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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, 2011

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 001-33306

 

 

OPNEXT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		22-3761205
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)
46429 Landing Parkway
Fremont, California		94538
(Address of principal executive offices)		(Zip Code)

(510) 580-8828

(Registrant’s telephone number, including area code)

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ¨    NO  x

As of February 9, 2012, 90,304,067 shares of the registrant’s common stock were outstanding.

 

 

 

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TABLE OF CONTENTS

 

		Page
PART I — Financial Information
Item 1. Financial Statements			3
Consolidated Balance Sheets as of December 31, 2011 (unaudited) and March 31, 2011			3
Unaudited Consolidated Statements of Operations for the Three Months and Nine Months Ended December  31, 2011 and 2010			4
Unaudited Consolidated Statements of Cash Flows for the Three Months and Nine Months Ended December  31, 2011 and 2010			5
Notes to Unaudited Consolidated Financial Statements			6
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			27
Item 4. Controls and Procedures			28
PART II — Other Information
Item 1. Legal Proceedings			29
Item 1A. Risk Factors			29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			29
Item 3. Defaults Upon Senior Securities			29
Item 4. (Removed and Reserved)			29
Item 5. Other Information			29
Item 6. Exhibits			29
Signatures			31
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

 

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PART I — FINANCIAL INFORMATION

 

Item 1.

Financial Statements

Opnext, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

 

		December 31, 2011				March 31, 2011
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents, including $1,264 and $1,210 of restricted cash at December 31 and March 31, 2011, respectively		$	85,215			$	100,284
Trade receivables, net, including $9,152 and $8,557 due from related parties at December 31 and March 31, 2011, respectively			39,435				70,701
Inventories			114,248				118,588
Prepaid expenses and other current assets			7,754				7,458
Total current assets			246,652				297,031
Property, plant, and equipment, net			44,530				59,992
Purchased intangibles			11,715				17,076
Other assets			226				258
Total assets		$	303,123			$	374,357
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Trade payables, including $6,070 and $6,191 due to related parties at December 31 and March 31, 2011, respectively		$	45,485			$	63,383
Accrued expenses			22,494				23,771
Short-term debt			19,483				18,055
Capital lease obligations			14,517				13,513
Total current liabilities			101,979				118,722
Capital lease obligations			11,248				12,554
Other long-term liabilities			8,419				6,855
Total liabilities			121,646				138,131
Commitments and contingencies
Shareholders’ equity:
Preferred stock, par value $0.01 per share: 15,000,000 authorized, no shares issued and outstanding			—				—
Preferred stock, Series A Junior Participating, par value $0.01 per share: 1,000,000 authorized, no shares issued and outstanding			—				—
Common stock, par value $0.01 per share: 150,000,000 authorized shares; 91,571,424 issued, 90,304,067 outstanding, at December 31, 2011 and; 91,363,613 issued, 90,028,612 outstanding at March 31, 2011			903				900
Additional paid-in capital			729,355				724,775
Accumulated deficit			(567,515	)			(504,977	)
Accumulated other comprehensive income			19,053				15,701
Treasury stock, at cost: 109,270 shares at December 31, 2011 and 58,630 shares at March 31, 2011			(319	)			(173	)
Total shareholders’ equity			181,477				236,226
Total liabilities and shareholders’ equity		$	303,123			$	374,357

The accompanying notes are an integral part of these consolidated financial statements.

 

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Opnext, Inc.

Unaudited Consolidated Statements of Operations

(in thousands, except per share amounts)

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
Revenues, including $10,296 and $9,965 from related parties for the three-month periods, and $23,217 and $22,492 from related parties for the nine-month periods, ended December 31, 2011 and 2010, respectively		$	53,066			$	97,051			$	232,180			$	262,293
Cost of sales			49,623				76,244				188,260				206,218
Amortization of acquired developed technology			1,445				1,445				4,335				4,335
Gross margin			1,998				19,362				39,585				51,740
Research and development expenses, including $1,071 and $911 incurred with related parties for the three-month periods, and $3,147 and $2,812 incurred with related parties for the nine-month periods, ended December 31, 2011 and 2010, respectively			13,193				13,656				40,679				46,480
Selling, general and administrative expenses, including $953 and $899 incurred with related parties for the three-month periods, and $3,462 and $3,095 incurred with related parties for the nine-month periods, ended December 31, 2011 and 2010, respectively			12,904				15,369				40,844				43,773
Amortization of purchased intangibles			342				342				1,026				1,026
Flood related impairment and other charges, and loss on disposal of property and equipment			21,774				—				21,649				239
Operating loss			(46,215	)			(10,005	)			(64,613	)			(39,778	)
Gain on sale of technology assets, net			—				—				2,078				—
Interest expense, net			(228	)			(225	)			(656	)			(614	)
Other income (expense), net			136				124				836				(354	)
Loss before income taxes			(46,307	)			(10,106	)			(62,355	)			(40,746	)
Income tax expense			(29	)			(74	)			(183	)			(121	)
Net loss		$	(46,336	)		$	(10,180	)		$	(62,538	)		$	(40,867	)
Net loss per share:
Basic and diluted		$	(0.51	)		$	(0.11	)		$	(0.69	)		$	(0.45	)
Weighted average number of shares used in computing net loss per share:
Basic and diluted			90,304				89,892				90,246				89,885

The accompanying notes are an integral part of these consolidated financial statements.

 

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Opnext, Inc.

Unaudited Consolidated Statements of Cash Flows

(in thousands)

 

		Nine Months Ended December 31,
		2011				2010
Cash flows from operating activities
Net loss		$	(62,538	)		$	(40,867	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			17,925				18,064
Amortization of purchased intangibles			5,361				5,361
Stock-based compensation expense			4,469				6,311
Flood related impairment and other charges, and loss on disposal of property and equipment			21,649				239
Gain on sale of technology assets, net			(2,078	)			—
Changes in assets and liabilities:
Trade receivables, net			32,019				(16,780	)
Inventories			(833	)			(16,349	)
Prepaid expenses and other current assets			(75	)			(2,886	)
Other assets			39				67
Trade payables			(21,178	)			17,672
Accrued expenses and other liabilities			230				1,233
Net cash used in operating activities			(5,010	)			(27,935	)
Cash flows from investing activities
Capital expenditures			(5,216	)			(6,324	)
Proceeds from disposal of property and equipment			148				—
Proceeds from sale of technology assets, net			2,078				—
Net cash used in investing activities			(2,990	)			(6,324	)
Cash flows from financing activities
Payments on capital lease obligations			(6,874	)			(8,525	)
Restricted shares repurchased			(145	)			—
Payments on short-term debt			—				(3,433	)
Exercise of stock options			113				55
Net cash used in financing activities			(6,906	)			(11,903	)
Effect of foreign currency exchange rates on cash and cash equivalents			(163	)			956
Decrease in cash and cash equivalents			(15,069	)			(45,206	)
Cash and cash equivalents at beginning of period			100,284				132,643
Cash and cash equivalents at end of period		$	85,215			$	87,437
Non-cash financing activities
Capital lease obligations incurred		$	(4,532	)		$	(9,455	)

The accompanying notes are an integral part of these consolidated financial statements.

 

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Opnext, Inc.

Notes to Unaudited Consolidated Financial Statements

1. Background and Basis of Presentation

Opnext, Inc. and subsidiaries (which may be referred to in these financial statements as “OPI,” “Opnext,” the “Company,” “we,” “us,” or “our”) is a leading designer and manufacturer of optical subsystems, modules and components that enable high-speed telecommunications and data communications networks, as well as lasers and infrared light-emitting diodes (LEDs) for industrial and commercial applications.

On October 22, 2011, flood waters resulting from heavy seasonal rains infiltrated the offices and manufacturing floor space of the Company’s primary contract manufacturer, Fabrinet, at its Chokchai campus in Pathum Thani, Thailand. As a result, the flooding had a significant impact on the Company’s revenues, operations and the ability to meet customer demand for products during the three-month period ended December 31, 2011. For the three-month period ending December 31, 2011, the Company recorded a charge of $10.9 million of damaged inventory, consisting of $8.8 million of raw materials and $2.1 million of finished goods, and a charge of $9.7 million of property, plant and equipment, net, the Company determined to be impaired having a gross value of $31.9 million. Multiple factors will affect the extent of revenue loss in the future, including, but not limited to, the Company’s ability to move production to other locations, the ability to locate alternatives in sourcing parts from suppliers that have been impacted by the flooding, the level of demand from customers, and the Company’s ability to incrementally increase production at other facilities.

The financial information for the Company as of December 31, 2011, and for the three-month and nine-month periods ended December 31, 2011 and 2010, is unaudited and includes all normal and recurring adjustments that management considers necessary for a fair statement of the financial information set forth herein in accordance with generally accepted accounting principles for interim financial information and rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, such information does not include all of the information and footnotes required under generally accepted accounting principles in the United States (GAAP) for annual financial statements. For further information, please refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2011, filed on June 14, 2011, as amended.

2. Summary of Significant Accounting Policies

Revenue Recognition

Revenue is derived principally from sales of products and is recognized when persuasive evidence of an arrangement exists, usually in the form of a purchase order, delivery has occurred or services have been rendered, title and risk of loss have passed to the customer, the price is fixed or determinable and collection is reasonably assured based on the creditworthiness of the customer and certainty of customer acceptance. These conditions generally exist upon shipment or upon notice from certain customers in Japan that they have completed their inspection and have accepted the product.

The Company participates in vendor managed inventory (“VMI”) programs with certain customers whereby the Company maintains an agreed upon quantity of certain products at a customer-designated warehouse. Revenue pursuant to the VMI programs is recognized when the products are physically pulled by the customer, or its designated contract manufacturer, and put into production in the manufacture of the customer’s product. Simultaneous with the inventory pulls, purchase orders are received from the customer, or its designated contract manufacturer, as evidence that a purchase request and delivery have occurred and that title and risk of loss have passed to the customer at a previously agreed upon price.

Warranties

The Company sells certain of its products to customers with a product warranty that provides for repairs at no cost to the customer or the issuance of a credit to the customer. The length of the warranty term depends on the product being sold, but generally ranges from one year to five years. In addition to accruing for specific known warranty exposures, the Company accrues its estimated exposure to warranty claims based upon historical claim costs as a percentage of sales multiplied by prior sales still under warranty at the end of any period. Management reviews these estimates on a regular basis and adjusts the warranty provisions as actual experience differs from historical estimates or other information becomes available.

Fair Value of Financial Instruments

The carrying amounts reported in the consolidated balance sheets for trade receivables, trade payables, accrued expenses and short-term debt approximate fair value due to their immediate to short-term maturity.

 

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Fair Value Measurements

Fair value is defined as an exit price, representing the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants based on the highest and best use of the asset or liability. The Company uses valuation techniques to measure fair value that maximize the use of observable inputs and minimize the use of unobservable inputs. Observable inputs are inputs that market participants would use in pricing the asset or liability and are based on market data obtained from sources independent of the Company. Unobservable inputs reflect assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

•

Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 assets or liabilities. Because valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these assets or liabilities does not entail a significant degree of judgment.

 

•

Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Valuations for Level 2 assets or liabilities are prepared on an individual asset or liability basis using data obtained from recent transactions for identical assets or liabilities in inactive markets or pricing data for similar assets or liabilities in active and inactive markets.

 

•

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

As of December 31 and March 31, 2011, the Company had $54.6 million and $59.6 million, respectively, of money market funds classified as cash and cash equivalents that were recorded at fair value based on Level 1 quoted market prices. At December 31, 2011, the Company had four forward foreign currency exchange contracts in place with an aggregate nominal value of $12.0 million classified in other current assets and recorded at a fair value of $0.1 million and at March 31, 2011 the Company had three forward foreign currency exchange contracts in place with an aggregate nominal value of $18.0 million classified in accrued expenses and recorded at a fair value of $0.3 million, in each case based on Level 2 inputs that primarily consisted of foreign currency spot and forward rates quoted by banks or foreign currency dealers. The Company utilizes forward contracts to mitigate foreign exchange currency risk between the Japanese yen and the U.S. dollar on forecasted intercompany sales transactions between its subsidiary units. These foreign currency exchange forward contracts have expiration dates of 120 days or less to hedge a portion of this future risk and the notional value of the contracts did not exceed $24.0 million in aggregate at any point in time during the nine-month period ended December 31, 2011. For the three-month period ended December 31, 2011, a total realized loss of $0.2 million was recorded on the foreign currency exchange forward contracts and was included in cost of goods sold. For the nine-month period ended December 31, 2011, a total realized gain of $0.7 million was recorded on the foreign currency exchange forward contracts and was included in cost of goods sold. For the three-month and nine-month periods ended December 31, 2010, the total realized benefits from the foreign currency exchange forward contracts were $0.4 million and $1.2 million, respectively. The Company does not enter into foreign currency exchange forward contracts for trading purposes, but rather as a hedging vehicle to minimize the effect of foreign currency fluctuations.

