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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
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
OPTICAL COMMUNICATION PRODUCTS, INC.
(Exact Name of Registrant as Specified in Its Charter)
--------------------
Delaware 95-4344224
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
6101 Variel Avenue
Woodland Hills, California 91367
(Address of principal executive offices,
including zip code)
Registrant's Telephone Number, Including Area Code: (818) 251-7100
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 check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The registrant has two classes of common stock authorized, Class A
Common Stock and Class B Common Stock. The rights, preferences and privileges of
each class of common stock are substantially identical except for voting rights.
The 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
to be voted on by stockholders. As of January 31, 2004, there were approximately
46,421,100 shares of Class A common stock outstanding and 66,000,000 shares of
Class B Common Stock outstanding.
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Optical communication products, INC.
INDEX TO FORM 10-Q FOR THE
QUARTERLY PERIOD ENDED DECEMBER 31, 2003
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of December 31, 2003 (unaudited) and September
30, 2003 ........................................................... 1
Unaudited Statements of Operations for the Three Months Ended 2
December 31, 2003 and 2002..........................................
Unaudited Statements of Cash Flows for the Three Months Ended
December 31, 2003 and 2002.......................................... 3
Unaudited Notes to Financial Statements............................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 9
Item 3. Quantitative and Qualitative Disclosure about Market Risk........... 26
Item 4. Controls and Procedures............................................. 26
PART II. OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings................................................... 28
Item 6. Exhibits and Reports on Form 8-K.................................... 28
Signatures.................................................................... 29
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OPTICAL COMMUNICATION PRODUCTS, INC.
- -------------------------------------------------------------------------------
BALANCE SHEETS
(Dollars in thousands)
September
December 31, 30,
2003 2003
- -------------------------------------------------------------------------------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 67,370 $ 64,895
Marketable securities 65,439 65,607
Accounts receivable less allowance for
doubtful accounts: $458 at December 31, 2003
and $459 at September 30, 2003 7,348 6,960
Income taxes receivable 11,551 11,743
Inventories 5,637 5,592
Prepaid expenses and other current assets 2,656 1,342
---------- ----------
Total current assets 160,001 156,139
PROPERTY, PLANT AND EQUIPMENT, Net 36,854 36,721
MARKETABLE SECURITIES 5,048
INTANGIBLE ASSETS 2,010 2,235
---------- ---------
TOTAL $ 198,865 $ 200,143
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 471 $ 471
Accounts payable 1,923 1,169
Accounts payable to related parties 2,648 1,061
Accrued bonus 2,818 4,433
Other accrued expenses 2,769 3,159
Income taxes payable 26 26
---------- ----------
Total current liabilities 10,655 10,319
LONG-TERM DEBT 746 864
OTHER LONG-TERM LIABILITIES 600 600
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Class A - common stock, $.001 par value;
200,000,000 shares authorized, 46,358,881
and 46,297,285 shares issued and outstanding
at December 31, 2003 and September 30, 2003,
respectively 46 46
Class B - common stock $.001 par value;
66,000,000 shares authorized,
66,000,000 shares issued and outstanding at
December 31, 2003 and September 30, 2003 66 66
Additional paid-in capital 132,759 132,712
Retained earnings 53,993 55,536
---------- ----------
Total stockholders' equity 186,864 188,360
TOTAL $ 198,865 $ 200,143
========== =========
1
OPTICAL COMMUNICATION PRODUCTS, INC.
- -------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended December 31,
-----------------------------
2003 2002
- -------------------------------------------------------------------------------
(Unaudited)
REVENUE $ 13,769 $ 9,400
---------- ---------
COST OF REVENUE 8,185 6,439
---------- ---------
GROSS PROFIT 5,584 2,961
---------- ---------
EXPENSES:
Research and development 4,253 3,011
Selling and marketing 1,348 959
General and administrative 1,596 1,309
---------- ---------
Total expenses 7,197 5,279
---------- ---------
LOSS FROM OPERATIONS (1,613) (2,318)
OTHER INCOME, Net 262 592
---------- ---------
LOSS BEFORE INCOME TAXES (1,351) (1,726)
---------- ---------
INCOME TAX PROVISION (BENEFIT) 192 (587)
---------- ---------
NET LOSS $ (1,543) $ (1,139)
========== =========
BASIC LOSS PER SHARE $ (.01) (.01)
========== =========
DILUTED LOSS PER SHARE $ (.01) (.01)
========== =========
BASIC SHARES OUTSTANDING 112,338 109,523
========== =========
DILUTED SHARES OUTSTANDING 112,338 109,523
========== =========
2
OPTICAL COMMUNICATION PRODUCTS, INC.
