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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 28, 2014

Or



TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file number 000-31581

 

 

OPLINK COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

46335 Landing Parkway, Fremont, CA 94538

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (510) 933-7200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 

The number of outstanding shares of the Registrant's common stock, $0.001 par value, as of  October 26, 2014, was 16,968,556. 

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OPLINK COMMUNICATIONS, INC.

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

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PART I.  FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

OPLINK COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

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OPLINK COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

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OPLINK COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

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

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OPLINK COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

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OPLINK COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Description of Business

The Company

Oplink Communications, Inc. ("Oplink" or the "Company") was incorporated in California in September 1995 and was reincorporated in Delaware in September 2000. The Company is headquartered in Fremont, California and has manufacturing, design and research and development facilities in Zhuhai, Shanghai and Wuhan, China and in Taipei and Hsinchu, Taiwan.

The Company designs, manufactures and sells optical networking components and subsystems. Its products expand optical bandwidth, amplify optical signals, monitor and protect wavelength performance, redirect light signals, ensure signal connectivity and provide signal transmission and reception within an optical network. Its products enable greater and higher quality bandwidth over longer distances, which reduces network congestion and transmission cost per bit. Its products also enable optical system manufacturers to provide flexible and scalable bandwidth to support the increase of data traffic on the Internet and other public and private networks.

The Company offers its customers design, integration and optical manufacturing solutions ("OMS") for the production and packaging of highly-integrated optical subsystems and turnkey solutions, based upon a customer's specific product design and specifications. The Company also offers solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions.

The Company's product portfolio also includes optical transmission products that broaden the addressable markets as well as the range of solutions that the Company can now offer its customers. The Company's transmission products consist of a comprehensive line of high-performance fiber optic modules, including fiber optic transmitters, receivers, transceivers, and transponders, primarily for use in metropolitan area network ("MAN"), local area network ("LAN"), and fiber-to-the-home ("FTTH") applications. Fiber optic modules are the integration of pre-assembled components that are used to build network equipment. The Company's transmission products convert data signals between optical domain and electronic domain, thereby facilitating the transmission of information over fiber optic communication networks.

The Company also has a business division, Oplink Connected, which has developed and is selling wireless security and home automation systems that can be monitored and managed with a Smartphone app. The security systems are plug-and-play solutions that are easy to install and eliminate the need for professional installation. As the Company continues to focus on driving shareholder value and increasing operational efficiencies, the Company has commenced a process to seek strategic alternatives for Oplink Connected, including a possible sale of all or part of the business. The Oplink Connected business has been classified as discontinued operations, see "Note 11. Discontinued Operations and Assets Held For Sale".

Note 2 - Basis of Presentation

The unaudited condensed consolidated financial statements included herein have been prepared by the Company in conformity with accounting principles generally accepted in the United States of America ("U.S.") and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the U.S., have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, these unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of the Company as of September 28, 2014, the results of its operations for the three month periods ended September 28, 2014 and September 29, 2013 and its cash flows for the three month periods ended September 28, 2014 and September 29, 2013. The results of operations for the periods presented are not necessarily indicative of those that may be expected for the full year. The condensed consolidated financial statements presented herein have been prepared by management, without audit by independent auditors who do not express an opinion thereon, and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended June 29, 2014. The June 29, 2014 condensed consolidated balance sheet data was derived from audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended June 29, 2014 but does not include all disclosures required for annual periods. Certain reclassifications have been made to conform to the current period's presentation.

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The Company operates and reports using a fiscal year, which ends on the Sunday closest to June 30. Fiscal 2015 and Fiscal 2014 are 52-week fiscal years.

The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company presents the financial information of some of its foreign operating subsidiaries in its condensed consolidated financial statements utilizing accounts as of a date one month earlier than the accounts of its parent company to ensure timely reporting of condensed consolidated results.

The Company conducts its business within one business segment and has no organizational structure dictated by product, service lines, geography or customer type.

There have been no significant changes in the Company's significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended June 29, 2014.

Note 3 - Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 uses a five-step model to determine revenue recognition in contracts with customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard permits the use of either the retrospective or cumulative effect transition method. This standard is effective for fiscal years beginning after December 15, 2016. The Company is currently evaluating the impact of this new guidance on its condensed consolidated financial statements and related disclosures.