Recent Accounting Pronouncements

In June and December 2011, the Financial Accounting Standards Board (the “FASB”) issued guidance on the presentation of comprehensive income. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity and also requires presentation of reclassification adjustments from other comprehensive income to net income on the face of the financial statements. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011, with the exception of the requirement to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements, which has been deferred pending further deliberation by the FASB. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

3. Restructuring Charges

On March 31, 2009, in connection with restructuring undertaken by the Company subsequent to the acquisition of StrataLight Communications, Inc. (“StrataLight”), the Company recorded liabilities of $1.1 million, which included severance and related benefit charges of approximately $0.3 million resulting from workforce reductions across the Company and facility charges of approximately $0.7 million for the Eatontown, New Jersey location in connection with the relocation of the Company’s headquarters to Fremont, California.

 

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As of December 31, 2011, the Company had no recorded liabilities related to the facility consolidation and no recorded liabilities related to workforce reduction. As of March 31, 2011, the Company had no recorded liabilities related to workforce reduction and recorded liabilities related to facility consolidation of $0.2 million. The Company’s accrual for and the change in its restructuring charges for the nine-month periods ended December 31, 2011 and 2010, were as follows (in thousands):

 

		Nine  Months Ended December  31, 2011				Nine Months Ended December 31, 2010
						Workforce
		Facilities				Reduction				Facilities
Beginning accrual balance		$	154			$	121			$	502
Restructuring charges:
Cost of goods sold			—				27				—
Research and development expense			—				201				—
Sales, general and administrative expense			—				53				—
Sales, general and administrative expense adjustments			(124	)			—				—
Cash payments			(30	)			(402	)			(259	)
Ending accrual balance		$	—			$	—			$	243

4. Inventories

Components of inventories are summarized as follows (in thousands):

 

		December 31,				March 31,
		2011				2011
Raw materials		$	74,078			$	64,144
Work-in-process			15,357				17,783
Finished goods			24,813				36,661
Inventories		$	114,248			$	118,588

Inventories included $14.3 million and $19.6 million of inventory consigned to customers and contract manufacturers at December 31 and March 31, 2011, respectively. For the three-month period ended December 31, 2011, the Company recorded a charge of $10.9 million of damaged inventory, consisting of $8.8 million of raw materials and $2.1 million of finished goods, associated with the flooding in Thailand.

5. Property, Plant, and Equipment

Property, plant, and equipment consist of the following (in thousands):

 

		December 31,				March 31,
		2011				2011
Machinery, electronic, and other equipment		$	255,087			$	282,064
Computer software			20,481				19,974
Building improvements			7,352				6,115
Construction-in-progress			5,077				5,233
Total property, plant, and equipment			287,997				313,386
Less accumulated depreciation and amortization			(243,467	)			(253,394	)
Property, plant, and equipment, net		$	44,530			$	59,992

Property, plant and equipment included assets under capitalized leases of $67.6 million and $67.3 million at December 31 and March 31, 2011, respectively, and related accumulated depreciation of $41.0 million and $37.9 million at December 31 and March 31, 2011, respectively. Amortization associated with assets under capital leases is recorded in depreciation expense. Amortization of computer software costs was $0.3 million and $0.2 million for the three-month periods, and $0.9 million and $0.6 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. At December 31, 2011, the Company determined that, in connection with the Thailand flood, $9.7 million of property, plant and equipment, net, consisting of machinery, electronic and other equipment, was impaired having an original cost of $31.9 million. In addition, for the three-month period ended December 31, 2011, the Company recorded a fixed asset impairment charge of $1.1 million for capitalized software expenses deemed not utilizable in the future.

6. Intangible Assets

As a result of the StrataLight acquisition, the Company recorded $46.1 million of intangible assets, including $28.9 million of developed product research with a weighted average life of five years, $13.1 million assigned to order backlog with a weighted average life of seven months, and $4.1 million assigned to customer relationships with a weighted average life of three years.

 

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The components of the intangible assets at December 31, 2011 were as follows (in thousands):

 

		Gross Carrying				Accumulated				Net Carrying
		Amount				Amortization				Amount
Developed product research		$	28,900			$	(17,214	)		$	11,686
Order backlog			13,100				(13,100	)			—
Customer relationships			4,100				(4,071	)			29
Total intangible assets		$	46,100			$	(34,385	)		$	11,715

Intangible assets amortization expense was $1.8 million for each of the three-month periods, and $5.4 million for each of the nine-month periods, ended December 31, 2011 and 2010, respectively. The following table outlines the estimated future amortization expense related to intangible assets as of December 31, 2011 (in thousands):

 

Year Ended March 31,		Amount
2012 (Remaining)		$	1,474
2013			5,780
2014			4,461
Total		$	11,715

Sale of Technology Assets

On February 9, 2011, Opnext Subsystems, Inc., our wholly owned subsidiary, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Juniper Networks, Inc. (“Juniper”) to sell certain technology related to modem application- specific integrated circuits used for long haul/ultra-long optical transmission to Juniper for $26.0 million, $23.5 million of which was paid simultaneously with the execution of the Purchase Agreement and $2.5 million of which was paid on May 6, 2011. The Company incurred $2.1 million and $0.4 million of direct expenses in connection with the payments received on February 9, 2011 and May 6, 2011, respectively. Juniper assumed all liabilities to the extent arising out of or related to the ownership, use and operation of this technology following the sale.

7. Income Taxes

During the three-month period ended December 31, 2011, the Company recorded current income tax expense of less than $0.1 million attributable to income earned in certain foreign tax jurisdictions and certain state tax jurisdictions. For those jurisdictions in which the Company generated operating losses, the Company recorded a valuation allowance to offset potential income tax benefits associated with these operating losses.

During the nine-month period ended December 31, 2011, the Company recorded $0.2 million of current income tax expense attributable to income earned in certain foreign and state tax jurisdictions. For those jurisdictions in which the Company generated operating losses, the Company recorded a valuation allowance to offset potential income tax benefits associated with these operating losses.

During each of the three-month and nine-month periods ended December 31, 2010, the Company recorded current income tax expense of less than $0.1 million attributable to income earned in certain foreign tax jurisdictions and certain state tax jurisdictions. For those jurisdictions in which the Company generated operating losses, the Company recorded a valuation allowance to offset potential income tax benefits associated with these operating losses.

Because of the uncertainty regarding the timing and extent of future profitability, the Company has recorded a valuation allowance to offset potential income tax benefits associated with operating losses and other net deferred tax assets. There can be no assurance that deferred tax assets subject to the valuation allowance will ever be realized.

As of December 31, 2011, the Company did not have any material unrecognized tax benefits, and the Company does not anticipate that its unrecognized tax benefits will significantly change within the next 12 months. The Company recognizes interest and penalties on unrecognized tax benefits as components of income tax expense. The Company did not have any accrued interest or penalties associated with any unrecognized tax benefits as of December 31 and March 31, 2011.

The Company is subject to taxation in the United States, Japan and various state, local and other foreign jurisdictions. The Company’s U.S. income tax returns have been examined by the Internal Revenue Service through the fiscal year ended March 31, 2008. The Company’s New Jersey corporate business tax returns and German tax returns have been examined by the respective tax authorities through the fiscal year ended March 31, 2007. The Company’s Japan tax returns have been examined by the Japan tax authorities through the fiscal year ended March 31, 2006.

 

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The Internal Revenue Service has completed an examination of StrataLight’s 2008 U.S. income tax return; there were no adjustments proposed and the return was accepted as filed. The State of Texas has completed an examination of StrataLight’s 2008 Texas Franchise Tax Report and no material adjustments were proposed.

8. Stockholders’ Equity

Common and Preferred Stock

The Company is authorized to issue 150 million shares of $0.01 par value common stock and 16 million shares of $0.01 par value preferred stock. Each share of the Company’s common stock entitles the holder to one vote on all matters to be voted upon by the shareholders. The board of directors has the authority to issue preferred stock in one or more classes or series and to fix the designations, powers, preferences and rights and qualifications, limitations or restrictions thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any class or series, without further vote or action by the stockholders. As of December 31, 2011, no shares of preferred stock had been issued.

On May 23, 2011, the Company repurchased 51,000 shares of common stock at a cost of $2.86 per share in connection with the payment of the tax withholding obligation related to the issuance of stock bonus awards to certain employees. These shares were recorded at cost.

Rights Agreement

On June 18, 2009, the Company’s board of directors adopted a shareholder rights plan (the “Rights Plan”) designed to protect the Company’s net operating loss carryforwards and other related tax attributes (“NOLs”) that the board of directors considered to be a valuable asset that could be used to reduce future potential federal and state income tax obligations. The rights were designed to deter stock accumulations made without prior approval from the Company’s board of directors that would trigger an “ownership change,” as that term is defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), with the result of limiting the availability for future use of the NOLs to the Company. The Rights Plan was not adopted in response to any known accumulation of shares of the Company’s stock.

On June 22, 2009, the Company distributed a dividend of one preferred stock purchase right on each outstanding share of the Company’s common stock to holders of record on such date. Subject to limited exceptions, the rights will be exercisable if a person or group acquires 4.99% or more of the Company’s common stock or announces a tender offer for 4.99% or more of the common stock.

Under certain circumstances, each right will entitle stockholders to buy one one-hundredth of a share of newly created series A junior participating preferred stock of the Company at an exercise price of $17.00. The Company’s board of directors is entitled to redeem the rights at a price of $0.01 per right at any time before a person has acquired 4.99% or more of the outstanding common stock.

The Rights Plan includes a procedure whereby the board of directors will consider requests to exempt certain proposed acquisitions of common stock from the applicable ownership trigger if the board of directors determines that the requested acquisition will not limit or impair the availability of future use of the NOLs to the Company. The rights will expire on June 22, 2012 or earlier, upon the closing of a merger or acquisition transaction that is approved by the board of directors prior to the time at which a person or group acquires 4.99% or more of the Company’s common stock or announces a tender offer for 4.99% or more of the common stock, or if the board of directors determines that the NOLs have been fully utilized or are no longer available under Section 382 of the Code.

If a person acquires 4.99% or more of the outstanding common stock of the Company, each right will entitle the right holder to purchase, at the right’s then-current exercise price, a number of shares of common stock having a market value at that time of twice the right’s exercise price. The person who acquired 4.99% or more of the outstanding common stock of the Company is referred to as the “acquiring person.” Existing stockholders of the Company who already own 4.99% or more of the Company’s common stock would only be an “acquiring person” if they acquired additional shares of common stock. Rights held by the acquiring person will become void and will not be exercisable. If the Company is acquired in a merger or other business combination transaction that has not been approved by the Company’s board of directors, each right will entitle its holder to purchase, at the right’s then-current exercise price, a number of shares of the acquiring company’s common stock having a market value at that time of twice the right’s exercise price.

On February 8, 2010, Marubeni Corporation filed a Schedule 13G/A reporting events that, when taken together with other changes in ownership of the Company’s common stock by its five percent or greater stockholders during the prior three-year period, constituted an “ownership change” for the Company as such term is defined in Section 382 of the Code, with the result of limiting the availability of the Company’s NOLs for future use.

9. Net Loss Per Share

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the periods presented. Diluted net loss per share includes dilutive common stock equivalents, using the treasury stock method, when dilutive.

 

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The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

 

		Three Months Ended								Nine Months Ended
		December 31								December 31,
		2011				2010				2011				2010
Net loss, basic and diluted		$	(46,336	)		$	(10,180	)		$	(62,538	)		$	(40,867	)
Denominator:
Weighted average shares outstanding — basic and diluted			90,304				89,892				90,246				89,885
Basic and diluted net loss per share		$	(0.51	)		$	(0.11	)		$	(0.69	)		$	(0.45	)

The following table summarizes the potential additional dilution arising from shares of common stock of the Company issuable at the end of each period but that have been excluded as their effect is anti-dilutive (in thousands).