- --------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended December 31,
-------------------------------
2003 2002
- -------------------------------------------------------------------------------
(Unaudited)
Operating Activities:
Net loss $ (1,543) $ (1,139)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,490 992
Amortization of premium on marketable
securities 310 417
Tax benefit from exercise of non-qualified
stock options 545
Stock option compensation expense 44
Changes in operating assets and liabilities:
Accounts receivable, net (388) (1,448)
Income taxes receivable 192 (1,132)
Inventories (45) 1,446
Prepaid expense and other current assets (1,314) (1,421)
Other long-term assets 117
Accounts payable 754 72
Accounts payable to related parties 1,587 477
Accrued bonus (1,615) (837)
Income taxes payable (20)
Other accrued expenses (390) 78
----------- -----------
Net cash used in operating activities (962) (1,809)
----------- -----------
Investing Activities:
Purchase of marketable securities (10,094) (20,376)
Maturities of marketable securities 15,000 15,000
Purchase of property, plant and equipment (1,398) (6,735)
----------- -----------
Net cash provided by (used in) investing
activities 3,508 (12,111)
----------- -----------
Financing Activities:
Principal payments on long-term debt (118) (117)
Issuance of common stock 47 26
----------- -----------
Net cash used in financing activities (71) (91)
----------- -----------
Increase (decrease) in cash and cash equivalents 2,475 (14,011)
Cash and cash equivalents, beginning of year 64,895 85,426
----------- -----------
Cash and cash equivalents end of period $ 67,370 $ 71,415
----------- -----------
Supplemental disclosures of cash flow
information:
Cash paid during period for:
Interest (paid) $ (11) $ (16)
Income taxes (paid) $ - $ (20)
3
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited interim financial statements of Optical
Communication Products, Inc., a Delaware Corporation (the "Company"), have
been prepared in accordance with accounting principles generally accepted
in the United States of America and Article 10 of the Securities and
Exchange Commission's Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In management's opinion, the unaudited financial statements
contain all adjustments, consisting of normal recurring adjustments,
necessary to present fairly the Company's financial statements as of
December 31, 2003 and for all interim periods presented. The financial
statements should be read in conjunction with the audited financial
statements included in the annual report of the Company filed on Form 10-K
with the Securities and Exchange Commission for the year ended September
30, 2003. The results of operations for the three months ended December 31,
2003 are not necessarily indicative of the results that may be expected for
the fiscal year ending September 30, 2004. The Company's operations are
primarily located in Woodland Hills, California. The Company is a
majority-owned subsidiary of The Furukawa Electric Company, Ltd. of Japan
("Furukawa"). Furukawa beneficially owned 58.7% of the Company's common
stock at December 31, 2003, which accounts for 93.4% of the combined voting
power of all of our outstanding stock.
Stock Based Compensation
The Company accounts for its employee stock option plan under the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. The
Company has a stock-based compensation plan. All options granted had an
exercise price equal to the quoted market price of the underlying common
stock on the date of grant. The following table illustrates the effect on
the operating results and per share amounts if the fair value recognition
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS No. 148
Accounting for Stock-Based Compensation--Transition and Disclosure an
amendment of FASB Statement No. 123 had been applied to stock-based
employee compensation:
4
Three months ended December 31,
-------------------------------
2003 2002
(in thousands, except per share
amounts)
Net loss:
As reported $ (1,543) $ (1,139)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (1,525) (1,730)
----------------------------
Pro forma $ (3,068) $ (2,869)
=============================
Basic loss per share
As reported $ (0.01) $ (0.01)
Pro forma $ (0.03) $ (0.03)
Diluted loss per share
As reported $ (0.01) $ (0.01)
Pro forma $ (0.03) $ (0.03)
The fair value of each option grant estimated on the date of grant used to
compute pro forma income per share is estimated using the Black-Scholes
option-pricing model. The following assumptions were used in completing the
model:
Three months ended December 31,
-------------------------------
2003 2002
---- ----
Dividend yield 0% 0%
Expected volatility 180% 174%
Risk-free rate of return 3.89% 4.02%
Expected life (years) 7.1 7.1
During the three months ended December 31, 2003 and 2002, the Company
granted 16,000 and 575,004 stock options, respectively, with exercise
prices equal to the fair value of the underlying Common Stock on the date
of grant. The fair market values of the underlying Common Stock on the
dates of the grant were $3.64 and $0.95, for the three months ended
December 31, 2003 and 2002, respectively.
Recent Accounting Pronouncements
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires a
guarantor to recognize, at the inception of a guarantee, a liability for
the fair value of the obligation it has undertaken in issuing the
guarantee. FIN 45 also requires guarantors to disclose certain information
for guarantees, beginning December 31, 2002. The adoption of FIN 45 did not
have a material effect on the Company's financial condition, results of
operations or liquidity.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51. FIN 46, which require certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient
5
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for
all new variable interest entities created or acquired after January 31,
2003. For variable interest entities created or acquired prior to February
1, 2003, the provision of FIN 46 must be applied for the first interim or
annual period ending after March 15, 2004. The adoption of FIN 46 did not
have a material effect on the Company's financial condition, results of
operations or liquidity.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. The
statement establishes standards for classifying and measuring as
liabilities certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. SFAS No.
150 must be applied immediately to instruments created or modified after
May 31, 2003. The adoption of SFAS No. 150 in the third quarter of fiscal
2003 did not have a material effect on the Company's financial condition,
results of operations or liquidity.