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. ASU 2014-08 redefines discontinued operations as disposals representing a strategic shift in operations and having a major effect on the organization's operations and financial results. The new standard is effective for fiscal years beginning after December 15, 2014. The Company is currently evaluating the impact of this new guidance on its condensed consolidated financial statements and related disclosures.

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Note 4 - Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and dilutive potential common shares outstanding during the period, if dilutive. Potentially dilutive common equivalent shares are composed of the incremental common shares issuable upon the exercise of stock options, the vesting of awards and purchases under the employee stock purchase plan. The following is the computations of the basic and diluted net income (loss) per share and the anti-dilutive common stock equivalents excluded from the computations for the periods presented (in thousands, except per share data):

Note 5 – Accumulated Other Comprehensive Income

The changes in accumulated other comprehensive income by component and related tax effects during the three months ended September 28, 2014 were as follows (in thousands):

Note 6 - Cash and Cash Equivalents

 The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company's cash equivalents consist primarily of money market funds and corporate commercial paper.

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Note 7 - Investments

Available-for-Sale and Held-to-Maturity Investments

The Company generally invests its excess cash in certificates of deposit, debt instruments of the U.S. Treasury, Government agencies, corporations with strong credit ratings and equity securities in publicly traded companies. Such investments are made in accordance with the Company's investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The available-for-sale investments are reported at their fair value. Unrealized gains and losses on these securities are reported as a separate component of accumulated other comprehensive income until realized. The investment securities which the Company has the ability and intent to hold until maturity are classified as held-to-maturity investments and are stated at amortized cost.

Investments as of September 28, 2014 and June 29, 2014 were as follows (in thousands):

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The gross unrealized losses related to available for sale and held to maturity investments were primarily due to changes in market interest rates.  The Company has determined that (i) it does not have the intent to sell any of these investments and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis to meet its cash or working capital requirements or contractual or regulatory obligations.  The Company did not recognize any impairment loss during the three months ended September 28, 2014 and September 29, 2013, respectively

 

The following tables show the gross unrealized losses and fair value of the Company's investments, aggregated by length of time that individual securities have been in a continuous unrealized loss position (in thousands):

As of September 28, 2014 and June 29, 2014, there were no individual securities that had been in a continuous loss position for 12 months or longer.

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The amortized cost and estimated fair value of debt securities as of September 28, 2014 and June 29, 2014 by contractual maturities are shown below (in thousands):

 

Non-Marketable Equity Securities

The Company accounts for its equity investments in privately held companies under the cost method.  These investments are subject to periodic impairment review and measured and recorded at fair value when they are deemed to be other-than-temporarily impaired. In determining whether a decline in the value of its investment has occurred and is other than temporary, an assessment was made by considering available evidence, including the general market conditions, the investee's financial condition, near-term prospects, market comparables and subsequent rounds of financing.  The valuation also takes into account the investee's capital structure, liquidation preferences for its capital and other economic variables. The valuation methodology for determining the decline in value of non-marketable equity securities is based on inputs that require management judgment. The aggregate carrying value of the Company's non-marketable equity securities was $4.9 million and $4.9 million as of September 28, 2014 and June 29, 2014, respectively, and was classified within other assets on the Company's condensed consolidated balance sheets .  The Company did not recognize any impairment loss during the three months ended September 28, 2014 and September 29, 2013, respectively.

Note 8 - Fair Value Measurements

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. The Company applies the fair value hierarchy which has the following three levels of inputs to measure fair value:

·	Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;

·	Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

·	Level 3 inputs are unobservable inputs for the asset or liability.

The Company's Level 1 financial assets generally include money market funds and publicly traded equity securities. The Company's Level 2 financial assets generally include United States Treasury securities, United States Government agency debt securities, certificates of deposit, commercial paper, and corporate debt securities.

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The Company bases the fair value of its financial assets on pricing from third party sources of market information obtained through the Company's investment brokers. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from brokers. The Company's investment brokers obtain pricing data from a variety of industry standard data providers (e.g., Bloomberg), and rely on comparable pricing of other securities because the Level 2 securities that the Company holds are not actively traded and have fewer observable transactions. The Company considers this the most reliable information available for the valuation of the securities. There were no changes in valuation techniques or related inputs in the three months ended September 28, 2014.