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
Stock options			10,609				12,629				10,609				12,629
Stock appreciation rights			480				516				480				516
Restricted stock units and other			546				339				546				339
Total			11,635				13,484				11,635				13,484

10. Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income as of December 31 and March 31, 2011 were as follows (in thousands):

 

		December 31,				March 31,
		2011				2011
Foreign currency translation adjustment		$	18,821			$	15,879
Unrealized income (loss) on foreign currency forward contracts			66				(271	)
Defined benefit plan costs, net			166				93
Accumulated other comprehensive income		$	19,053			$	15,701

The components of comprehensive loss for the three-month and nine-month periods ended December 31, 2011 and 2010 were as follows (in thousands):

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
Net loss		$	(46,336	)		$	(10,180	)		$	(62,538	)		$	(40,867	)
Other comprehensive income (loss):
Foreign currency translation adjustment			(494	)			1,251				2,942				6,631
Change in valuation of foreign currency forward contracts			73				86				337				548
Change in defined benefit plan actuarial assumptions			25				23				73				67
Total comprehensive loss		$	(46,732	)		$	(8,820	)		$	(59,186	)		$	(33,621	)

11. Employee Benefits

The Company sponsors the Opnext, Inc. 401(k) Plan (the “Plan”) to provide retirement benefits for its U.S. employees. As allowed under Section 401(k) of the Code, the Plan provides tax-deferred salary deductions for eligible employees. Employees may contribute from one percent to 60 percent of their annual compensation to the Plan, subject to an annual limit as set periodically by the Internal Revenue Service. The Company generally matches employee contributions at a ratio of two-thirds of one dollar for each dollar an employee contributes up to a maximum of two-thirds of the first six percent of compensation contributed. All matching contributions vest immediately. The Company’s matching contributions to the Plan totaled $0.2 million for the three-month period, and $0.5 million for the nine-month period, ended December 31, 2011. The Company suspended its matching contributions during the fiscal years ended March 31, 2010 and 2011 and, thus, the Company

 

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made no matching contribution to the Plan for the three-month and nine-month periods ended December 31, 2010. In addition, the Plan provides for discretionary contributions as determined by the board of directors. Such contributions to the Plan, if made, are allocated among eligible participants in the proportion of their salaries to the total salaries of all participants. No discretionary contributions were made in the three-month and nine-month periods ended December 31, 2011 and 2010.

The Company sponsors a defined contribution plan and a defined benefit plan to provide retirement benefits for its employees in Japan. Under the defined contribution plan, contributions are provided based on grade level and totaled $0.3 million and $0.2 million for the three-month periods, and $0.8 million and $0.7 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. The employee can elect to receive the benefit as additional salary or contribute the benefit to the plan on a tax-deferred basis.

Under the defined benefit plan, the Company calculates benefits based on an employee’s individual grade level and years of service. Employees are entitled to a lump sum benefit upon retirement or upon certain instances of termination. As of December 31 and March 31, 2011, there were no plan assets. Net periodic benefit costs for the three-month and nine-month periods ended December 31, 2011 and 2010 were as follows (in thousands):

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
Pension benefit:
Service cost		$	291			$	266			$	856			$	761
Interest cost			36				28				105				80
Amortization of prior service cost			25				23				73				67
Net pension plan loss		$	352			$	317			$	1,034			$	908
Weighted average assumptions used to determine net pension plan loss:
Discount rate			2.00%				2.00%				2.00%				2.00%
Salary increase rate			2.5%				2.7%				2.5%				2.7%
Expected residual active life			14.9 years				15.5 years				14.9 years				15.5 years

The reconciliation of the actuarial present value of the projected benefit obligations for the defined benefit pension plan is as follows (in thousands):

 

		Nine Months Ended December 31,
		2011				2010
Projected benefit obligation at beginning of period		$	6,617			$	4,957
Service cost			856				761
Interest cost			105				80
Benefits paid			(64	)			(35	)
Foreign currency translation			550				807
Project benefit obligation at end of period		$	8,064			$	6,570
		December 31,				December 31,
		2011				2010
Amount recognized in the consolidated balance sheet as follows:
Accrued liabilities		$	145			$	156
Other long-term liabilities			7,919				6,414
Net amount recognized		$	8,064			$	6,570
Amounts recognized in accumulated other comprehensive income as follows:
Net unrealized actuarial gain		$	376			$	279
Prior service cost			(210	)			(276	)
Accumulated other comprehensive income		$	166			$	3

The Company estimates the future benefit payments for the defined benefits plan will be $0.2 million in 2012, $0.1 million in 2013, $0.4 million in 2014, $0.3 million in 2015, $0.5 million in 2016 and $3.6 million in aggregate over the five years 2017 through 2021.

12. Stock-Based Incentive Plans

The Company’s Second Amended and Restated 2001 Long-Term Stock Incentive Plan, as amended, provides for the grant of restricted common shares, restricted stock units, stock options and stock appreciation rights to eligible employees, consultants and directors of the Company and its affiliates. As of December 31, 2011, this plan had 15.3 million shares of common stock available for future grants.

 

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Restricted Stock

Restricted stock units represent the right to receive a share of Opnext stock at a designated time in the future, provided that the stock unit is vested at the time. Restricted stock units granted to non-employee directors generally vest over a one-year period from the grant date. The restricted stock units are convertible into common shares on a one-for-one basis on or within 15 days following the earliest to occur of the date of the director’s separation from service, the date of the director’s death or the date of a change in control of the Company. Recipients of restricted stock units do not pay any cash consideration for the restricted stock units or the underlying shares and do not have the right to vote or any other rights of a shareholder until such time as the underlying shares of stock are distributed.

The following table presents a summary of restricted stock unit activity:

 

		Restricted Stock Units				Weighted- Average Grant Date Fair Value				Aggregate Intrinsic Value				Average Remaining Vesting Period
		(in thousands)				(per share)				(in thousands)				(in years)
Non-vested balance at March 31, 2011			207			$	2.11
Vested			(75	)			2.56
Converted			—				—
Non-vested balance at December 31, 2011			132			$	1.85			$	107				0.1
Vested at December 31, 2011			414			$	2.33			$	334

The Company did not issue any restricted stock units during the nine-month period ended December 31, 2011. The non-vested balance at December 31, 2011 represented issuances to non-employee members of the board of directors as compensation for services to be performed. Total compensation expense of $0.1 million was recognized for all awards in each of the three-month periods, and $0.3 million was recognized for all awards in each of the nine-month periods, ended December 31, 2011 and 2010, respectively.

Employee Incentive Award Program

On June 29, 2011, the compensation committee (the “Committee”) of the board of directors of the Company approved an annual incentive award program (the “Program”) for the Company’s fiscal year ending March 31, 2012. The Program provides for the payment of fully vested shares of the Company’s common stock under the Opnext, Inc. Second Amended and Restated 2001 Long-Term Stock Incentive Plan, as amended, based upon the achievement of pre-established corporate and/or individual performance objectives established by the Committee. The Program is in lieu of an annual cash bonus opportunity for participants in the Program for the Company’s fiscal year ending March 31, 2012 and will be administered by the Committee.

Employees of the Company at specified grade levels, including the Company’s executive officers, are eligible to participate in the Program. The individual performance objectives relate to certain functional goals established by the Committee based on the recipient’s position within the Company, and include, without limitation, goals relating to product delivery and support, organizational and leadership development, market position, operational and departmental objectives, financial and strategic objectives, and supplier related objectives. The Company performance objectives relate to the Company’s achievement of a minimum level of operating income and, for certain recipients, the achievement of other financial goals established for the Company or particular business units of the Company, including, without limitation, contribution margin, inventory management and other operational objectives. The achievement of any performance objectives will be determined by the Committee in its sole discretion. An employee’s right to receive a stock bonus under the Program is subject to and conditioned on his or her active employment with the Company in good standing on the date on which the shares related to such stock bonus are issued. Any payments under the Program are expected to be made following the first regularly scheduled meeting of the Committee that occurs after the close of the Company’s fiscal year ending March 31, 2012 in accordance with the Company’s equity grant policies.

Compensation expense associated with the Program was less than $0.1 million for the three-month period ended December 31, 2011 and was $0.2 million for the nine-month period ended December 31, 2011. During the three-month period ending December 31, 2011, $0.2 million of compensation expense previously recorded during the six-month period ended September 30, 2011 and associated with awards expected to be issued upon the Company’s achievement of a minimum level of operating income was reversed. At December 31, 2011, $0.1 million of additional compensation expense was anticipated to be recorded over the remainder of the fiscal year ending March 31, 2012.

On July 18, 2011, awards consisting of 300,000 restricted shares of the Company’s common stock were issued in connection with a key employee incentive award program. These shares were issued with a fair value of $2.21 per share and vest in two equal installments on the first and second anniversaries of the date of issuance. Total compensation expense associated with the program for the three-month and nine-month periods ended December 31, 2011 was $0.1 million and $0.3 million, respectively. At December 31, 2011, the total compensation costs related to the unvested common stock awards but not recognized was $0.3 million and will be recognized over the remaining vesting period.

Stock Options

Stock option awards to employees generally become exercisable with respect to one-quarter or one-third of the shares awarded on each one-year anniversary of the date of grant and generally have a ten- or seven-year life. At March 31, 2011, the Company had 1,010,000 and 1,000,000 outstanding options that were granted to Hitachi Ltd. (“Hitachi”) and Clarity Partners, L.P., respectively, in connection with the appointment of their employees as directors of the Company. The non-employee options expire ten years from the grant date and were fully vested as of November 2004. Accordingly, no costs were incurred in connection with non-employee options during the nine-month periods ended December 31, 2011 and 2010, respectively. During the three-month period ended December 31, 2011, the 1,000,000 options granted to Clarity Partners, L.P. and 500,000 of the options granted to Hitachi expired unexercised.

 

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The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation and the assumptions noted in the following table:

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
Expected term (in years)			4.75				4.75				4.75				4.75
Volatility			80.3	%			77.8	%			80.0	%			83.7	%
Risk-free interest rate			0.85	%			1.07	%			1.67	%			1.91	%
Forfeiture rate			10.0	%			10.0	%			10.0	%			10.0	%

Compensation expense for employee stock option awards was $0.9 million and $2.3 million for the three-month periods, and $3.7 million and $5.9 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. At December 31, 2011, the total compensation costs related to unvested stock option awards granted under the Company’s stock-based incentive plan but not recognized was $5.9 million and will be recognized over the remaining weighted average vesting period of 1.7 years. The weighted average fair value of options granted were $0.65 and $0.86 during the three-month periods, and $1.76 and $1.33 during the nine-month periods, ended December 31, 2011 and 2010, respectively.

A summary of stock option activity follow:

 

		Shares				Weighted Average Exercise Price				Aggregate Intrinsic Value				Average Remaining Contractual Life
		(in thousands)				(per share)				(in thousands)				(in years)
Balance at March 31, 2011			12,725			$	5.68
Granted			1,467				2.80
Forfeited or expired			(3,511	)			8.90
Exercised			(72	)			1.69
Balance at December 31, 2011			10,609			$	4.24			$	—				6.3
Options exercisable at December 31, 2011			5,980			$	5.55			$	—				6.3

The following table summarizes information concerning outstanding and exercisable options at December 31, 2011:

 

		Options Outstanding												Options Exercisable
Range of Exercise Prices		Number Outstanding				Weighted Average Remaining Life				Weighted Average Exercise Price				Number Exercisable				Weighted Average Remaining Life				Weighted Average Exercise Price
		(in thousands)				(in years)								(in thousands)				(in years)
$0.78 — $1.68			895				7.0			$	1.66				516				7.0			$	1.67
$1.74 — $2.86			6,411				6.7				2.32				2,423				6.9				2.25
$4.47 — $8.89			2,054				6.6				5.98				1,792				6.6				5.56
$11.34 — $15.00			1,249				3.6				13.97				1,249				3.6				13.52
Total			10,609												5,980

Stock Appreciation Rights (SAR)

The Company has awarded stock appreciation rights to its employees in Japan and China. The awards generally vested with respect to one-third or one-quarter of the shares on each of the first three or four anniversaries of the date of grant and have a ten-year life. During the nine-month period ended December 31, 2011, the Company granted 9,100 stock appreciation rights requiring settlement in cash which vest in four years with a seven-year contract life. These rights had a Black-Scholes average fair value of $1.56 per award based on an exercise price of $2.23, a risk-free rate of 1.51% and a volatility rate of 80.0%. As of December 31, 2011, the Company had 515,000 SARs outstanding, 480,000 requiring settlement in the Company’s stock with average remaining lives of 2.5 years and 35,000 requiring settlement in cash with average remaining lives of 2.9 years.

No compensation expense was recorded for vested stock appreciation rights requiring settlement in the Company’s stock for the nine-month period ended December 31, 2011 and $46,000 of compensation expense was recorded for the nine-month period ended December 31, 2010. At December 31, 2011, the total compensation expense related to these stock appreciation rights had been fully recognized. Stock appreciation rights requiring cash settlement are revalued at the end of each reporting period.

 

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13. Short-Term Debt

The Company entered into a 2.0 billion yen loan with The Sumitomo Trust Bank (“Sumitomo”) on March 28, 2008, which is due monthly unless renewed. As of December 31 and March 31, 2011, the outstanding loan balance was $19.5 million or 1.5 billion yen, and $18.0 million or 1.5 billion yen, respectively. Interest is paid monthly at TIBOR plus premium, and was paid at a rate of 1.73% for the three-month and nine-month periods ended December 31, 2011. Interest expense related to the loan was $0.1 million for each of the three-month periods, and $0.2 million and $0.3 million for each of the nine-month periods, ended December 31, 2011 and 2010, respectively.

Total interest expense was $0.3 million for each of the three-month periods, and $0.7 million for each of the nine-month periods, ended December 31, 2011 and 2010, respectively.

14. Concentrations of Risk

At December 31 and March 31, 2011, cash and cash equivalents consisted primarily of investments in overnight money market funds with several major financial institutions in the United States.