2. INVENTORIES
Inventories consist of the following:
December 31, September 30,
-------------------------------------
2003 2003
(Unaudited)
(in thousands)
--------------------------------------------------------------------------
Raw materials $ 1,571 $ 1,988
Work-in-process 3,722 3,090
Finished goods 344 514
----------- ------------
Total inventories $ 5,637 $ 5,592
=========== ============
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
December 31, September 30,
-----------------------------------
2003 2003
(Unaudited)
(in thousands) Useful Lives
------------------------------------------------------------------------------------------
Land $ 8,074 $ 8,074
Buildings and improvements 18,841 17,959 39 years
Machinery and equipment 19,260 18,937 5 years
Furniture and fixtures 378 367 3 years
Computer hardware and software 1,446 1,388 5 years
Leasehold improvements 156 32 5 years
----------- -----------
Less accumulated depreciation 48,155 46,757
11,301 10,036
----------- -----------
$ 36,854 $ 36,721
=========== ===========
4. DEFERRED INCOME TAXES
The income tax expense of $192,000 in the quarter ended December 31, 2003
includes a charge of $523,000 related to the valuation allowance for the
carry-forward of net loss for the quarter
6
ended December 31, 2003, to reduce the deferred income tax asset to the
amount expected to be realized. The income tax benefit was $587,000 in the
quarter ended December 31, 2002, based on an effective tax rate of 34.0%.
5. INTANGIBLE ASSETS
Effective May 1, 2001, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." The Company completed its annual impairment test
during the fourth quarter of fiscal year ended September 30, 2003 and no
impairment was recorded. The following sets forth the intangible assets by
major asset class:
As of As of Weighted Average
December 31, September 30, Amortization
2003 2003 Period
-------------------------------------------------
(in thousands) (Years)
Licensing Fees $ 2,000 $ 2,000 3.5
Accumulated Amortization (1,183) (1,067)
Patents 950 950 5.0
Accumulated Amortization (222) (174)
Acquired Technology 1,216 1,216 5.0
Accumulated Amortization (284) (223)
--------------------------
Total intangible assets 2,477 2,702
(Less) current portion (467) (467)
------------------------------
$ 2,010 $ 2,235
==============================
Aggregate amortization expense related to intangible assets was
approximately $225,000 and $117,000 for the three months ended December 31,
2003 and 2002, respectively. There was no impairment loss recorded during
three months ended December 31, 2003 or 2002.
Following is a summary of future amortization expense in each of the next
five fiscal years.
(in thousands)
remaining nine months fiscal 2004 $ 675
fiscal 2005 900
fiscal 2006 433
fiscal 2007 433
fiscal 2008 36
--------
$ 2,477
========
6. EARNINGS (LOSS) PER SHARE
The following is a calculation of basic and diluted loss per share
("EPS"):
7
Three Monts Ended December 31,
----------------------------------
2003 2002
(in thousands, except per share data)
BASIC EPS COMPUTATION:
Net loss applicable to common stock $ (1,543) $ (1,139)
========== ==========
Weighted average common shares outstanding 112,338 109,523
---------- ----------
Basic loss per share $ (0.01) $ (0.01)
========== ==========
DILUTED EPS COMPUTATION:
Net loss applicable to common stock $ (1,543) $ (1,139)
========== ==========
Diluted shares outstanding 112,338 109,523
---------- ----------
Diluted earnings (loss) per share $ (0.01) $ (0.01)
========== ==========
7. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has operating leases for certain facilities. Lease payments
are made monthly. The Company's leases are renewable monthly,
semiannually, annually or for five years. Rent expense for these leases
for the three months ended December 31, 2003 and 2002 was $102,000 and
$119,000, respectively.
Following is a summary of future minimum payments due under operating
leases that have initial or remaining noncancelable lease terms in
excess of one year at December 31, 2003:
(in thousands)
------------------------------------------------------
nine months thru September 30, 2004 $ 385
2005 518
2006 185
2007 12
------------------------------------------------------
Total minimum lease payments $ 1,100
=====================================================
Warranty Accruals - The Company provides a standard warranty of its
products from defects in materials and workmanship. The warranty is
limited to repair or replacement, at the Company's option, of defective
items authorized for return within one year from the date of the sale.
The table below sets forth the activity of the Company's warranty
reserve.
Balance at Additions Balance at
beginning charged to end of
Warranty Reserve of period expense (Deductions) period
Three months ended:
December 31, 2002 $ 43,000 $ 9,000 $ (6,000) $ 46,000
December 31, 2003 $ 46,000 $(14,000) $ (3,000) $ 29,000
8
ITEM 2. 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.
The following discussion contains forward-looking statements that involve risks
and uncertainties. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "may," "will" or similar expressions are intended to identify
forward-looking statements. The statements are based on current expectations and
actual results could differ materially from those discussed herein. Factors that
could cause or contribute to the differences are discussed below in this Report
under "Risk Factors" and elsewhere in this Report, and in our Annual Report on
Form 10-K filed with the Securities and Exchange Commission ("SEC") for the year
ended September 30, 2003.
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the Financial Statements and accompanying notes. Note 2 to
the Financial Statements in the Annual Report on Form 10-K for the fiscal year
ended September 30, 2003 describes the significant accounting policies and
methods used in the preparation of the Financial Statements. Estimates are used
for, but not limited to, the accounting for the allowance for doubtful accounts,
inventory write-downs, accrued expenses and deferred tax assets. Actual results
could differ from these estimates. The following critical accounting policies
are impacted significantly by judgments, assumptions and estimates used in the
preparation of the Financial Statements.
