California, seeking unspecified damages, injunctive relief, attorneys' fees
and costs arising from the alleged infringement of Methode's U.S. patents. On
December 17, 1999, the Company filed an answer to the complaint denying the
claims of infringement against the Company and asserting a number of defenses,
including invalidity of the Methode patents. After Methode initiated the
lawsuit, it assigned to Stratos Lightwave, Inc. ("Stratos"), a Methode spin-
off, all of Methode's rights, title and interest in the patent at issue. The
court has added Stratos as a plaintiff to the lawsuit.
The parties have exchanged extensive "Initial Disclosures," supplemental
disclosures of information mandated by the court's local rules and currently
are engaged in formal discovery. Unless the case terminates through
dispositive motions or through settlement, trial is scheduled to commence in
September 2002. An unfavorable resolution of this lawsuit could have a
material adverse impact on the Company.
In recent discussions among the parties' counsels, Methode has indicated
that it believes the Company's recently released Small Form Factor Pluggable
transceiver ("SFP") infringes one or more of Methode's patents, including the
patents at issue in the current action. Methode has also indicated that it
believes the Company's Small Form Factor transceiver ("SFF") infringes Methode
patents. While Methode has filed actions against other manufacturers regarding
such transceivers, Methode has not filed any additional actions against the
Company, nor has Methode attempted to add SFPs, SFFs or any other transceivers
as additional accused devices in the current action. In the event that Methode
filed a lawsuit (or sought to amend its current lawsuit) and charged the
Company with infringement through the manufacture and sale of these
transceivers, an unfavorable resolution of such a lawsuit could have a
material adverse impact on the Company.
8. STOCKHOLDERS' EQUITY
Initial Public Offering--On November 3, 2000, the Company completed its
initial public offering of 12,075,000 newly issued shares of Class A common
stock, which included the exercise of the underwriters' over-allotment option
of 1,575,000 shares, at an offering price of $11.00 per share. Proceeds from
the offering were $123,572,000 less underwriting discounts and commissions.
Preferred and Common Stock--On October 27, 2000, the Company reincorporated
in Delaware and created two new classes of common stock with a par value of
$0.001 per share. All of the Company's outstanding shares of common stock and
convertible preferred stock automatically converted into shares of Class A and
Class B common stock, respectively. Holders of Class A common stock generally
have identical rights to holders of Class B common stock, except that holders
of Class A common stock are entitled to one vote per share while holders of
Class B common stock are entitled to ten votes per share on matter submitted
to a vote of the stockholders. Furukawa owns all 66,000,000 shares of the
Company's outstanding Class B common stock.
Stock Options--In September 1992, the Company's Board of Directors approved
the 1992 Stock Option Plan for the issuance of 6,666,680 shares of the
Company's common stock to certain key employees. In August 2000, the Company's
Board of Directors approved the 2000 Stock Option/Stock Issuance Plan for the
issuance of 1,000,000 shares of the Company's common stock to certain key
employees. These plans provide that options may have a term of up to 10 years,
and become exercisable and generally vest in annual increments of 25 percent
F-11
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
per year over four years. In addition, key executives were granted 9,670,360
founders' stock options, which were separate from the Company's stock option
plans and are fully vested. All options were granted at fair value.
On August 29, 2000, the Board of Directors approved the 2000 Stock Incentive
Plan (the "2000 Plan"). Upon the effectiveness of the Company's IPO, the 1992
Stock Option Plan and the 2000 Stock Option/Stock Issuance Plan were
terminated and no further options grants may be made under these plans. All
options outstanding from the 1992 Stock Option Plan and the 2000 Stock
Option/Stock Issuance Plan were transferred to the 2000 Plan. The 2000 Plan
provides that options may have a term of up to 10 years, and become
exercisable and vest in increments. The normal vesting is 25 percent per year.
However, the vesting period can vary. All options were granted at fair value.