The Company sells primarily to customers involved in the application of laser technology and the manufacture of data and telecommunications products. For the three-month period ended December 31, 2011, sales to two customers in aggregate, Cisco Systems, Inc. and subsidiaries (“Cisco”) and Hitachi, represented 42.6 % of total revenues. For the nine-month period ended December 31, 2011, sales to Cisco represented more than ten percent of revenues. No other customer accounted for more than 10% of revenues in any of these fiscal periods. For the three-month period ended December 31, 2010, sales to two customers in aggregate, Alcatel-Lucent and Cisco, represented 32.8% of total revenues. For the nine-month period ended December 31, 2010, sales to three customers in aggregate, Alcatel-Lucent, Cisco and Huawei Technologies Co. Ltd. (“Huawei”), represented 45.9% of total revenues. No other customer accounted for more than 10% of revenues in any of these fiscal periods. At December 31, 2011, Hitachi, Cisco, and Nokia Siemens Networks in aggregate accounted for 49.9% of total accounts receivable and at March 31, 2011, Hitachi and Huawei in aggregate accounted for 27.2% of total accounts receivable.

15. Commitments and Contingencies

The Company leases buildings and certain other property. Rental expense under these operating leases was $0.9 million for each of the three-month periods, and $2.5 million and $2.7 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. Operating leases associated with leased buildings include escalating lease payment schedules. Expense associated with these leases is recognized on a straight-line basis. In addition, the Company has entered into capital leases with Hitachi Capital Corporation for certain equipment. The table below shows the future minimum lease payments due under non-cancelable capital leases with Hitachi Capital Corporation and operating leases at December 31, 2011(in thousands):

 

		Capital				Operating
		Leases				Leases
Year ending March 31:
2012 (Remaining)		$	3,120			$	767
2013			10,501				2,440
2014			4,880				808
2015			4,608				469
2016			3,378				438
Thereafter			1,080				226
Total minimum lease payments			27,567			$	5,148
Less amount representing interest			(1,802	)
Present value of capitalized payments			25,765
Less current portion			(14,517	)
Long-term portion		$	11,248

As of December 31, 2011, the Company had outstanding purchase commitments of $55.3 million, primarily for the purchase of raw materials expected to be transacted within the next fiscal year.

 

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The Company’s accrual for and the change in its product warranty liability, which is included in accrued expenses, are as follows (in thousands):

 

		Nine Months Ended December 31,
		2011				2010
Beginning balance		$	3,838			$	7,583
Warranty provision on products sold			643				1,337
Warranty claims processed			(1,307	)			(2,057	)
Warranty expirations and changes to prior estimates			(874	)			(2,527	)
Foreign currency translation			157				262
Ending balance		$	2,457			$	4,598

On March 27, 2008, Furukawa Electric Co. (“Furukawa”) filed a complaint against Opnext Japan, Inc., the Company’s wholly owned subsidiary (“OPJ” or “Opnext Japan”), in the Tokyo District Court, alleging that certain laser diode modules sold by Opnext Japan infringe Furukawa’s Japanese Patent No. 2,898,643 (the “Furukawa Patent”). The complaint sought an injunction as well as 300.0 million yen in royalty damages. Opnext Japan filed its answer on May 7, 2008 stating therein its belief that it does not infringe the Furukawa Patent and that the Furukawa Patent is invalid. On February 24, 2010, the Tokyo District Court entered judgment in favor of Opnext Japan, which judgment was appealed by Furukawa to the Intellectual Property High Court on March 9, 2010. On September 5, 2011, the Intellectual Property High Court ruled in favor of Opnext Japan, holding Furukawa’s patent to be invalid. On September 5, 2011, Furukawa appealed the judgment of the Intellectual Property High Court to the Supreme Court of Japan. The Company intends to defend itself vigorously in this litigation.

On May 27, 2011, Opnext Japan filed a complaint against Furukawa in the Tokyo District Court, alleging that certain laser diode modules sold by Furukawa infringe Opnext Japan’s Japanese patent No. 3,887,174. Opnext Japan is seeking an injunction as well as damages in the amount of 100.0 million yen. On August 5, 2011, Opnext Japan filed a complaint against Furukawa in the Tokyo District Court, alleging that certain integrable tunable laser assemblies sold by Furukawa infringe Opnext Japan’s Japanese patent No. 4,124,845. Opnext Japan is seeking an injunction as well as damages in the amount of 200.0 million yen.

On September 2, 2011, Tyco Electronics Subsea Communications, LLC (“Tyco”) filed a complaint against the Company in the Supreme Court of the State of New York, alleging that the Company failed to meet certain obligations owed to Tyco pursuant to a non-recurring engineering development agreement entered into between the Company and Tyco. The complaint seeks contract damages in an amount not less than $1 million, punitive damages, costs and attorneys’ fees and such other relief as such court deems just and proper. The Company filed a motion to dismiss this complaint on October 14, 2011. The Company intends to defend itself vigorously in this litigation.

16. Related Party Transactions

OPI was incorporated on September 18, 2000 (date of inception) in Delaware as a wholly owned subsidiary of Hitachi, a corporation organized under the laws of Japan. As of March 31, 2011, Hitachi held approximately 31% of OPI’s outstanding common stock and one executive of Hitachi is a member of OPI’s Board of Directors.

The Company enters into transactions with Hitachi and its subsidiaries in the normal course of business. Sales to Hitachi and its subsidiaries were $10.3 million and $10.0 million for the three-month periods, and $23.2 million and $22.5 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. Purchases from Hitachi and its subsidiaries were $6.2 million and $5.7 million for the three-month periods, and $18.5 million and $18.9 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. Amounts paid for services and certain facility leases provided by Hitachi and its subsidiaries were $0.8 million and $1.0 million for the three-month periods, and $2.6 million and $2.4 million for the nine-month periods, ended December 31, 2011 and 2010, respectively. At December 31 and March 31, 2011, the Company had accounts receivable from Hitachi and its subsidiaries of $9.2 million and $8.6 million, respectively. In addition, at December 31 and March 31, 2011, the Company had accounts payable to Hitachi and its subsidiaries of $6.1 million and $6.2 million, respectively. The Company has also entered into capital equipment leases with Hitachi Capital Corporation as described in Note 15.

Sales Transition Agreement

Under the terms and conditions of the Sales Transition Agreement, Hitachi, through a wholly owned subsidiary, provides certain logistic services to Opnext in Japan. Specific charges for such services were $0.2 million and $0.3 million for the three-month periods, and $0.8 million and $1.0 million for the nine-month periods, ended December 31, 2011 and 2010, respectively.

Intellectual Property License Agreements

Opnext Japan and Hitachi are parties to two intellectual property license agreements pursuant to which Hitachi licenses certain intellectual property rights to Opnext Japan on the terms and subject to the conditions stated therein on a fully paid, nonexclusive basis and Opnext Japan licenses certain intellectual property rights to Hitachi on a fully paid, nonexclusive basis. Hitachi has also agreed to sublicense certain intellectual property to Opnext Japan to the extent that Hitachi has the right to make available such rights to Opnext Japan in accordance with the terms and subject to the conditions stated therein.

 

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In October 2002, Opnext Japan and Hitachi Communication Technologies, Ltd., a wholly owned subsidiary of Hitachi, entered into an intellectual property license agreement pursuant to which Hitachi Communication Technologies, Ltd. licenses certain intellectual property rights to Opnext Japan on a fully paid, nonexclusive basis, and Opnext Japan licenses certain intellectual property rights to Hitachi Communication Technologies, Ltd. on a fully paid, nonexclusive basis, in each case on the terms and subject to the conditions stated therein.

Opnext Japan Research and Development Agreement

Opnext Japan and Hitachi are parties to the Opnext Japan Research and Development Agreement pursuant to which Hitachi provides certain research and development support to Opnext Japan in accordance with the terms and conditions of the agreement. Intellectual property resulting from certain research and development projects is owned by Opnext Japan and licensed to Hitachi on a fully paid, nonexclusive basis. Intellectual property resulting from certain other research and development projects is owned by Hitachi and licensed to Opnext Japan on a fully paid, nonexclusive basis. Certain other intellectual property is jointly owned. The agreement expires on February 20, 2012. The research and development expenditures relating to this agreement are generally negotiated semi-annually on a fixed-fee project basis and were $1.0 million and $0.8 million for the three-month periods, and $2.9 million and $2.6 million for the nine-month periods, ended December 31, 2011 and 2010, respectively.

Opnext Research and Development Agreement

Opnext and Hitachi are parties to a research and development agreement pursuant to which Hitachi provides certain research and development support to Opnext and/or its affiliates other than Opnext Japan. Opnext is charged for research and development support on the same basis that Hitachi’s wholly owned subsidiaries are allocated research and development charges for their activities. Additional fees may be payable by Opnext to Hitachi if Opnext desires to purchase certain intellectual property resulting from certain research and development projects. Intellectual property resulting from certain research and development projects is owned by Opnext and licensed to Hitachi on a fully paid, nonexclusive basis and intellectual property resulting from certain other research and development projects is owned by Hitachi and licensed to Opnext on a fully paid, nonexclusive basis in accordance with the terms and conditions of the Opnext Research and Development Agreement. Certain other intellectual property is jointly owned. The agreement expires on February 20, 2012.

Preferred Provider and Procurement Agreements

Pursuant to the terms and conditions of the Preferred Provider Agreement, subject to Hitachi’s product requirements, Hitachi agreed to purchase all of its optoelectronics component requirements from Opnext, subject to product availability, specifications, pricing, and customer needs as defined in the agreement. Pursuant to the terms and conditions of the Procurement Agreement, Hitachi agreed to provide Opnext each month with a rolling three-month forecast of products to be purchased, the first two months of such forecast to be a firm and binding commitment to purchase. Although each of these agreements was terminated on July 31, 2008 by mutual agreement of the parties, Opnext has continued to sell to Hitachi and its subsidiaries under the general arrangements established by these agreements. Sales under these arrangements were $10.3 million and $10.0 million for the three-month periods, and $23.2 million and $22.5 million for the nine-month periods, ended December 31, 2011 and 2010, respectively.

Raw Materials Supply Agreement

Pursuant to the terms and conditions of the Raw Materials Supply Agreement, Hitachi agreed to continue to make available for purchase by Opnext laser chips, other semiconductor devices and all other raw materials that were provided by Hitachi to the business prior to or as of July 31, 2001 for the production of Opnext optoelectronics components. By mutual agreement of the parties, the agreement was terminated on July 31, 2008. However, Opnext has continued to make purchases from Hitachi and its subsidiaries under the arrangements established by the agreement. Purchases under the arrangements were $6.2 million and $5.7 million for the three-month periods, and $18.5 million and $18.9 million for the nine-month periods, ended December 31, 2011 and 2010, respectively.

Outsourcing Agreement

Pursuant to the terms and conditions of the Outsourcing Agreement, Hitachi agreed to provide on an interim, transitional basis various data processing services, telecommunications services and corporate support services, including: accounting, financial management, information systems management, tax, payroll, human resource administration, procurement and other general support. By mutual agreement of the parties, the agreement was terminated on July 31, 2008. However, Hitachi has continued to make various services available to Opnext under the arrangements established pursuant to the Outsourcing Agreement. Expenses pursuant to these arrangements were $0.8 million and $1.0 million for the three-month periods, and $2.6 million and $2.4 million for the nine-month periods, ended December 31, 2011 and 2010, respectively.

Software User License Agreement with Renesas Technology

Opnext Japan and Renesas Technology, a subsidiary of Hitachi, are parties to a software user license agreement pursuant to which Renesas Technology grants to Opnext Japan a non-exclusive, royalty-free, fully paid right to duplicate, modify or alter proprietary software for use in developing, manufacturing and selling Opnext Japan’s products, which includes Renesas Technology’s microcomputer product or a version of the program for such product. The agreement also grants Opnext Japan the right to sublicense to third parties the right to use a copy of such proprietary software as a component part of Opnext Japan’s products, including the right to sublicense to a third party service provider for purposes of production of such software or manufacturing of Opnext Japan’s products. The initial agreement had a term of one year with automatic one-year renewals unless terminated earlier by mutual agreement. The current term expires on October 20, 2012.

 

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Secondment Agreements

Opnext Japan and Hitachi entered into a one-year secondment agreement effective February 1, 2001 with automatic annual renewals. Per the agreement, Opnext may offer employment to any seconded employee, however, approval must be obtained from Hitachi in advance. All employees listed in the original agreement have either been employed by Opnext or have returned to Hitachi. In addition to the original agreement, additional secondment agreements have been entered into with terms that range from two to three years, however, Hitachi became entitled to terminate these agreements after July 31, 2005. The seconded employees are covered by the Hitachi, Ltd. Pension Plan. There were eight and seven seconded employees as of December 31 and March 31, 2011, respectively.