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts and the aging of the accounts
receivable. If there is a deterioration of a major customer's credit worthiness
or actual defaults are higher than our historical experience, our estimates of
the recoverability of amounts due us could be adversely affected.
Inventory purchases and commitments are based upon future demand
forecasts. If there is a sudden or significant decrease in demand for our
products or there is a higher risk of inventory obsolescence because of rapidly
changing technology and customer requirements, we may be required to write down
our inventory and our gross margin could be adversely affected.
We use estimates in the determination of the required accrual for
warranty costs. This estimate is based upon a detailed examination of past
experience and current information. The information available to us may change
in the future and may require us to revise this accrual.
We have evaluated the available evidence about future taxable income and
other possible sources of realization of deferred tax assets. We have
established a valuation allowance to reduce deferred tax assets to an amount
that represents management's best estimate of the amount of such deferred tax
assets that more likely than not will be realized.
We continually reassess our assumptions and judgments and make
adjustments when significant facts and circumstances dictate.
Overview
We design, manufacture and sell a comprehensive line of high
performance, highly reliable fiber optic subsystems and modules for fiber optic
transmission systems that are used to address the bandwidth limitations in
metropolitan area networks, or MANs, local area networks, or LANs, and storage
area
9
networks, or SANs, markets. 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.
Furukawa beneficially owns all of our outstanding Class B common stock,
representing 58.7% of our outstanding shares of common stock and 93.4% of the
combined voting power of all of our outstanding common stock as of the fiscal
quarter ended December 31, 2003. 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 that we purchase from Furukawa for inclusion in our products. We
currently purchase the majority of lasers from Furukawa under a Master Purchase
Agreement, which we entered into with Furukawa on October 1, 2003.
We operate in one industry segment, the design and manufacture of fiber
optic subsystems and modules. We sell our products to original equipment
manufacturers or OEMs, their contract manufacturers or CMs, who incorporate them
into systems they assemble for OEMs and to distributors. We define our customers
as OEMs who have purchased our products directly or indirectly through CMs and
distributors. We recognize revenue upon product shipment, and sales returns and
allowances have been insignificant. Historically, a relatively small number of
customers have accounted for a significant percentage of our revenue. Our 10
largest customers accounted for approximately 70.3% and 63.3% of our total
revenue for the fiscal quarters ended December 31, 2003 and 2002, respectively.
Cisco Systems and Alcatel (including sales to each of their contract
manufacturers) accounted for approximately 13.7% and 12.6%, respectively, of our
total revenue for the fiscal quarter ended December 31, 2003. Acterna, Cisco
Systems, and Alcatel (including sales to each of their contract manufacturers)
accounted for approximately 12.8%, 12.2% and 10.7%, respectively, of our total
revenue for the fiscal quarter ended December 31, 2002. No other customer
accounted for more than 10.0% of our total revenue for the fiscal quarters ended
December 31, 2003 and 2002.
For financial reporting purposes, we consider our customers to be the
OEMs, CMs and distributors who place purchase orders with us directly. For the
fiscal quarter ended December 31, 2003, Comstar Communications accounted for
10.2% of our total revenue. No other direct sales customer accounted for more
than 10.0% of our total revenue for the fiscal quarters ended December 31, 2003
and 2002. 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.
Since early 2001, the telecommunications sector, and in particular the
fiber optic networking sector, has suffered a severe downturn. System providers
have scaled back on deployment and have dramatically reduced their purchases of
systems from equipment manufacturers. As a result, equipment manufacturers have
also reduced purchases of components and modules from our competitors and from
us.
On October 9, 2002, we acquired certain assets of Cielo Communications,
Inc., ("Cielo Communications") a research and design company located in
Broomfield, Colorado, focused on creating VCSEL technology for fiber optic
communication networks for a cash purchase price and direct costs of $6.6
million. The purchase price includes the acquisition of capital equipment and
intellectual property.
On January 31, 2003, we acquired parallel optical module assets and
intellectual property from Gore Photonics, an industry leader in the research
and development of VCSEL parallel optical modules for fiber optic communication
networks located in Elkton, Maryland, for a cash purchase price of $3.4 million.
The purchase price includes the acquisition of capital equipment and inventory.
10
The average selling prices of our products generally decrease as the
products mature from factors such as increased competition, the introduction of
new products, increased unit volumes, and price concessions required by our
customers. 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, 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 may continue 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 may increase in
future periods.
Sales and marketing expenses consist primarily of salaries and related
expenses for sales and marketing personnel, commissions paid to sales personnel
and independent manufacturers' representatives, marketing and promotion costs.
We intend to expand our sales and marketing operations and efforts in order to
increase sales and market awareness of our products. In July 2000 we opened
sales offices in Bury St. Edmunds, England and Richardson, Texas; in May 2001 we
opened a sales office in Ottawa, Canada; in May 2002 we opened a sales office in
Santa Clara, California; and in March 2003 we opened a sales office in Nashua,
New Hampshire. 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, stock
compensation and related expenses for our administrative, finance and human
resources personnel, professional fees and other corporate expenses. We expect
that general and administrative expenses will decrease in the near term
primarily due to a decrease in stock compensation. However, we believe that this
decrease will be partially offset by an increase in our legal and consulting
fees associated with analysis of strategic alternatives, including future market
opportunities that have been undertaken by our management and board of
directors. As a result, our general and administrative expenses in absolute
dollars may increase in future periods.