There were 7,286,177 shares available for future grant under the Company's
2000 Stock Incentive Plan at September 30, 2001. Stock option activity,
including the options granted outside the plans, is as follows:
Weighted
Number Exercise Price Average
of Options per Option Exercise Price
---------- --------------- --------------
Options outstanding--September
30, 1998...................... 9,088,680 0.00025 to 0.19 0.04
Options granted.............. 760,000 0.39 0.39
Options exercised............ (80,000) 0.06 0.06
Options canceled............. (160,000) 0.06 to 0.19 0.1
---------- --------------- -----
Options outstanding--September
30, 1999...................... 9,608,680 0.00025 to 0.39 0.07
Options granted.............. 3,621,680 2.88 to 11.00 10.28
Options exercised............ (470,000) 0.10 to 0.19 0.18
Options canceled............. (570,000) 0.10 to 0.39 0.25
---------- --------------- -----
Options outstanding--September
30, 2000...................... 12,190,360 0.0003 to 11.00 3.09
Options granted.............. 2,507,535 3.20 to 17.38 14.08
Options exercised............ (2,041,700) .0003 to 2.88 0.10
Options canceled............. (196,560) 2.88 to 17.38 10.26
---------- --------------- -----
Options outstanding--September
30, 2001...................... 12,459,635 .0003 to 17.38 5.67
========== =============== =====
The following table summarizes information regarding options outstanding at
September 30, 2001.
Options Outstanding Options Exercisable
-------------------------------------------------- ---------------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Range of Exercise Prices Number Outstanding Contractual Life Exercise Price Shares Exercisable Exercise Price
- ------------------------ ------------------ ---------------- -------------- ------------------ --------------
$ 0.0000--$0.00025...... 5,127,480 1.7 $ 0.0003 5,127,480 $ 0.0003
$ 0.0004--$0.0700....... 220,000 4.0 $ 0.0642 220,000 $ 0.0642
$ 0.0701--$0.1000....... 315,000 5.7 $ 0.1000 315,000 $ 0.1000
$ 0.1001--$0.1900....... 415,000 6.8 $ 0.1875 280,000 $ 0.1875
$ 0.1901--$0.3900....... 487,000 7.8 $ 0.3875 207,000 $ 0.3875
$ 0.3901--$2.8800....... 252,500 8.9 $ 2.8780 35,000 $ 2.8780
$ 2.8801--$8.0500....... 149,740 9.8 $ 7.3394 -- $ --
$ 8.0501--$11.0000...... 4,169,460 8.9 $10.9963 3,430,740 $11.0000
$11.0001--$13.3800...... 73,155 9.6 $11.4910 -- $ --
$13.3801--$17.3800...... 1,250,300 9.3 $17.3800 -- $ --
---------- --- -------- --------- --------
12,459,635 5.7 $ 5.6630 9,615,220 $ 3.9540
========== === ======== ========= ========
F-12
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The weighted average estimated fair value of options granted in 1999, 2000
and 2001 was $0.39, $1.58 and $11.33.
The Company accounts for its stock option and employee stock purchase plans
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees." Had compensation cost been determined on the basis
of fair value pursuant to SFAS No. 123, "Accounting for Stock-Based
Compensation," net income and earnings per share would have been:
Year Ended
September 30,
----------------------
1999 2000 2001
------ ------- -------
(in thousands, except
per share amounts)
Net Income:
As reported........................................... $7,036 $25,180 $26,444
Pro forma............................................. $7,002 $19,714 $16,911
Basic earnings per share
As reported........................................... $ 0.26 $ 0.91 $ 0.26
Pro forma............................................. $ 0.08 $ 0.72 $ 0.17
Diluted earnings per share
As reported........................................... $ 0.07 $ 0.25 $ 0.24
Pro forma............................................. $ 0.07 $ 0.19 $ 0.15
The fair value of each option grant estimated on the date of grant used to
compute pro forma net income and pro forma income per share is estimated using
the Black-Scholes option pricing model. The following assumptions were used in
completing the model:
September 30,
----------------
1999 2000 2001
---- ---- ----
Dividend yield................................................ 0% 0% 0%
Expected volatility........................................... 30% 30% 137%
Risk-free rate of return...................................... 5.84% 6.33% 5.16%
Expected life (years)......................................... 4.0 1.3 7.3
In November, 2000, the Company adopted an Employee Stock Purchase Plan and
reserved 300,000 shares for issuance under this plan. Under the Stock Purchase
Plan, the Company's employees may purchase shares of Common Stock at a price
per share that is 85% of the lesser of the fair market value as of the
beginning or the end of the offering period that begins on May 1 and November
1 of each year. At September 30, 2001 there were 18,462 shares issued under
this plan.