Lease Agreements

Opnext Japan leases certain manufacturing and administrative premises from Hitachi located in Totsuka, Japan. The term of the lease commenced on February 1, 2001 and is renewable annually provided neither party notifies the other of its contrary intent. The current term of the lease expires on December 31, 2012. The annual lease payments for these premises were $0.2 million for each of the three-month periods, and $0.7 million and $0.6 million for each of the nine-month periods, ended December 31, 2011 and 2010, respectively. In addition, Opnext Japan leases certain manufacturing and administrative premises from Renesas Technology. The lease expires on March 31, 2016. The lease payments for these properties were less than $0.1 million for each of the three-month periods, and $0.1 million for each of the nine-month periods, ended December 31, 2011 and 2010, respectively.

17. Operating Segments and Geographic Information

Operating Segments

The Company operates in one business segment — optical subsystems, modules and components. Optical subsystems, modules and components transmit and receive data delivered via light in telecommunication, data communication, industrial and commercial applications.

Geographic Information

 

		Three Months Ended								Nine Months Ended
		December 31,								December 31,
		2011				2010				2011				2010
		(in thousands)								(in thousands)
Revenues:
North America		$	24,658			$	40,463			$	111,758			$	107,846
Japan			13,864				16,618				36,125				39,358
Europe			9,074				19,630				35,852				56,651
Asia Pacific			5,470				20,340				48,445				58,438
Total		$	53,066			$	97,051			$	232,180			$	262,293

Revenues attributed to geographic areas are based on the bill-to location of the customer.

 

		December 31,				March 31,
		2011				2011
		(in thousands)
Assets:
North America		$	158,673			$	208,356
Japan			134,741				144,696
Europe			9,709				21,305
Total		$	303,123			$	374,357

The geographic designation of assets represents the country in which title is held.

18. Subsequent Events

On January 13, 2012, Opnext Japan and Hitachi entered into a Master Research Services Agreement pursuant to which Hitachi will provide research and development support to Opnext Japan and/or its affiliates on terms and conditions to be agreed on a project-by-project basis. To the extent any intellectual property (patents, copyrights, mask works, software or trade secrets) results from research funded by Opnext Japan, Hitachi has agreed to assign the right to such intellectual property to Opnext Japan in return for the payment of a nominal fee. In all other cases, Hitachi will own any intellectual property resulting from the research. Opnext Japan will license to Hitachi any such intellectual property owned by Opnext Japan, and Hitachi will license to Opnext Japan any such intellectual property owned by Hitachi, in each case on a royalty-free and non-exclusive basis. The effective term of the agreement shall commence on February 15, 2012 and terminate on March 31, 2015; provided, however, that the agreement shall be extended for additional periods of one (1) year each unless either party notifies the other in writing of its intent to terminate the agreement at least three (3) months prior to the expiration of the original term or of any extended term.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

The following discussion relates to our consolidated financial statements and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from the forward-looking statement. Although the information is based on our current expectations, actual results could vary from expectations stated in this report. Numerous factors will affect our actual results, some of which are beyond our control. These include: the ongoing impact of the flooding in Thailand, including, but not limited to, the possibility that our customers could scale back or cancel orders in light of perceived or real production and delivery constraints, the possibility that we could encounter unexpected difficulties in connection with our efforts to recover the supply chain and production capacity disrupted as a result of the flooding in Thailand, or the possibility that we could incur material unusual charges and expenses in connection with our recovery efforts; uncertainty surrounding the ongoing impact of the earthquake and tsunami in Japan; the impact of natural events such as severe weather or earthquakes in other locations in which we, our customers, our contract manufacturers, or our suppliers operate; the impact of rapidly changing technologies; the impact of competition on product development and pricing; the success of our research and development efforts; our ability to source critical parts and to react to changes in general industry and market conditions, including regulatory developments; expenses associated with litigation; rights to intellectual property; market trends and the adoption of industry standards; our ability to realize the value from the acquisition of StrataLight Communications, Inc.; consolidations within or affecting the optical modules and components industry; current and future economic conditions and events and their impact on us and our customers; the strength of telecommunications and data communications markets; competitive market conditions; interest rate levels; volatility in our stock price; and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this quarterly report. We assume no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under federal securities laws to disclose material information. For a discussion of important risks related to our business, and related to investing in our securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information, see Part I, Item 1A of our Annual Report on Form 10-K filed with the SEC on June 14, 2011. The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in Item 1 of this report and our audited consolidated financial statements and notes for the fiscal year ended March 31, 2011, included in our Annual Report on Form 10-K filed with the SEC on June 14, 2011.

Overview and Background

We were incorporated as a wholly owned subsidiary of Hitachi, Ltd., or Hitachi, in September of 2000. In July of 2001, Clarity Partners, L.P. and related investment vehicles invested in us and we became a majority owned subsidiary of Hitachi. In October 2002, we acquired Hitachi’s opto device business and expanded our product line into select industrial and commercial markets. In June 2003, we acquired Pine Photonics Communication Inc. (“Pine”) and expanded our product line to include SFP transceivers with data rates less than 10Gbps that are sold to telecommunication and data communication customers. In February 2007, we completed our initial public offering of common stock on the NASDAQ market. On January 9, 2009, we completed our acquisition of StrataLight Communications, Inc. (“StrataLight”), which expanded our product line to include 40Gbps subsystems.

We have sales and marketing offices strategically located in close proximity to our major customers in the U.S., Europe, Japan and China. We also have research and development facilities that are co-located with each of our manufacturing facilities in the U.S. and Japan. In addition, we use contract manufacturers that are located in China, Japan, the Philippines, Taiwan, Thailand and the U.S. Certain of our contract manufacturers that assemble or produce modules are strategically located close to our customers’ contract manufacturing facilities to shorten lead times and enhance flexibility.

Flooding in Thailand

On October 22, 2011, flood waters resulting from heavy seasonal rains infiltrated the offices and manufacturing floor space of our primary contract manufacturer, Fabrinet, at its Chokchai campus in Pathum Thani, Thailand. Production at Fabrinet’s Chokchai factory remains suspended and is unlikely to resume. As a result, we have relocated limited production capacity to our manufacturing facilities in Totsuka, Japan and Fremont, California. In addition, we are diverting a portion of the 10Gbps module production capacity previously at Fabrinet’s Chokchai facility to Fabrinet’s Pinehurst facility, located approximately seven miles north of Chokchai. Fabrinet has allocated surface mount technology (SMT) lines at Pinehurst to us and new test systems are being constructed to replace systems lost in the flooding. We anticipate that Fabrinet will start production this month and ramp production as new test systems come online. We are also in the process of engaging an additional contract manufacturer with the goal of dual sourcing the manufacturing of certain high volume products. We had restored approximately 20 percent of the lost 10Gbps module production capacity by the end of December, and we expect a return to pre-flood production capacity by March 31, 2012.

We expect that the loss of production capacity at Fabrinet will have significant impact on our operations and ability to meet customer demand for our products during the quarter ending March 31, 2012. We lost a significant amount of revenue in our third fiscal

 

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quarter ended December 31, 2011 as a result of the flooding and we expect that the loss of revenue in the fourth fiscal quarter ending March 31, 2012 will be material as well. Multiple factors will affect the extent of revenue loss, including, but not limited to, our ability to move production to other locations, our ability to source parts from suppliers that have been impacted by the flooding or from alternative suppliers in instances where we have had to locate alternatives, our ability to recapture business from customers that took their business to our competitors as a result of our loss of production capacity, and our ability to incrementally increase production at our other facilities.

In addition to the loss of revenue, we have experienced a significant loss of equipment and inventory in connection with the flooding at Fabrinet’s facility. At the time of the flooding, we had production equipment at the Chokchai facility, primarily consisting of 10Gbps module test sets, with an original cost of approximately $33.4 million. We also had approximately $14.6 million of inventory with Fabrinet in Thailand, consisting of approximately $8.8 million of raw materials and $5.7 million of finished goods. During the quarter ended December 31, 2011, we recorded charges of $9.7 million for fixed asset impairments and $10.9 million for damaged inventory resulting from the flood. While Fabrinet maintains insurance for the equipment and inventory located at the facility (and we maintain independent insurance for a portion of the inventory) and there are additional contractual protections in favor of us that Fabrinet has stated it will honor, it is not clear that the insurance will be adequate to fully cover our losses or that we will otherwise be made whole.

Japan Earthquake and Tsunami

On March 11, 2011, the northeast coast of Japan experienced a severe earthquake followed by a tsunami, with continuing aftershocks from the earthquake. These geological events caused significant damage in the region, including severe damage to nuclear power plants, and impacted Japan’s power and other infrastructure as well as its economy.

Our industrial and commercial production facility located in Komoro, Japan and our Tokyo sales office were undamaged by the earthquake and operations at these facilities resumed shortly following the earthquake. Our module assembly facility in Totsuka, Japan suffered minor disruption from the earthquake and production at this facility was reinstated on March 21, 2011. While our chip production facility in Totsuka also suffered minor damage, production at this facility did not fully resume until mid-April, however, due to the time required to recalibrate and verify the proper operation of the equipment. While certain of our suppliers located in Japan were also impacted by the earthquake and tsunami, we were able to obtain alternative sources of supply or implement other measures.

We were also impacted by power outages in the Totsuka area in March and April 2011 and we have installed backup power systems to mitigate the impact of any future interruptions. Nonetheless, uncertainty persists regarding the availability of electrical power. There is a risk that we could in the future experience interruptions to our production or delays or other constraints in obtaining key components and/or price increases related to such components that could materially adversely affect our financial condition and operating results.

The ten-day interruption in our module manufacturing operations resulted in some loss of revenue in the fiscal quarters ended March 31 and June 30, 2011. Although the value of equipment and inventory damaged by the earthquake was minimal, we experienced approximately $1.0 million, and $0.2 million, of idle capacity costs in the fiscal quarters ended March 31, and June 30, 2011 respectively.

Sale of Technology Assets

On February 9, 2011, Opnext Subsystems, Inc., our wholly-owned subsidiary entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Juniper Networks, Inc. (“Juniper”) to sell certain technology related to modem application-specific integrated circuits used for long haul/ultra-long optical transmission to Juniper for $26 million, $23.5 million of which was paid simultaneously with the execution of the Purchase Agreement and $2.5 million of which was paid on May 6, 2011. We incurred $2.1 million and $0.4 million of direct expenses in connection with the payments received on February 9, 2011 and May 6, 2011, respectively. Juniper assumed all liabilities to the extent arising out of or related to the ownership, use and operation of this technology following the sale.

Revenues

Through our direct sales force supported by manufacturer representatives and distributors, we sell products to many of the leading network systems vendors throughout North America, Europe, Japan and Asia. Our customers include many of the top telecommunications and data communications network systems vendors in the world. We also supply components to several major transceiver module companies and we sell to select industrial and commercial customers. Sales to telecommunication and data communication customers, our communication sales, accounted for 87.4% and 91.9% of our total revenues during the three-month periods, and 89.6% and 91.5% of our total revenues during the nine-month periods, ended December 31, 2011 and 2010, respectively. Sales of our communication products with 10Gbps or lower data rates, which we refer to as our “10Gbps and below products,” represented 49.4% and 63.6% of our total revenues during the three-month periods, and 52.5% and 66.4% of our total revenues during the nine-month periods, ended December 31, 2011 and 2010, respectively. Sales of our communications products with 40Gbps or higher rates, which we refer to as our “40Gbps and above products,” represented 38.0% and 28.2% of our total revenues during the three-month periods, and 37.1% and 25.1% of our total revenues during the nine-month periods, ended December 31, 2011 and 2010, respectively. The term “sales” when used herein in reference to our 40Gbps and above products includes revenues received pursuant to research and development agreements.

The number of leading network systems vendors that supply the global telecommunications and data communications markets is concentrated and so, in turn, is our customer base. For the three-month period ended December 31, 2011, sales to two customers in aggregate, Cisco Systems, Inc. and subsidiaries (“Cisco”) and Hitachi, represented 42.6% of our total revenues, and for the nine-month period ended December 31, 2011, sales to Cisco represented greater than ten percent of our total revenues. No other customer accounted for more than ten percent

 

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of revenues in any of these periods. For the three-month period ended December 31, 2010, sales to two customers in aggregate, Alcatel-Lucent and Cisco, represented 32.8% of our total revenues. For the nine-month period ended December 31, 2010, sales to three customers in aggregate, Alcatel-Lucent, Cisco and Huawei Technologies Co., Ltd. (“Huawei”), represented 45.9% of our total revenues. Although we continue to attempt to expand our customer base, we anticipate that a small number of customers will continue to represent a significant portion of our total revenues.

During the three-month periods ended December 31, 2011 and 2010, sales attributed to North America represented 46.5% and 41.7% of our total revenues, sales attributed to Japan represented 26.1% and 17.1% of our total revenues, sales attributed to Europe represented 17.1.% and 20.2% of our total revenues, and sales attributed to Asia Pacific (excluding Japan) represented 10.3% and 21.0%, respectively. During the nine-month periods ended December 31, 2011 and 2010, sales attributed to North America represented 48.1% and 41.1% of our total revenues, sales attributed to Asia Pacific (excluding Japan) represented 20.9% and 22.3% of our total revenues, sales attributed to Japan represented 15.6% and 15.0% of our total revenues, and sales attributed to Europe represented 15.4% and 21.6% of our total revenues, respectively.