Results of Operations - Comparison of Three Months Ended December 31, 2003 and
2002
Revenue - Revenue increased 46.5% to $13.8 million in the quarter ended
December 31, 2003 from $9.4 million in the quarter ended December 31, 2002. This
increase was due substantially to an increase in demand from our existing
customers. Sales of our products for metropolitan area networks increased to
approximately 88% of revenue for the quarter ended December 31, 2003 from
approximately 79% of revenue for the quarter ended December 31, 2002. Sales of
our products for local area and storage area networks decreased to approximately
11% of revenue for the quarter ended December 31, 2003 from approximately 16% of
revenue for the quarter ended December 31, 2002. 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.
11
Cost of Revenue - Cost of revenue increased 27.1% to $8.2 million in the
quarter ended December 31, 2003 from $6.4 million in the quarter ended December
31, 2002. Gross margin increased to 40.6% from 31.5% during this period. The
increase in gross margin was primarily due to the result of $1.1 million of
inventory used in production during the quarter ended December 31, 2003 that was
previously written down as excess inventory. This increase was partially offset
by an increase in material costs used for production of our products. Gross
margin also increased due to a decrease in manufacturing cost as a percent of
sales from 25.3% to 19.4% during the quarters ended December 31, 2002 and 2003,
respectively, which is the result of favorable economies of scale achieved due
to the increase in our production activities during the quarter.
Research and Development - Research and development expenses increased
41.2% to $4.3 million in the quarter ended December 31, 2003 from $3.0 million
in the quarter ended December 31, 2002. This increase was primarily due to an
increase in salaries and other operating costs associated with the hiring of
additional engineering personnel. This increase was primarily due to an increase
in salaries and other operating costs associated with the hiring of additional
engineering personnel in Woodland Hills, California and an increase in salaries
and other operating costs associated with our October 9, 2002 acquisition of
certain assets of Cielo Communications, a research and design company located in
Broomfield, Colorado and our January 31, 2003 acquisition of certain assets of
Gore Photonics, a research and development company in Elkton, Maryland.
Sales and Marketing - Sales and marketing expenses increased 40.6% to
$1.3 million in the quarter ended December 31, 2003 from $959,000 in the quarter
ended December 31, 2002. This increase was primarily due to an increase of
$226,000 in salaries and benefits resulting from the addition of sales and
marketing personnel hired since December 31, 2002 and an increase of $166,000 in
commissions to independent manufacturers' representatives as a result of the
increase in revenue.
General and Administrative - General and administrative expenses
increased 21.9% to $1.6 million in the quarter ended December 31, 2003 from $1.3
million in the quarter ended December 31, 2002. This increase was due to an
increase in salaries and benefits as a result of additional personnel hired and
an increase of legal and consulting fees primarily associated with analysis of
strategic alternatives. These increases were partially offset by a $150,000
decrease in bad debt provision due to a decrease in delinquent accounts.
Income Taxes - The income tax expense of $192,000 in the quarter ended
December 31, 2003 includes a charge of $523,000 related to the valuation
allowance for the carry-forward of net loss for the quarter ended December 31,
2003, to reduce the deferred income tax asset to the amount expected to be
realized. The income tax benefit was $587,000 in the quarter ended December 31,
2002, based on an effective tax rate of 34.0%.
Liquidity and Capital Resources
As of December 31, 2003, our primary source of liquidity was our cash
and cash equivalents balance of $67.4 million and our marketable securities
balance of $65.4 million, which consists primarily of United States Treasury
notes and bonds. At September 30, 2003, we had $64.9 million in cash and cash
equivalents and $65.6 million in current and $5.0 million in long-term
marketable securities.
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, and through our initial public offering of our Class A
common stock, which we completed on November 3, 2000. As of December 31, 2003,
our working capital was $149.3 million with a current ratio of 15:1 compared to
our working capital of $145.8 million with a current ratio of 15:1 as of
September 30, 2003. Our working capital increased during the three months ended
December 31, 2003 primarily due to approximately $5.0 million in long-term
marketable securities, which have rolled into current marketable securities
during the
12
quarter ended December 31, 2003. Because of our low debt balances, we believe
that additional cash could be borrowed if necessary; however, cash flow from
operations, cash and equivalents, marketable securities and existing loan
facilities are expected to be sufficient to fund operations for the next twelve
months.
As of December 31, 2003, we had a $1.2 million balance outstanding under
our term loan. The term loan bears 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
in July 2006, and the proceeds of the term loan were used to purchase our former
primary corporate and manufacturing facility in Chatsworth, California.
The term loan contains 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 also requires that we comply with financial covenants,
which require us to maintain our tangible net worth, cash position and revenue
at specified levels. As of December 31, 2003, we were in compliance with all
loan covenants. Our need to comply with these covenants does not materially
affect the operation of our business.
On March 27, 2003, we terminated our revolving credit facility with
Manufacturer's Bank. The credit limit of the revolving credit facility was $1.0
million. No amounts had been borrowed against the revolving credit facility
through the termination date of the revolving credit facility in 2003.