The following table presents the Company's financial assets which were measured at fair value on a recurring basis at September 28, 2014 and June 29, 2014 (in thousands):

As of September 28, 2014 and June 29, 2014, the Company did not have any assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value measurement hierarchy in the three months ended September 28, 2014 and June 29, 2014.

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Note 9 – Balance Sheet Components (in thousands)

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Note 10 - Goodwill and Acquired Intangible Assets, Net

 

     The Company had goodwill of $0.6 million on its condensed consolidated balance sheets as of September 28, 2014 and June 29, 2014. During the three months ended September 28, 2014 and September 29, 2013, there were no indicators of impairment for the goodwill.

The following table presents details of the intangible assets acquired as a result of acquisitions as of September 28, 2014 and June 29, 2014 (in thousands):

The following table presents details of the amortization expense of acquired intangible assets as reported in the condensed consolidated statements of operations (in thousands):

Based on the purchased intangible assets recorded as of  September 28, 2014, and assuming no subsequent additions to or impairment of the underlying assets, the remaining estimated amortization expense is expected to be as follows (in thousands):

Note 11 - Discontinued Operations and Assets Held For Sale

On July 29, 2014, the Company announced it had commenced a process to seek strategic alternatives for Oplink Connected, including a possible sale of all or part of the business as it continues to focus on driving shareholder value and increasing operational efficiencies. The Company currently intends to complete the process within the next twelve months.   The assets of the discontinued operations presented as assets held for sale in the condensed consolidated balance sheet as of September 28, 2014 and consisted of $1.2 million in inventories and $0.1 million in intangible assets. The Company has classified the Oplink Connected business as discontinued operations.  

For financial statement purposes, the results of operations for the discontinued operations have been segregated from those of the continuing operations and are presented in the Company's condensed consolidated statements of operations as discontinued operations.

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The results of discontinued operations for the three months ended September 28, 2014 and September 29, 2013 were as follows (in thousands):

Note 12 - Stock-Based Compensation

 Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the employee's requisite service period. The Company's stock-based compensation is generally accounted for as an equity instrument.

The following table represents details of stock-based compensation expense by function line item for the three months ended September 28, 2014 and September 29, 2013 (in thousands):

Total stock-based compensation expense related to the Company's discontinued operation business was $0.1 million for the three months ended September 28, 2014 and September 29, 2013, respectively and was included in loss from discontinued operations, net of tax on the condensed consolidated statements of operations.  Stock-based compensation capitalized as inventory was immaterial as of September 28, 2014 and September 29, 2013.

 

 Forfeitures are estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.

Valuation Assumptions

The Company estimates the fair value of stock options and purchase rights under the Company's employee stock purchase plan using a Black-Scholes valuation model. The fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model and the straight-line attribution approach with the following weighted-average assumptions:

No purchase rights were granted under the Company's employee stock purchase plan during the three months ended September 28, 2014 and September 29, 2013.

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Dividend yield is based on annualized dividends per share and the Company's average stock price. Expected volatility is based on the historical volatility of the Company's common stock. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded U.S. Treasury securities for terms equal to the expected term of the options or purchase rights. The expected term calculation for stock options is based on the observed historical option exercise behavior and post-vesting forfeitures of options by the Company's employees.

Equity Incentive Program

The Company adopted the 2000 Equity Incentive Plan (the "2000 Plan") in July 2000. The 2000 Plan was terminated in November 2009 immediately upon the effectiveness of the Company's 2009 Equity Incentive Plan (the "2009 Plan"). No further awards will be granted under the 2000 Plan. However, the 2000 Plan will continue to govern awards previously granted under that plan.

The 2009 Plan was adopted by the Company in September 2009 and became effective upon approval by the Company's stockholders at the annual meeting held in November 2009. The 2009 Plan provides for the grant of stock awards to employees, directors and consultants. These stock awards include stock options, restricted stock awards ("RSAs"), restricted stock units ("RSUs"), stock appreciation rights, performance units, and performance shares. The maximum aggregate number of shares of common stock that may be issued under the 2009 Plan is 2.5 million shares, plus any shares subject to stock awards granted under 2000 Plan that expire or otherwise terminate without having been exercised in full, or that are forfeited to or repurchased by the Company. Shares subject to "full value" awards (RSUs, RSAs, performance shares and performance units) will count against the 2009 Plan's share reserve as 1.3 shares for every one share subject to such awards. Accordingly, if such awards are forfeited or repurchased by the Company, 1.3 times the number of shares forfeited or repurchased will return to the 2009 Plan. The maximum term of stock options and stock appreciation rights under the 2009 Plan is 7 years.