Because certain sales transactions and the related assets and liabilities are denominated in currencies other than the U.S. dollar, primarily the Japanese yen, our revenues are exposed to market risks related to fluctuations in foreign currency exchange rates. For example, for the three-month periods ended December 31, 2011 and 2010, 25.9% and 17.7% of our sales were denominated in Japanese yen, respectively, and for each of the nine-month periods ended December 31, 2011 and 2010, 15.6% of our sales were denominated in Japanese yen. To the extent we continue to generate a significant portion of our sales in currencies other than the U.S. dollar, our revenues will continue to be affected by foreign currency exchange rate fluctuations.

Cost of Sales and Gross Margin

Our cost of sales primarily consists of materials, including components, that are either assembled at one of our three internal manufacturing facilities, or at one of our several contract manufacturers or procured from third-party vendors. Because of the complexity and proprietary nature of laser manufacturing, and the advantage of having our internal manufacturing resources co-located with our research and development staffs, most of the lasers used in our optical module and component products are manufactured in our facilities in Komoro and Totsuka, Japan. Our materials include certain parts and components that are purchased from a limited number of suppliers or, in certain situations, from a single supplier. Our cost of sales also includes labor costs for employees and contract laborers engaged in the production of our components and the assembly of our finished goods, outsourcing costs, the cost and related depreciation of manufacturing equipment, as well as manufacturing overhead costs, including the costs for product warranty repairs and inventory adjustments for excess and obsolete inventory.

Our cost of sales is exposed to market risks related to fluctuations in foreign currency exchange rates because a significant portion of our costs and the related assets and liabilities are denominated in Japanese yen. During the three-month periods ended December 31, 2011 and 2010, 44.5% and 49.9%, respectively, of our cost of sales was denominated in Japanese yen and during the nine-month periods ended December 31, 2011 and 2010, 44.2% and 46.7%, respectively, of our cost of sales was denominated in Japanese yen.

Our gross margins vary among our product lines and are generally higher on our 40Gbps and above and longer distance 10Gbps products. Our gross margins are also generally higher on products where we enjoy a greater degree of vertical integration with respect to the subcomponents of such products. Our overall gross margins primarily fluctuate as a result of our overall sales volumes, changes in average selling prices and product mix, the introduction of new products and subsequent generations of existing products, manufacturing yields, our ability to reduce product costs and fluctuations in foreign currency exchange rates. Our gross margins are also impacted by amortization of acquired developed technology resulting from the acquisition of StrataLight.

Research and Development Expenses

Research and development expenses consist primarily of salaries and benefits of personnel related to the design, development and quality testing of new products or enhancement of existing products, as well as outsourced services provided by Hitachi’s research laboratories pursuant to our contractual agreements. We incurred $1.0 million and $0.8 million of expenses in connection with these agreements during the three-month periods, and $2.9 million and $2.6 million during the nine-month periods, ended December 31, 2011 and 2010, respectively. In addition, our research and development expenses include the cost of developing prototypes and material costs associated with the testing of products prior to shipment, the cost and related depreciation of equipment used in the testing of products prior to shipment, and the expenses associated with other contract research and development related services.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries and benefits for our employees that perform our sales and related support, marketing, supply chain management, finance, legal, information technology, human resource and other general corporate functions, as well as internal and outsourced logistics and distribution costs, commissions paid to our manufacturers’ representatives, professional fees and other corporate related expenses. Selling, general and administrative expenses also include the costs associated with pending litigation.

Inventory

Certain of our more significant customers have implemented a supply chain management tool called vendor managed inventory (“VMI”) that requires suppliers, such as us, to assume responsibility for maintaining an agreed upon level of consigned inventory at the customer’s

 

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location or at a third-party logistics provider based on the customer’s demand forecast. Notwithstanding the fact that we build and ship the inventory, the customer does not purchase the consigned inventory until the inventory is drawn or pulled by the customer or third-party logistics provider to be used in the manufacture of the customer’s product. Though the consigned inventory may be at the customer’s or the third-party logistics provider’s physical location, it remains inventory owned by us until the inventory is drawn or pulled, which is the time at which the sale takes place. Given that under such programs we are subject to the production schedule and inventory management decisions of the customer or the third-party logistics provider, our participation in VMI programs generally requires us to carry higher levels of finished goods inventory than we might otherwise carry. As of December 31 and March 31, 2011, inventories included $3.5 million and $9.7 million, respectively, of inventory consigned to customers or their third-party logistics providers pursuant to VMI arrangements.

Income Taxes

We are subject to taxation in the United States, Japan and various state, local and other foreign jurisdictions. Our U.S. income tax returns have been examined by the Internal Revenue Service through the fiscal year ended March 31, 2008. The Company’s New Jersey corporate business tax returns and German tax returns have been examined by the respective tax authorities through the fiscal year ended March 31, 2007. The Company’s Japan tax returns have been examined by the Japan tax authorities through the fiscal year ended March 31, 2006.

The Internal Revenue Service has completed an examination of StrataLight’s 2008 U.S. income tax return; there were no adjustments proposed and the return was accepted as filed. The State of Texas has completed an examination of StrataLight’s 2008 Texas Franchise Tax Report and no material adjustments were proposed

Factors That May Influence Future Results of Operations

Flooding in Thailand

On October 22, 2011, flood waters resulting from heavy seasonal rains infiltrated the offices and manufacturing floor space of our primary contract manufacturer, Fabrinet, at its Chokchai campus in Pathum Thani, Thailand. Production at Fabrinet’s Chokchai factory remains suspended and is unlikely to resume. As a result, we have relocated limited production capacity to our manufacturing facilities in Totsuka, Japan and Fremont, California. In addition, we are diverting a portion of the 10Gbps module production capacity previously at Fabrinet’s Chokchai facility to Fabrinet’s Pinehurst facility, located approximately seven miles north of Chokchai. We anticipate that Fabrinet will start production in February 2012 and ramp production as new test systems come online. We are also in the process of engaging an additional contract manufacturer with the goal of dual sourcing the manufacturing of certain high volume products. We had restored approximately 20 percent of the lost 10Gbps module production capacity by the end of December, and we expect a return to pre-flood production capacity by March 31, 2012.

We expect that the loss of production capacity at Fabrinet will have significant impact on our operations, results of operations and ability to meet customer demand for our products in the quarter ending March 31, 2012. We lost a significant amount of revenue in our third fiscal quarter ended December 31, 2011 as a result of the flooding and we expect that the loss of revenue in the fourth fiscal quarter ending March 31, 2012 will be material as well. Multiple factors will affect the extent of revenue loss, including, but not limited to, our ability to move production to other locations, our ability to source parts from suppliers that have been impacted by the flooding or from alternative suppliers in instances where we have had to locate alternatives, our ability to recapture business from customers that took their business to our competitors as a result of our loss of production capacity, and our ability to incrementally increase production at our other facilities. In addition, we have incurred and expect in the future to incur significant charges and expenses related to the flooding in Thailand and the recovery from the flooding, including fixed asset impairments, inventory write-downs, and charges related to qualifications of our products after the flooding. During the quarter ended December 31, 2011, as a result of the flooding, we recorded charges of $9.7 million for fixed asset impairments and $10.9 million for damaged inventory. We expect that we will also incur additional expenses and charges, estimated to be in the range of $2.0 million to $3.0 million, in the quarter ending March 31, 2012 primarily related to the recovery of production after the flooding.

Prior to January 1, 2012, Fabrinet maintained insurance coverage that provided for reimbursement of losses resulting from flood damage to our property over which it had custody and control and we maintained independent coverage for the inventory we held at Fabrinet. Because we and Fabrinet have yet to make claims with respect to our losses, we cannot yet estimate the amount or timing of any proceeds we may ultimately receive under the insurance policies or in respect of any contractual claims we may have against Fabrinet. In addition, because of specified exclusions and limitations in these policies, we may ultimately recover substantially less than our losses. Finally, as a result of the flooding, as of January 1, 2012 Fabrinet no longer has flood insurance to cover our assets at its facilities in Thailand. While we are working closely with them to secure coverage, we cannot guarantee that they or we will be successful. In the event we were to experience a significant uninsured loss in Thailand or elsewhere, it could have a material adverse effect on our business, financial condition and results of operations.

Global Economic Conditions

In recent years, the credit and financial markets have experienced significant volatility characterized by the bankruptcy, failure, collapse or sale of various financial institutions, increased volatility in securities and commodities prices and currency rates, severely diminished liquidity and credit availability, concern over the economic stability of certain economies in Europe and a significant level of intervention from the United States and other governments, as applicable. Continued concerns about the systemic impact of potential long-term or widespread recession, the adverse effects of the ongoing sovereign debt crisis in Europe, difficulties associated with increasing the debt ceiling or reducing the overall level of debt in the United States, unemployment, energy costs, geopolitical issues including government deficits, the availability and cost of credit, and reduced consumer confidence have contributed to diminished expectations for most developed and emerging economies and periods of increased market volatility. Continued turbulence in the United States and international markets and global economies could restrict our ability and the ability of our customers to refinance indebtedness, increase the cost or decrease the availability of credit, limit access to capital necessary to meet liquidity needs and materially harm operations or the ability to implement planned business strategies. With respect to our customers, these factors could also negatively impact the timing and amount of infrastructure spending, further negatively impacting our sales. For a more detailed discussion of our capital needs, please see the section “Management’s Discussion and Analysis of Financial Conditions and Results of Operations — Liquidity and Capital Resources” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

Japan Earthquake and Tsunami

The March 11, 2011 earthquake and tsunami in Japan resulted in a ten-day interruption in our manufacturing operations at our module assembly facility in Totsuka, Japan and an approximate five-week disruption to full production at our chip production facility also located in Totsuka. Certain of our suppliers located in Japan were also impacted by the earthquake and tsunami, and in certain instances we had to obtain alternative sources of supply or implement other measures.

 

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These events in Japan caused significant damage to Japan’s power infrastructure and, during March and April 2011, we were impacted by power outages in the Totsuka area. While we have installed backup power systems to mitigate the impact of any future interruptions, uncertainty still exists with respect to the availability of electrical power. Thus, there is a risk that we could in the future experience interruptions to our production or delays or other constraints in obtaining key components and/or price increases related to such components that could materially adversely affect our financial condition and operating results.

Fluctuations of the Japanese Yen and the U.S. Dollar

The Japanese yen has appreciated significantly relative to the U.S. dollar in the past several years. For example, one U.S. dollar approximated 100 Japanese yen on March 31, 2008, 81 Japanese yen on December 31, 2010 and 77 Japanese yen on December 31, 2011. Our operating results are sensitive to fluctuations in the relative value of the Japanese yen and U.S. dollar because certain of our sales, costs and expenses and the related assets and liabilities are denominated in Japanese yen. As a result, fluctuations in the relative value of the Japanese yen and U.S. dollar impact both our revenues and our operating costs. Our sales denominated in Japanese yen represented 25.9% and 17.7% of our revenues in the three-month periods, respectively, and 15.6% of our revenues for each of the nine-month periods, ended December 31, 2011 and 2010, respectively. The percentage of our cost of sales denominated in Japanese yen was 44.5% and 49.9% for the three month periods, and 44.2% and 46.7% for the nine-month periods, ended December 31, 2011 and 2010, respectively. We anticipate that the percentage of our cost of sales denominated in Japanese yen is likely to increase in the near term as we have relocated manufacturing capacity impacted by the flooding in Thailand to our facilities in Japan. Over the longer term, however, we would expect the percentage of our cost of sales denominated in Japanese yen to diminish as we expand the use of contract manufacturers outside of Japan and procure more raw materials in U.S. dollars. As long as a substantial percentage of our cost of sales remains denominated in Japanese yen, continued appreciation in the value of the Japanese yen relative to the U.S. dollar could increase our operating costs and, therefore, adversely affect our financial condition and results of operations. In addition, to the extent we continue to generate a significant portion of our sales in Japanese yen or other currencies, our future revenues will continue to be affected by foreign currency exchange rate fluctuations, and could be materially adversely affected.

Impact of Price Declines and Supply Constraints on Revenues

Our revenues are affected by capital spending of our customers for telecommunications and data communications networks and for lasers and infrared LEDs used in select industrial and commercial markets. The primary markets for our products continue to be characterized by increasing demand, primarily driven by increases in traditional telecommunication and data communication traffic and increasing demand for high bandwidth applications, such as video and music downloads and streaming, on-line gaming, peer-to-peer file sharing and IPTV, as well as new industrial and commercial laser applications. The increased unit volumes as service providers deploy network systems has contributed — along with intense price competition among optical component manufacturers, excess capacity, and the introduction of next generation products — to the market for optical components continuing to be characterized by declining average selling prices. In recent years, we have observed a modest acceleration in the decline of average selling prices. We anticipate that our average selling prices will continue to decrease in future periods, although we cannot predict the extent of these decreases for any particular period.