During the three months ended December 31, 2003, cash used in operations
was $1.0 million compared to cash used in operations of $1.8 million in the
three months ended December 31, 2002. The cash used in operating activities
during the three months ended December 31, 2003 was the result of increases in
accounts receivable and prepaid expenses and a decrease in accrued bonus. These
were partially offset by increases in accounts payable, accounts payable to
related parties and the net loss after adding back the adjustments for
depreciation and amortization used to reconcile net loss to net cash. The cash
used in operating activities during the three months ended December 31, 2002 was
the result of increases in accounts receivable, income taxes receivable and
prepaid expenses and a decrease in accrued bonus. These were partially offset by
the net loss after adding back the adjustments for depreciation and amortization
used to reconcile net loss to net cash, and a decrease in inventories.
During the three months ended December 31, 2003, cash provided by
investing activities was $3.5 million compared to cash used in investing
activities of $12.1 million in the three months ended December 31, 2002. The
cash provided by investing activities in the three months ended December 31,
2003 was primarily the result of $4.9 million in marketable securities purchases
net of maturities, partially offset by $1.4 million in property plant and
equipment purchases. The cash used in investing activities during the three
months ended December 31, 2002 was due to $6.7 million in cash purchase price
and direct costs associated with the October 9, 2002 acquisition of certain
assets of Cielo Communications, Inc. and $5.4 million in marketable securities
purchases net of maturities. Cielo Communications, Inc. is a research and design
company located in Broomfield, Colorado. The purchase price includes the
acquisition of capital equipment and intellectual property.
During the three months ended December 31, 2003 and 2002, cash used in
financing activities was $71,000 and $91,000, respectively. The majority of cash
used in financing activities was for principal payments on the long-term debt.
We believe that our existing cash, cash equivalents and investments on
hand, together with cash that we expect to generate from our operations, will be
sufficient to meet our capital needs for at least the next twelve months.
However, it is possible that we may need or elect to raise additional funds to
fund our activities beyond the next year or to consummate acquisitions of other
businesses, products or technologies. We could raise such funds by selling more
stock to the public or to selected investors, or by
13
borrowing money. In addition, even though we may not need additional funds, we
may still elect to sell additional equity securities or obtain credit facilities
for other reasons. We cannot assure you that we will be able to obtain
additional funds on commercially favorable terms, or at all. If we raise
additional funds by issuing additional equity or convertible debt securities,
the ownership percentages of existing stockholders would be reduced. In
addition, the equity or debt securities that we issue may have rights,
preferences or privileges senior to those of the holders of our common stock.
Although we believe we have sufficient capital to fund our activities for at
least the next twelve months, our future capital requirements may vary
materially from those now planned. The amount of capital that we will need in
the future will depend on many factors, including:
o the market acceptance of our products;
o the levels of promotion and advertising that will be required to launch our
new products and achieve and maintain a competitive position in the
marketplace;
o price discounts on our products to our customers;
o our business, product, capital expenditure and research and development plans
and product and technology roadmaps;
o the levels of inventory and accounts receivable that we maintain;
o capital improvements to new and existing facilities;
o technological advances;
o our competitors' response to our products;
o our pursuit of strategic alternatives, including future market opportunities;
and
o our relationships with suppliers and customers.
In addition, we may require additional capital to accommodate planned
growth, hiring, infrastructure and facility needs or to consummate acquisitions
of other businesses, products or technologies.
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.
RISK FACTORS
This Report contains forward-looking statements based on the current
expectations, assumptions, estimates and projections about us and our industry.
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. These forward-looking
statements involve risks and uncertainties. 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" and elsewhere in this Report, 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. 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.
Our continued success in generating revenue depends on growth in construction of
fiber optic MAN, LAN, and SAN.
14
Our fiber optic subsystems and modules are used primarily in MAN, LAN,
and SAN. 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. A substantial portion of our revenue
is derived from sales of our product in the MAN market. Sales of our products
for the MAN market represented approximately 88% and 79% of our revenue for the
three months ended December 31, 2003 and 2002, respectively.
The downturn in our industry have caused communications service
providers to reduce their capital spending on fiber optic equipment and delayed
the deployment of new and build-out of existing fiber optic networks. As the
result of currently uncertain economic and market conditions, (a) our revenue
may decline, (b) we are unable to predict future revenue accurately, and (c) we
are currently unable to provide long-term guidance for future financial
performance. The conditions contributing to this difficulty include:
o uncertainty regarding the capital spending plans of the major
telecommunications carriers, upon whom our customers and,
ultimately we, depend for revenue;
o the telecommunications carriers' current limited access to
the capital required for expansion;
o lower near term revenue visibility; and
o general market and economic uncertainty.
` Based on these and other factors, many of our major customers have
reduced orders for our products and have expressed uncertainty as to their
future requirements. As a result, our revenue in future periods may decline. In
addition, our ability to meet financial expectations for future periods may be
harmed.
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. 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.
15
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 our lasers
from Furukawa under a Master Purchase Agreement. We do not have long-term supply
contracts with any of our other key suppliers and our agreement with Furukawa is
only for one year. Our dependence on a small number of suppliers and our lack of
longer 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 comparisons of our operating results should not be relied upon
as an indicator of our future performance. Some of the factors that could cause
our operating results to vary include:
o fluctuations in demand for, and sales of, our products, which
is dependent on the implementation of fiber optic networks;
o the timing of customer orders, particularly from our significant
customers;
o 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;
o our ability to control expenses;
o the mix of our products sold; and
o 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 or that new product
introductions will generate sufficient revenue in subsequent quarters to recover
our research and development expenditures. If
16
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.