The following table summarizes activity under the equity incentive plans for the indicated periods:

 

The Company settles employee stock option exercises and RSUs with newly issued common shares.

 

As of September 28, 2014, the unrecognized stock-based compensation expense related to stock options to purchase the Company's common stock was $2.5 million, which is expected to be recognized over a weighted average period of 2.1 years. The unrecognized stock-based compensation expense related to unvested RSUs was $10.1 million, which is expected to be recognized over a weighted average period of 3.1 years.

A majority of the vested restricted stock units were net share settled. During the three months ended September 28, 2014 and September 29, 2013, the Company withheld less than 0.1 million shares, based upon the Company's closing stock price on the vesting date to settle the employees' minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities. Total payments for the employees' tax obligations to the relevant taxing authorities were $0.4 million and $1.1 million for the three months ended September 28, 2014 and September 29, 2013, and were reflected as a financing activity within the condensed consolidated statements of cash flows. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

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Employee Stock Purchase Plan

 

The Company's employee stock purchase plan authorizes the granting of stock purchase rights to eligible employees during an offering period not more than 27 months with exercise dates approximately every six months. Shares are purchased through employee payroll deductions at purchase prices equal to 85% of the lesser of the fair market value of the Company's common stock at either the first day of each offering period or the date of purchase. No shares were purchased under the employee stock purchase plan during the three months ended September 28, 2014 and September 29, 2013. As of September 28, 2014, 1.2 million shares were available for issuance under the Company's employee stock purchase plan.

Note 13 – Stockholder's Equity

Repurchase of Common Stock

On May 8, 2014, the Company's Board of Directors approved a program to repurchase up to $40 million of its outstanding common shares. On July 28, 2014, the Company's Board of Directors approved an increase of $40 million to this stock repurchase program to a total of $80 million. In fiscal 2014, the Company repurchased 0.6 million shares at an average price of $16.87 per share for a total purchase price of $10.1 million. During the three months ended September 28, 2014, the Company repurchased 0.7 million shares at an average price of $18.39 per share for a total purchase price of $12.1 million under the program.  As of September 28, 2014, approximately $57.8 million was available for future purchase under this share repurchase program. Repurchases under the program will be made in open market or privately negotiated transactions in compliance with the Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors.

Dividends

On July 29, 2014, the Company announced that its board of directors declared a quarterly cash dividend of $0.05 per share of its common stock.  The first payment of $0.9 million was made on August 28, 2014 to stockholders of record as of August 14, 2014.

On October 30, 2014, the Company announced that its board of directors declared a quarterly cash dividend of $0.05 per share of its common stock.  The payment will be made on November 17, 2014 to stockholders of record as of November 10, 2014.

The Company currently anticipates that cash dividends will continue to be paid on a quarterly basis, although the declaration of any future cash dividend is at the discretion of the Board of Directors and will depend on the Company's financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination by the Board of Directors that cash dividends are in the best interests of its stockholders.

Note 14 - Commitments and Contingencies

Indemnification Agreements

The Company has entered into certain indemnification arrangements in the ordinary course of business. Pursuant to these arrangements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties, generally their business partners or customers, for losses suffered or incurred by the indemnified party in connection with any patent, or any copyright or other intellectual property infringement claim by any third party with respect to the Company's products. Based on negotiation and special circumstances of each case, the terms of the agreements may vary. The maximum potential amount of future payments the Company could be required to make under these agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.

The Company has entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to obtain directors' and officers' insurance if available on reasonable terms, which the Company currently has in place.

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Product Warranties

 

The Company provides reserves for the estimated cost of product warranties at the time revenues are recognized based on historical experience of known product failure rates and expected material and labor costs to provide warranty services. The Company generally provides a one-year warranty on its products. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. On a quarterly basis, the Company assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

 

Changes in the warranty liability, which is included as a component of "Accrued liabilities" on the condensed consolidated balance sheets as disclosed in Note 9, is as follows (in thousands):

Contractual Obligations

 

Contractual obligations as of September 28, 2014 have been summarized below (in thousands):

 

Litigation

The Company is subject to legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated financial position, results of operations and cash flows.