Our revenues are also impacted by our ability to procure critical component parts for our products from our suppliers. During the last several years, the number of suppliers of component parts has decreased significantly and, more recently, demand for component parts has increased rapidly. Any supply deficiencies relating to the quality or quantities of components we use to manufacture our products can adversely affect our ability to fulfill customer orders and our results of operations. For example, during the calendar year ended December 31, 2010, we experienced significant limitations on the availability of components from certain of our suppliers, resulting in losses of anticipated sales and the related revenues. We cannot be assured that such limitations will not reoccur in the future.

Effect of Product Life Cycle and Product Mix on Gross Margins

In recent periods, certain of our products that operate at 10Gbps data rates have generated reduced gross margins, which reduced margins we believe are attributable to, among other factors, the increased average age of such products, delays in the development of certain internal subcomponents, our low level of vertical integration, as well as intensified competition in these product groups. To the extent that we are unable to introduce, or experience delays in introducing, the next generation of these products, or to the extent we are unsuccessful in achieving a desirable level of vertical integration with respect to the subcomponents of these products, we may continue to experience diminished gross margins in connection with the sales of these products.

In addition, certain of our customers, particularly the larger China-based OEMs, are developing their own internally produced 40 Gbps modules for use in their systems in addition to purchasing from third party suppliers such as us. We anticipate this trend will continue on a case-by-case basis and that price will continue to be a critical selection factor. Given that our gross margins are generally higher on 40Gbps and above products, continuation of this unfavorable trend could negatively affect future gross margins.

As data and telecommunication networks transition to next generation systems, quarterly demand for our 40Gbps and above products may be volatile. For example, our 40Gbps and above revenues in the quarter ended December 31, 2011 declined by $11.9 million, or 37.1%, from the quarter ended September 30, 2011, and our 40Gbps and above revenues in the quarter ended March 31, 2011 increased by $10.3 million, or 36.9%, from the quarter ended December 31, 2010. In addition, we experienced a 90% decline in sales of our 40Gbps subsystems products over five consecutive quarterly periods through the quarter ended June 30, 2010 as 40Gbps module technology initially became available. Continuation of this volatility or declines could negatively affect future gross margins, given that our gross margins are generally higher on our 40G and above products.

 

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Research and Development Expense

Our research and development expense will vary with our efforts to meet the anticipated market demand for our new and planned products and to support enhancements to our existing products. We believe that focused investments in research and development are critical to our future growth and competitive position and are directly related to timely development of new and enhanced products that are central to our core business strategy. As such, we expect to make further investments in research and development to remain competitive and we expect that our financial results will vary depending on the level of such investments in any particular period.

Selling, General and Administrative Expenses

We expect that out selling, general and administrative expenses will fluctuate with sales volumes and be impacted by the continuing costs associated with pending litigation.

Critical Accounting Policies

There have been no significant changes in our critical accounting policies, which are described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

Unaudited Results of Operations for the Three-Month and Nine-Month Periods Ended December 31, 2011 and 2010

The following table reflects the unaudited results of our operations in U.S. dollars and as a percentage of sales. Our historical operating results may not be indicative of the results of any future period.

 

		Three Months Ended December 31,																Nine Months Ended December 31,
		2011				2010				2011				2010				2011				2010				2011				2010
		(in thousands)								(as percentage of sales)								(in thousands)								(as percentage of sales)
Revenues		$	53,066			$	97,051				100.0	%			100.0	%		$	232,180			$	262,293				100.0	%			100.0	%
Cost of sales			49,623				76,244				93.5	%			78.6	%			188,260				206,218				81.1	%			78.6	%
Amortization of developed product research			1,445				1,445				2.7	%			1.5	%			4,335				4,355				1.9	%			1.7	%
Gross margin			1,998				19,362				3.8	%			20.0	%			39,585				51,740				17.0	%			19.7	%
Research and development expenses			13,193				13,656				24.9	%			14.1	%			40,679				46,480				17.5	%			17.7	%
Selling, general and administrative expenses			12,904				15,369				24.3	%			15.8	%			40,844				43,773				17.6	%			16.7	%
Amortization of purchased intangibles			342				342				0.6	%			0.4	%			1,026				1,026				0.4	%			0.4	%
Flood related impairment and other charges, and loss on disposal of property and equipment			21,774				—				41.0	%			0.3	%			21,649				239				9.3	%			0.1	%
Operating loss			(46,215	)			(10,005	)			(87.1	)%			(10.3	)%			(64,613	)			(39,778	)			(27.8	)%			(15.2	)%
Gain on sale of technology assets, net			—				—				0.0	%			0.0	%			2,078				—				0.8	%			—
Interest expense, net			(228	)			(225	)			(0.4	)%			(0.2	)%			(656	)			(614	)			(0.3	)%			(0.2	)%
Other income (expense), net			136				124				0.3	%			0.1	%			836				(354	)			0.4	%			(0.1	)%
Loss before income taxes			(46,307	)			(10,106	)			(87.2	)%			(10.4	)%			(62,355	)			(40,746	)			(26.9	)%			(15.5	)%
Income tax expense			(29	)			(74	)			(0.1	)%			(0.1	)%			(183	)			(121	)			(0.0	)%			(0.1	)%
Net loss		$	(46,336	)		$	(10,180	)			(87.3	)%			(10.5	)%		$	(62,538	)		$	(40,867	)			(26.9	)%			(15.6	)%

Comparison of the Three-Month Periods Ended December 31, 2011 and 2010

Revenues. Revenues in the three-month period ended December 31, 2011 decreased $44.0 million, or 45.3%, to $53.1 million, compared to $97.1 million for the three-month period ended December 31, 2010. Revenue from sales of 10Gbps and below products decreased $35.6 million, or 57.6%, to $26.2 million compared to $61.8 million in the three-month period ended December 31, 2010. The decrease was primarily due to lower sales of all 10Gbps and below products due to the loss of production capacity at Fabrinet’s Chokchai facility resulting from the October floods in Thailand. Revenue from sales of 40Gbps and above products decreased $7.2 million, or 26.3%, to $20.2 million compared to $27.4 million in the three-month period ended December 31, 2010, primarily as a result of a decrease in sales of 40Gbps line-side modules. Revenue from sales of our industrial and commercial products decreased $1.2 million, or 15.2%, to $6.7 million compared to $7.9 million in the three-month period ended December 31, 2010.

 

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Gross Margin. Gross margin in the three-month period ended December 31, 2011 decreased $17.4 million, or 89.7%, to $2.0 million, compared to $19.4 million for the three-month period ended December 31, 2010. Gross margin for the three-month period ended December 31, 2011 included a $2.1 million negative effect from foreign currency exchange rate fluctuations, net of the benefit from our hedging program. Gross margin for each of the three-month periods ended December 31, 2011 and 2010 included $1.4 million of developed product technology amortization expense associated with the acquisition of StrataLight. In addition, gross margin for the three-month period ended December 31, 2011 included a $2.1 million inventory charge resulting from discontinuation of a 10Gbps product and gross margin for the three-month periods ended December 31, 2011 and 2010 included charges of $1.7 million and $0.6 million, respectively, for excess and obsolete inventory.

Gross margin as a percentage of sales decreased to 3.8% for the three-month period ended December 31, 2011 from 20.0% for the corresponding period in 2010 due to lower sales due to the impact of the Thailand flood, lower average selling prices and the negative effect from fluctuations in foreign currency exchange rates, partially offset by the favorable impact of higher 40Gbps and above product sales as a percentage of total sales, lower excess and obsolete inventory charges and lower average per unit material and outsourcing costs.

Research and Development Expenses. Research and development expenses decreased $0.5 million to $13.2 million for the three-month period ended December 31, 2011, from $13.7 million for the three-month period ended December 31, 2010, despite a $0.5 million increase from fluctuations in foreign currency exchange rates. Research and development expenses increased as a percentage of sales to 24.9% for the three-month period ended December 31, 2011, from 14.1% for the corresponding period in 2010, as a result of lower revenues due to the Thailand flood. The decrease in research and development expenses was due to lower outsourcing costs associated with new product introductions and lower employee-related costs.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $2.5 million to $12.9 million for the three-month period ending December 31, 2011, from $15.4 million for the three-month period ended December 31, 2010, despite a $0.3 million increase from fluctuations in foreign currency exchange rates. Selling, general and administrative expenses decreased as a percentage of sales to 24.3% for the three-month period ended December 31, 2011, from 15.8% for the corresponding period in 2010, as a result of lower revenues due to the Thailand flood. The decrease in selling, general and administrative expenses was due to lower employee-related costs and reduced professional services expenses.

Amortization of Purchased Intangibles. Amortization of purchased intangibles related to the acquisition of StrataLight was $0.3 million for each of the three-month periods ended December 31, 2011 and 2010, and all such amortization related to customer relationships.

Flood Related Impairment and Other Charges, and Loss on Disposal of Property and Equipment . During the three-month period ended December 31, 2011, we recorded charges of $10.9 million for fixed assets and $9.7 million for inventory damaged in the flooding in Thailand. In addition, we recorded a fixed asset impairment charge of $1.1 million for capitalized software expenses deemed not utilizable in the future and a $0.1 million loss on disposal of property and equipment.

Interest Expense, Net. Interest expense, net, was $0.2 million for each of the three-month periods ended December 31, 2011 and 2010 and consisted of interest expense on short-term debt and capital lease obligations partially offset by interest income earned on cash and cash equivalents.

Other Income (Expense), net. Other income, net, was $0.1 million for each of the three-month periods ended December 31, 2011 and 2010, and consisted primarily of net exchange gains on foreign currency transactions.

Income Tax Expense. During each of the three-month periods ended December 31, 2011 and 2010, we recorded less than $0.1 million of current income tax expense attributable to income earned in certain foreign tax jurisdictions and certain state tax jurisdictions. For those jurisdictions in which we generated operating losses, we recorded a valuation allowance to offset potential income tax benefits associated with these operating losses.

Because of the uncertainty regarding the timing and extent of future profitability, we have recorded a valuation allowance to offset potential income tax benefits associated with operating losses and other net deferred tax assets. There can be no assurance that deferred tax assets subject to the valuation allowance will ever be realized.

Comparison of the Nine-Month Periods Ended December 31, 2011 and 2010

Revenues. Overall revenues decreased $30.1 million, or 11.5%, to $232.2 million in the nine-month period ended December 31, 2011, from $262.3 million in the nine-month period ended December 31, 2010. During the nine-month period ended December 31, 2011, revenues from sales of our 40Gbps and above products increased $20.3 million, or 30.8%, to $86.2 million, primarily as a result of an increase in 40Gbps subsystems and 100Gbps modules sales. Revenue from sales of our 10Gbps and below products decreased $52.1 million, or 29.9%, to $121.9 million compared to $174.1 million in the nine-month period ended December 31, 2010, due to the effects of the Thailand Flood in October 2011 as well as lower sales of XFP and 300 PIN modules, partially offset by increased sales of X2 and SFP+ modules. Revenue from sales of our industrial and commercial products increased $1.7 million, or 7.6%, to $24.1 million compared to $22.3 million in the nine-month period ended December 31, 2010.

Gross Margin. Gross margin decreased $12.2 million, or 23.5%, to $39.6 million in the nine-month period ended December 31, 2011, from $51.7 million in the nine-month period ended December 31, 2010. Gross margin for the nine-month period ended December 31, 2011,

 

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included a $5.7 million negative effect from fluctuations in foreign currency exchange rates, net of the benefit from our hedging program. Gross margin for each of the nine-month periods ended December 31, 2011 and 2010 included $4.3 million of developed product technology amortization expense associated with the acquisition of StrataLight. In addition, gross margin for the nine-month periods ended December 31, 2011 and 2010 included charges of $3.8 million and $2.0 million, respectively, for excess and obsolete inventory charges. Also included in the nine-month period ended December 31, 2011 was a $2.1 million inventory charge resulting from discontinuation of a 10Gbps product.

As a percentage of sales, gross margin decreased to 17.0% for the nine-month period ended December 31, 2011, from 19.7% for the nine-month period ended December 31, 2010, due to the unfavorable impact of the Thailand flood on production volumes, a decline in average selling prices and the negative effects of fluctuations in foreign currency exchange rates, partially offset by higher 40Gbps and above sales volumes, lower excess and obsolete inventory charges and lower average per unit material and outsourcing costs.

Research and Development Expenses. Research and development expenses decreased by $5.8 million to $40.7 million in the nine-month period ended December 31, 2011 from $46.5 million in the nine-month period ended December 31, 2010, notwithstanding a $2.3 million increase due to fluctuations in foreign currency exchange rates. Research and development expenses decreased as a percentage of sales to 17.5% for the nine-month period ended December 31, 2011 from 17.7% for the nine-month period ended December 31, 2010, as a result of lower employee costs and reduced expenses for outsourcing and professional services.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased by $3.0 million to $40.8 million in the nine-month period ended December 31, 2011 from $43.8 million in the nine-month period ended December 31, 2010, despite a $1.2 million increase from fluctuations in foreign currency exchange rates. Selling, general and administrative expenses increased as a percentage of sales to 17.6% for the nine-month period ended December 31, 2011 from 16.7% for the corresponding period in 2010. The decrease in expenses was due primarily to lower employee-related costs.