Since early 2001, unfavorable economic conditions in the United States
detrimentally affected the U.S. manufacturing industry, particularly 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 and April 2002 announcements of the elimination of
approximately 110 jobs and 45 jobs, respectively, primarily in the manufacturing
area. Our business, operating results and financial condition may continue to
suffer if the global economy, economic conditions in the United States, or fiber
optics equipment market do not improve.
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.
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 9001. Delays in product qualification or loss of ISO 9001
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.
We have been registered under ISO 9001:1994 in the past and we are
undergoing a transition to be registered under ISO 9001:2000. If we are
unsuccessful in obtaining timely registration under ISO 9001:2000 standards, we
may lose the sales opportunities with certain customers based on their specific
requirements. We are currently certified under ISO 9001:1994.
17
If we fail to predict our manufacturing requirements accurately, we could incur
additional carrying costs and have excess and obsolete inventory or we could
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 levels of inventories that
increase our inventory carrying costs and periodically cause 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 Agilent Technologies, ExceLight Communications, Finisar, Infineon
Technologies, JDS Uniphase, MRV Communications, OpNext, Picolight, and Stratos
Lightwave. 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 Fujitsu, 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
capitalization 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.
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.
18
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 sell 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.
We could be subjected to 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. 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:
o stop selling, incorporating or using our products that use the
infringed intellectual property;
o 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
o 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.
19
Our success and ability to compete is dependent in part on our
proprietary technology. We rely primarily on patent, copyright, trademark and
trade secret laws, as well as confidentiality agreements and other methods, to
establish and protect our proprietary rights. Existing patent, copyright,
trademark and trade secret laws afford only limited protection. While we are
pursuing foreign patent protections, 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. Many U.S. companies have encountered
substantial infringement problems in some foreign countries. Because we sell
some of our products overseas, we have exposure to foreign intellectual property
risks. 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.
If we are unable to generate adequate additional revenue as a result of the
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 have incurred and will continue to incur significant costs
related to the expansion of our sales operations. If the expansion of our sales
operations does not generate adequate additional revenue, our operating margins
may decline. To the extent we are unsuccessful in developing 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 our domestic and foreign 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. Since the costs for
research and development of new products and technology are expensed as
incurred, we expect a negative impact on our reported net operating results. 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
20
changes or industry changes in standards would likely prevent our products from
gaining market acceptance and harm our competitive position.
Terrorist activities and resulting military and other actions could adversely
affect our business.
The September 11, 2001 terrorist attacks in the United States and recent
terrorist attacks in other parts of the world, as well as continued threats of
global terrorism, current and future military response to them and the United
States military action against Iraq 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
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, revenue 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, Mohammad Ghorbanali, our Chief Operating Officer and
Vice President of Technical Operations, and Masato Sakamoto, our Executive Vice
President of Corporate Development. 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.
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 that 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
21
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:
o increased costs associated with the replacement of defective
products, redesign of products to meet customer design
specification and/or refund of the purchase price;
o diversion of development resources; and
o 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 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 2004 fiscal year.
We face risks associated with our international operations that could prevent us
from marketing and distributing our products internationally.
Although a significant portion of our sales has historically been in
North America, a growing percentage of our revenue is generated from sales
outside North America. Sales of our products outside North America accounted for
approximately 39.9% and 39.6% of our revenue for the three months ended December
31, 2003 and 2002, respectively. We expect that our sales outside of North
America will continue to contribute materially to our revenue. We have limited
experience in marketing and distributing our products internationally. We may
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:
22
o greater difficulty in accounts receivable collection and longer
collection periods;
o difficulties and costs of staffing and managing foreign
operations with personnel who have expertise in fiber optic
technology;
o unexpected changes in regulatory or certification requirements
for optical networks; and
o 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. These factors could adversely impact our international sales or
increase our costs of doing business abroad or impair our ability to expand into
international markets, and therefore could significantly harm our business.
Disruption of our operations at our Woodland Hills, California manufacturing
facility could require us to lease alternative manufacturing facilities or limit
our manufacturing operations.
In August 2003, we relocated our headquarters from Chatsworth,
California to Woodland Hills, California. All of our manufacturing operations
are conducted in our Woodland Hills, 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.
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 little experience in acquiring other businesses and
technologies. Potential acquisitions also involve numerous risks, including:
o problems assimilating the purchased operations, technologies
or products;
o unanticipated costs associated with the acquisition;
o diversion of management's attention from our core business;
o adverse effects on existing business relationships with
suppliers and customers;
o risks associated with entering markets in which we have no or
limited prior experience; and
o potential loss of key employees of purchased organizations.
On October 9, 2002, we acquired certain assets of privately-held Cielo
Communications, Inc and on January 31, 2003 we acquired certain assets of Gore
Photonics, the fiber optics business unit of W.L. Gore & Associates. We may
encounter problems integrating the acquired operations, technologies or products
into our own and could lose the services of certain key employees associated
with these acquired entities.
Our stock price is likely to be volatile and could drop unexpectedly.