Note 15 - Segment

 

The Company has determined that it has one reportable segment: fiber optic component and subsystem product sales. This segment consists of organizations located in the United States, China and Taiwan, which develop, manufacture, and/or market fiber optic networking components.  The chief executive officer has been identified as the chief operating decision maker ("CODM"). The Company's CODM is ultimately responsible for and actively involved in the allocation of resources and the assessment of the Company's operational and financial performance.

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The geographic breakdown of revenues by customers' ship-to location was as follows (in thousands):

 

The Company's top five customers, although not the same five customers, together accounted for 52 % of revenues for the three months ended September 28, 2014 and September 29, 2013, respectively.

The breakdown of property, plant and equipment, net by geographical location was as follows (in thousands):

 

 

Note 16 - Income Taxes

The Company accounts for uncertain tax positions in accordance with the authoritative guidance on income taxes under which the Company may only recognize or continue to recognize tax positions that meet a "more likely than not" threshold. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of the provision for income taxes.

As of September 28, 2014, the Company's total unrecognized tax benefits were $17.0 million, of which $14.6 million, if recognized, would affect the Company's effective tax rate. The Company had accrued interest and penalties related to unrecognized tax benefits of approximately $1.9 million as of September 28, 2014.

The Company is required to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. The Company recorded a tax provision of $0.6 million and $1.2 million from its continuing operations for the three months ended September 28, 2014 and September 29, 2013, respectively. The effective tax rate for the three months ended September 28, 2014 differed from the statutory rate primarily due to the mix of foreign earnings, non-deductible stock-based compensation and research and development deduction in China. The effective tax rate could fluctuate in the future due to changes in the taxable income mix between various jurisdictions.

The Company is currently under a tax audit by the California Franchise Tax Board for its fiscal years 2008 through 2011. The audit is in process and the outcome of the audit cannot be predicted at this time.

Although the Company files U.S. federal, various state, and foreign tax returns, the Company's only major tax jurisdictions are the United States, California, Taiwan and China. The tax years 2005 to 2013 remain open in several jurisdictions.

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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking statements

This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words "expect," "anticipate," "intend," "believe," "estimate" or "assume" or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information set forth below and under the captions "Risk Factors" in addition to the other information set forth herein. We caution you that our business and financial performance are subject to substantial risks and uncertainties. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Report on Form10-Q.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements and accompanying Notes in this report, and Management's Discussion and Analysis of Financial Condition and Results of Operations, related financial information and Audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended June 29, 2014 filed with the Securities and Exchange Commission ("SEC").

Overview

We design, manufacture and sell optical networking components and subsystems. Our products expand optical bandwidth, amplify optical signals, monitor and protect wavelength performance, redirect light signals, ensure bandwidth distribution connectivity and provide signal transmission and reception within an optical network. Our products enable greater and higher quality bandwidth over longer distances, which reduces network congestion and transmission cost per bit. Our products also enable optical system manufacturers to provide flexible and scalable bandwidth to support the increase of data traffic on the Internet and other public and private networks.

We offer our customers design, integration and optical manufacturing solutions ("OMS") for the production and packaging of highly-integrated optical subsystems and turnkey solutions, based upon a customer's specific product design and specifications. We also offer solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions.

We also have a business division, Oplink Connected, which has developed and is selling wireless security and home automation systems that can be monitored and managed with a Smartphone app. The security systems are plug-and-play solutions that are easy to install and eliminate the need for professional installation. As we continue to focus on driving shareholder value and increasing operational efficiencies, we have commenced a process to seek strategic alternatives for Oplink Connected, including a possible sale of all or part of the business. The Oplink Connected business has been classified as discontinued operations, see "Note 11. Discontinued Operations and Assets Held For Sale" in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q.  For financial statement purposes, the results of operations for discontinued businesses have been segregated from those of the continuing operations and are presented in the condensed consolidated financial statements as discontinued operations. Unless otherwise indicated, the following discussion pertains only to our continuing operations.

Use of Estimates and Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure. On an ongoing basis, we evaluate our estimates, including those related to product returns, accounts receivable, inventories, intangible assets, warranty obligations, restructuring accruals, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis and by the audit committee of our board of directors at the end of each quarter prior to the public release of our financial results.