Amortization of Purchased Intangibles. Amortization of purchased intangibles related to the acquisition of StrataLight was $1.0 million for each of the nine-month periods ended December 31, 2011 and 2010 and was entirely related to customer relationships.

Flood Related Impairment and Other Charges, and Loss on Disposal of Property and Equipment. During the nine-month period ended December 31, 2011, we recorded charges of $10.9 million for fixed assets and $9.7 million for inventory damaged in the flooding in Thailand. In addition, we recorded a fixed asset impairment charge of $1.1 million for capitalized software expenses deemed not utilizable in the future and a $0.1 million loss on disposal of property and equipment. For the nine-month period ended December 31, 2010 we recorded a loss on disposal of property and equipment of $0.2 million.

Gain on Sales of Technology Assets, Net. Gain on sale of technology assets, net was $2.1 million for the nine-month period ended December 31, 2011. Total proceeds of $2.5 million from the sale of technology assets were partially offset by $0.4 million of associated direct expenses.

Interest Expense, Net. Interest expense, net was $0.7 million and $0.6 million for the nine-month periods ended December 31, 2011 and 2010, respectively. Interest expense, net for the nine-month periods ended December 31, 2011 and 2010 primarily consisted of interest expense on short-term debt and capital lease obligations, partially offset by interest income earned on cash and cash equivalents. The increase in interest expense primarily reflects the increase in capital lease obligations.

Other Income (Expense), Net. Other income, net was $0.8 million for the nine-month period ended December 31, 2011 and consisted primarily of net exchange gains on foreign currency transactions, and other expense, net was $0.4 million in the corresponding period in 2010 and consisted primarily of net exchange losses on foreign currency transactions.

Income Tax Expense. During the nine-month periods ended December 31, 2011 and 2010, we recorded $0.2 million and $0.1 million, respectively, of current income tax expense attributable to income earned in certain foreign and state tax jurisdictions. For those jurisdictions in which we generated operating losses, we recorded a valuation allowance to offset potential income tax benefits associated with these operating losses.

Because of the uncertainty regarding the timing and extent of future profitability, we have recorded a valuation allowance to offset potential income tax benefits associated with operating losses and other net deferred tax assets. There can be no assurance that deferred tax assets subject to the valuation allowance will ever be realized.

Liquidity and Capital Resources

        During the nine-month period ended December 31, 2011, cash and cash equivalents decreased by $15.1 million to $85.2 million from $100.3 million at March 31, 2011. This decrease consisted primarily of $5.0 million of net cash used in operating activities, $6.9 million of capital lease payments and $5.2 million of capital expenditures, partially offset by $2.1 million of net proceeds from the sale of technology assets. Net cash used in operating activities primarily reflected our net loss of $62.5 million, excluding a $2.1 million net gain on the sale of technology assets, partially offset by a decrease in net current assets excluding cash and cash equivalents of $10.2 million, impairment and flood charges and loss on disposal of property and equipment of $21.6 million, depreciation and amortization of $17.9 million, amortization of purchased intangibles of $5.4 million, and non-cash stock-based compensation expense of $4.5 million. The decrease in net current assets excluding cash and cash equivalents primarily resulted from lower accounts receivable and lower levels of inventory partially offset by a decrease in accounts payable. During the nine-month period ended December 31, 2011, we also entered into $4.5 million of new capital lease obligations.

 

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We believe that existing cash and cash equivalents will be sufficient to fund our anticipated cash needs for at least the next twelve months. However, we may require additional financing to fund our operations in the future and there can be no assurance that additional funds will be available, especially if we experience operating results below expectations, or, if available, there can be no assurance as to the terms on which funds might be available. In addition, unprecedented volatility in the global credit markets may affect the availability and cost of funding in the future. If adequate financing is not available as required, or is not available on favorable terms, our business, financial position and results of operations will be adversely affected.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements or unconsolidated special purpose entities.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Our exposure to market risk consists of foreign currency exchange rate fluctuations related to our international sales and operations and changes in interest rates on cash and cash equivalents and short-term debt.

To the extent we generate sales in currencies other than the U.S. dollar, our revenues will be affected by foreign currency exchange rate fluctuations. For the three-month periods ended December 31, 2011 and 2010, 25.9% and 17.7%, respectively, of our sales were denominated in Japanese yen and 1.6% and 1.0%, respectively, of our sales were denominated in euros. The remaining sales were denominated in U.S. dollars. For each of the nine-month periods ended December 31, 2011 and 2010, 15.6% of our sales were denominated in Japanese yen. For the nine-month periods ended December 31, 2011 and 2010, 1.5% and 0.9%, respectively, of our sales were denominated in euros. The remaining sales were denominated in U.S. dollars.

To the extent we manufacture our products in Japan, our cost of sales will be affected by foreign currency exchange fluctuations. During the three-month and nine-month periods ended December 31, 2011 and 2010, approximately 44.5% and 49.9%, and 44.2% and 46.7%, respectively, of our cost of sales were denominated in Japanese yen. We anticipate that the percentage of our cost of sales denominated in Japanese yen is likely to increase in the near term as we have relocated manufacturing capacity impacted by the flooding in Thailand to our facilities in Japan. Over the longer term, however, we would anticipate that the percentage of our cost of sales denominated in Japanese yen to diminish as we plan to expand the use of contract manufacturers outside of Japan and procure more raw materials in U.S. dollars. As long as a substantial percentage of our cost of sales remains denominated in Japanese yen, continued appreciation in the value of the Japanese yen relative to the U.S. dollar could increase our operating costs and, therefore, adversely affect our financial condition and results of operations.

To the extent we perform research and development activities and selling, general and administrative functions in Japan, our operating expenses will be affected by foreign currency exchange rate fluctuations. During the three-month and nine-month periods ended December 31, 2011 and 2010, approximately 49.3% and 42.6%, and 47.4% and 40.3%, respectively, of our operating expenses were denominated in Japanese yen. We anticipate that a substantial portion of our operating expenses will continue to be denominated in Japanese yen in the foreseeable future.

To the extent that our sales, cost of sales and operating expenses are denominated in Japanese yen, our operating results will be subject to fluctuations due to changes in foreign currency exchange rates. If the exchange rate of the Japanese yen in relation to the U.S dollar had appreciated by ten percent during the three-month and nine-month periods ending December 31, 2011, our operating loss would have increased by approximately $1.2 million and $8.7 million, respectively. If the exchange rate had depreciated by ten percent during the three-month and nine-month periods ending December 31, 2011, our operating loss would have been reduced by approximately $1.0 million and $7.1 million, respectively.

As of December 31 and March 31, 2011, we had net payable positions of $5.6 million and $10.7 million, respectively, subject to foreign currency exchange risk between the Japanese yen and the U.S. dollar. We are also exposed to foreign currency exchange risk between the Japanese yen and the U.S. dollar on intercompany sales transactions involving the Japanese yen and the U.S. dollar. At December 31, 2011, we had four forward currency exchange contracts in place to hedge a portion of this risk with an aggregate nominal value of $12.0 million, and at March 31, 2011, we had three forward currency exchange contracts in place to hedge a portion of this risk with an aggregate nominal value of $18.0 million, in each case with expiration dates of 120 days or less. We do not enter into foreign currency exchange forward contracts for trading purposes but rather as a hedging vehicle to minimize the effects of foreign currency exchange fluctuations. We have estimated that a 10% fluctuation in the Japanese yen between December 31, 2011 and the maturity date of the foreign currency exchange forward contracts currently held would lead to a gain of $1.3 million if the Japanese yen were to appreciate, or a loss of $1.1 million if the Japanese yen were to depreciate, and the contracts were held to maturity.

We have entered into a short-term, yen-denominated loan with The Sumitomo Trust Bank which is due monthly unless renewed. At December 31 and March 31, 2011, the outstanding loan balance was $19.5 million and $18.0 million, respectively. The increase of $1.5 million was due to changes in foreign currency exchange rates. Interest is paid monthly at TIBOR plus a premium, and was paid at a rate of 1.73% for the nine-month period ended December 31, 2011 and a rate that ranged from 1.26% to 1.50% during the nine-month period ended December 31, 2010. Total interest expense was $0.3 million and $0.2 million for three-month periods ended December 31, 2011 and 2010, repectively, and $0.6 million for each of the nine-month periods ended December 31, 2011 and 2010, respectively.

 

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To the extent we maintain significant cash balances in money market accounts, our interest income will be affected by interest rate fluctuations. As of December 31 and March 31, 2011, we had $85.2 million and $100.3 million, respectively, of cash balances invested primarily in traded institutional money market funds or money market deposit accounts at banking institutions.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

Our Chief Executive Officer and Chief Financial Officer, after evaluating with management the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) or Rule 15d-15(e) under the Exchange Act) as of December 31, 2011, have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level based on their evaluation of these controls and procedures required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) or Rule 15d-15(f) under the Exchange Act), which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that occurred during the three-month period ended December 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

On March 27, 2008, Furukawa Electric Co. (“Furukawa”) filed a complaint against Opnext Japan, Inc., the Company’s wholly owned subsidiary (“OPJ” or “Opnext Japan”), in the Tokyo District Court, alleging that certain laser diode modules sold by Opnext Japan infringe Furukawa’s Japanese Patent No. 2,898,643 (the “Furukawa Patent”). The complaint sought an injunction as well as 300.0 million yen in royalty damages. On February 24, 2010, the Tokyo District Court entered judgment in favor of Opnext Japan, which judgment was appealed by Furukawa to the Intellectual Property High Court on March 9, 2010. On September 5, 2011, the Intellectual Property High Court ruled in favor of Opnext Japan, holding Furukawa’s patent to be invalid. On September 5, 2011, Furukawa appealed the judgment of the Intellectual Property High Court to the Supreme Court of Japan. The Company intends to defend itself vigorously in this litigation.

On May 27, 2011, Opnext Japan filed a complaint against Furukawa in the Tokyo District Court alleging that certain laser diode modules sold by Furukawa infringe Opnext Japan’s Japanese patent No. 3,887,174. Opnext Japan is seeking an injunction as well as damages in the amount of 100.0 million yen.

On August 5, 2011, Opnext Japan filed a complaint against Furukawa in the Tokyo District Court alleging that certain integratable tunable laser assemblies sold by Furukawa infringe Opnext Japan’s Japanese patent No. 4,124,845. Opnext Japan is seeking an injunction as well as damages in the amount of 200.0 million yen.

On September 2, 2011, Tyco Electronics Subsea Communications, LLC (“Tyco”) filed a complaint against the Company in the Supreme Court of the State of New York, alleging that the Company failed to meet certain obligations owed to Tyco pursuant to a non-recurring engineering development agreement entered into between the Company and Tyco. The complaint seeks contract damages in an amount not less than $1 million, punitive damages, costs and attorneys’ fees and such other relief as such court deems just and proper. The Company filed a motion to dismiss this complaint on October 14, 2011. The Company intends to defend itself vigorously in this litigation.

Item 1A. Risk Factors.

There have been no material changes to our risk factors as previously disclosed in the Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. (Removed and Reserved)

Item 5. Other Information.

None.

Item 6. Exhibits

 

Exhibit No.		Description of Document
3.1		Form of Amended and Restated Certificate of Incorporation of Opnext, Inc.(1)
3.2		Form of Amended and Restated Bylaws of Opnext, Inc.(1)
3.3		Specimen of stock certificate for common stock.(1)

 

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Exhibit No.		Description of Document
31.1*		Certification of Principal Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Principal Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**		The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statement of Operations, (iii) the Condensed Consolidated Statements of Shareholder’s Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) related notes, tagged as blocks of text.

 

(1)	Filed as an exhibit to the Form S-1 Registration Statement (No. 333-138262) declared effective on February 14, 2007 and incorporated herein by reference.

*	Filed herewith.

**	Furnished herewith and not ‘filed’ for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

+	Management contract or compensatory plan or arrangement.

 

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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.

 

Date: February 9, 2012

 

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Exhibit Index

 

Exhibit No.		Description of Document
3.1		Form of Amended and Restated Certificate of Incorporation of Opnext, Inc.(1)
3.2		Form of Amended and Restated Bylaws of Opnext, Inc.(1)
3.3		Specimen of stock certificate for common stock.(1)
31.1*		Certification of Principal Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Principal Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**		The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statement of Operations, (iii) the Condensed Consolidated Statements of Shareholder’s Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) related notes, tagged as blocks of text.

 

(1)	Filed as an exhibit to the Form S-1 Registration Statement (No. 333-138262) declared effective on February 14, 2007 and incorporated herein by reference.

*	Filed herewith.

**	Furnished herewith and not ‘filed’ for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

+	Management contract or compensatory plan or arrangement.

 

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