9. PROFIT SHARING PLAN
The Company has a deferred cash and profit sharing plan covering all
employees, subject to certain participation and vesting requirements. The plan
provides that the Company will partially match employees contributions or
provide discretionary contributions up to a certain amount. Total
contributions by the Company were $299,000, $957,000 and $375,000 for each of
the years ended September 30, 1999, 2000 and 2001, respectively.
F-13
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
10. INCOME TAXES
The components of income tax expense are as follows:
Year Ended September
30,
------------------------
1999 2000 2001
------ ------- -------
(in thousands)
Current:
Federal........................................ $3,960 $14,495 $15,548
State.......................................... 1,081 4,004 4,130
------ ------- -------
Total current.................................... 5,041 18,499 19,678
------ ------- -------
Effect of non-qualified stock option exercises
upon inome taxes currently payable.............. 5,467
Deferred:
Federal........................................ (273) (933) (5,915)
State.......................................... (75) (247) (1,575)
------ ------- -------
Total deferred................................... (348) (1,180) (7,490)
------ ------- -------
Provision for income taxes....................... $4,693 $17,319 $17,655
====== ======= =======
The components of deferred tax assets (liabilities) are as follows:
September 30,
--------------
2000 2001
------ ------
Allowance for doubtful accounts.............................. $ 780 $ 504
Uniform capitalization and obsolete inventory................ 747 8,708
Accumulated depreciation..................................... (59) (57)
Accrued warranty............................................. 179 322
Other........................................................ 102 (238)
------ ------
Net deferred tax asset....................................... $1,749 $9,239
====== ======
A reconciliation of the Company's provision for income taxes to the U.S.
federal statutory rate is as follows (in thousands):
Year Ended September 30,
-----------------------------------------
1999 2000 2001
------------ ------------ -------------
Amount % Amount % Amount %
------ ---- ------- ---- ------- ----
Provision for income taxes at
statutory rate.................... $4,105 35.0% $14,875 35.0% $15,435 35.0%
State taxes, net of federal
benefit........................... 654 5.6 2,442 5.7 2,415 5.5
Other.............................. (66) (0.6) 2 0.1 (195) (0.5)
------ ---- ------- ---- ------- ----
$4,693 40.0% $17,319 40.8% $17,655 40.0%
====== ==== ======= ==== ======= ====
11. RELATED PARTY TRANSACTIONS
The Company is a subsidiary of Furukawa Electric North America, which is a
wholly owned subsidiary of Furukawa. The Company's related party transactions
occur between itself and other Furukawa owned subsidiaries and affiliates.
F-14
OPTICAL COMMUNICATION PRODUCTS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company sells fiber optic components and purchases raw materials from
some of these entities in the regular course of business. Sales of fiber optic
subsystems and modules to related parties amounted to $611,000, $1,126,000 and
$2,726,291 for the years ended September 30, 1999, 2000 and 2001,
respectively. Purchases of raw materials from related parties amounted to
$8,416,000, $21,778,911 and $42,062,722 for the years ended September 30,
1999, 2000 and 2001, respectively. Accounts receivable due from related
parties were $42,000 and $26,000 at September 30, 2000 and 2001, respectively.
Accounts payable to related parties were $5,175,000 and $1,260,000 at
September 30, 2000 and 2001, respectively. In 2000, the Company paid Furukawa
$84,000 in development costs. The Company paid $69,000 in management fees to
Furukawa for consulting and advisory services on management issues for the
year ending September 30 1999. No management fees were paid in the fiscal
years ended September 30, 2000 and 2001.
12. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one reportable segment, which includes the design
and manufacture of fiber optic subsystems and modules. The following are
summaries of sales to geographic areas based on the location of the entity
purchasing the Company's products and sales for each of the components within
the segment:
September 30,
-------------------------
1999 2000 2001
------- -------- --------
(in thousands)
Revenue by Geographical Area:
United States...................................... $24,439 $ 78,866 $ 95,582
Canada............................................. 5,371 8,418 23,942
Israel............................................. 2,951 11,003 15,290
Europe............................................. 2,567 2,770 5,272
Other.............................................. 708 810 3,926
------- -------- --------
$36,036 $101,867 $144,012
======= ======== ========
Revenue by Component:
Receivers.......................................... $ 5,913 $ 15,503 $ 17,420
Transceivers....................................... 25,226 74,737 104,190
Transmitters....................................... 4,157 10,135 15,120
Other.............................................. 740 1,492 7,282
------- -------- --------
$36,036 $101,867 $144,012
======= ======== ========
* * * * * *
F-15