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Our Class A common stock has been publicly traded since November 3,
2000. The market price of our Class A common stock has been subject to
significant fluctuations since the date of our initial public offering. The
stock market has from time to time experienced significant price and volume
fluctuations that have affected the market prices of securities, particularly
securities of telecommunications and fiber optic companies. As a result, the
market price of our Class A common stock may materially decline, regardless of
our operating performance. In the past, following periods of volatility in the
market price of a particular company's securities, securities class action
litigation has often been brought against that company. We may become involved
in this type of litigation in the future. Litigation of this type is often
expensive and diverts management's attention and resources.
We may not be able to maintain our listing on the Nasdaq National Market and if
we fail to do so, the price and liquidity of our Class A common stock may
decline.
The Nasdaq Stock Market has quantitative maintenance criteria for the continued
listing of securities on the Nasdaq National Market. The current requirements
affecting us include maintaining a minimum bid price per share of $1. Our bid
price has been below $1 in the past. If the bid price of our Class A common
stock drops below $1 per share and remains at that level for more than 30
consecutive trading days, we will be in violation of Nasdaq's listing standards.
If within 90 days thereafter, our Class A common stock does not have a minimum
bid price of $1 per share for 10 consecutive trading days, Nasdaq will commence
proceedings to delist our Class A common stock from the Nasdaq National Market.
If we fail to maintain continued listing on the Nasdaq National Market and must
move to a market with less liquidity, our stock price would likely decline. If
we are delisted, it could have a material adverse effect on the market price of,
and the liquidity of the trading market for, our Class A common stock.
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 that 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 under a Master Purchase Agreement. We cannot
assure you that Furukawa will renew the Agreement upon its expiration on
September 30, 2004 or whether it 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 can control the outcome of any
stockholder votes, as discussed below. The terms of future transactions with
Furukawa may or may not be comparable to those that would be available from
unaffiliated third parties.
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.
24
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 31, 2003 represented 93.4% 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:
o a change of control, including a merger;
o our acquisition or disposition of assets;
o our future issuances of common stock or other securities;
o our incurrence of debt; and
o our payment of dividends on our common stock.
Two 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.
Our exploration of strategic alternatives may not be successful.
On September 29, 2003, we announced that a special committee of our board of
directors is evaluating strategic alternatives. The special committee, which is
comprised of our three independent directors, has retained Bear, Stearns & Co.
Inc. to advise it in evaluating strategic alternatives, including a special
dividend, share repurchase, strategic merger or sale of the Company.
We are uncertain as to what strategic alternatives may be available to us or
what impact any particular strategic alternative will have on our stock price if
accomplished. Uncertainties and risks relating to our exploration of strategic
alternatives include:
o the exploration of strategic alternatives may disrupt operations
and distract management, which could have a material adverse
effect on our operating results;
o the process of exploring strategic alternatives may be more time
consuming and expensive than we currently anticipate;
o we may not be able to successfully achieve the benefits of the
strategic alternative undertaken by us; and
o perceived uncertainties as to the future direction of the Company
may result in the loss of employees or business partners.
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ITEM 3. 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 $1.2 million.
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 $67.4 million the majority of
which is invested in money market and other interest bearing accounts. In
addition, we have $65.4 million invested in marketable securities, which
represents investments in United States treasury notes and treasury bonds.
As of December 31, 2003, our investment in marketable securities had a
weighted-average time to maturity of approximately 202 days. Marketable
securities represent United States treasury notes and treasury bonds with
maturity on the date purchased 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 the date purchased of held-to-maturity marketable debt securities
can 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 $12,000 on
our term loan and an annual increase or decrease of interest income of $1.3
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 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based on their evaluation, as of the end of the period covered by this quarterly
report, our principal executive officer and principal financial officer have
concluded that our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange
Act")) are effective based on their evaluation of these controls and procedures
required by paragraph (b) of Rules 13a-15 or 15d-15 under the Exchange Act.
Changes in Internal Control
There were no changes in our internal control over financial reporting
identified in connection with the evaluation required by paragraph (d) of Rules
13a-15 or 15d-15 under the Exchange Act that occurred during our last fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
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PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not currently involved in any material legal proceedings. We are
not aware of any other material legal proceedings threatened or pending against
us. From time to time, however, we may become subject to additional legal
proceedings, claims, and litigation arising in the ordinary course of business.
In addition, in the past we have received, and we may continue to receive in the
future, letters alleging infringement of patent or other intellectual property
rights. Our management believes that these letters generally are without merit
and intend to contest them vigorously.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Number Description
31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Report on Form 8-K:
The Company furnished, but did not file, one Current Report on
Form 8-K during the quarter ended December 31, 2003. The report dated November
3, 2003 contained the Company's press release announcing its earnings for
quarter ended September 30, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OPTICAL COMMUNICATION PRODUCTS, INC.,
a Delaware corporation
Date: February 11, 2004 By: /s/ Muoi Van Tran
----------------- ---------------------
Name: Muoi Van Tran
Title: Chairman of the Board,
Chief Executive Officer and President
Date: February 11, 2004 BY: /s/ Susie Nemeti
----------------- ---------------------
Name: Susie Nemeti
Title: Chief Financial Officer (Principal
Financial and Accounting Officer)
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EXHIBIT INDEX
Exhibit Number Description
31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
29