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As of the date of the filing of this quarterly report, we believe there have been no material changes to our critical accounting policies and estimates during the three months ended September 28, 2014 compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended June 29, 2014 as filed with the SEC. Additional information about these critical accounting policies may be found in the "Management's Discussion & Analysis of Financial Condition and Results of Operations" section included in our Annual Report on Form 10-K for the fiscal year ended June 29, 2014.

Results of Operations

Revenues

The increase in revenues for the three months ended September 28, 2014 compared to the three months ended September 29, 2013 was primarily due to an increase in revenues in our amplifier and routing and switching products as a result of increased unit shipments for these products.  In addition, revenues from our transmission products increased as a result of the ramp up of new products.    Partially offsetting these increases was a decrease in revenues in multiplexing products as a result of lower unit shipments in the three months ended September 28, 2014 compared to the three months ended September 29, 2013.

Historically, a relatively small number of customers have accounted for a significant portion of our revenues. Our top five customers, although not necessarily the same five customers, together accounted for 52% of revenues for the three months ended September 28, 2014 and September 29, 2013, respectively.

For the three months ending December 28, 2014, we expect our revenues to be in the range of $58 million to $62 million.

Gross Profit

 

(In thousands, except percentage)													Percentage
		Three Months Ended								Change			Change
		September 28, 2014				September 29, 2013
Gross profit		$	18,203			$	17,966			$	237				1.3	%
Gross profit margin			31.9	%			32.8	%

Gross profit increased for the three months ended September 28, 2014 compared to the three months ended September 29, 2013 primarily due to higher revenues and lower labor costs partially offset by higher direct material costs and increased manufacturing overhead. The gross profit for the three months ended September 28, 2014 and September 29, 2013 was positively impacted by sales of previously reserved inventory of $0.5 million and $0.6 million.

Our gross profit margin decreased for the three months ended September 28, 2014 compared to the three months ended September 29, 2013 primarily due to higher material costs as a percentage of revenues and higher manufacturing overhead expenses as a percentage of revenues, partially offset by lower labor costs as a percentage of revenues.

We expect our gross profit margin for the three months ending December 28, 2014, to increase slightly compared to the three months ended September 28, 2014.

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Research and Development (R&D)

 

(In thousands, except percentage)													Percentage
	Three Months Ended									Change			Change
	September 28, 2014				September 29, 2013
Research and development		$	6,189			$	5,699			$	490				8.6	%
Stock-based compensation			326				368				(42	)			(11.4	)%
Total expenses		$	6,515				6,067			$	448				7.4	%

Research and development expenses increased $0.4 million for the three months ended September 28, 2014 compared to the three months ended September 29, 2013. The increase was primarily due to higher salary expenses and other employee related compensation expenses.

We expect our R&D expenses, excluding stock-based compensation expense, to increase for the three months ending December 28, 2014 compared to the three months ended September 28, 2014 as a result of R&D material spending related to new product development projects.

Sales and Marketing

 

(In thousands, except percentage)													Percentage
	Three Months Ended									Change			Change
	September 28, 2014				September 29, 2013
Sales and marketing		$	3,149			$	2,970			$	179				6.0	%
Stock-based compensation			575				583				(8	)			(1.4	)%
Total expenses		$	3,724				3,553			$	171				4.8	%

Sales and marketing expenses increased $0.2 million for the three months ended September 28, 2014 compared to the three months ended September 29, 2013. The increase was primarily due to increases in salary and other employee related compensation expenses.

We expect our sales and marketing expenses, excluding stock-based compensation expense, to remain at the same level for the three months ending December 28, 2014 compared to the three months ended September 28, 2014.

General and Administrative

 

General and administrative expenses increased $0.4 million for the three months ended September 28, 2014 compared to the three months ended September 29, 2013. The increase was primarily due to an increase in legal, advisory and other charges related to certain corporate governance matters, partially offset by a decrease in stock-based compensation expense as a result of less new grants in the three months ended September 28, 2014 compared to September 29, 2013.

We expect our general and administrative expenses, excluding stock-based compensation expense, to decrease for the three months ending December 28, 2014 compared to the three months ended September 28, 2014.

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Interest and Other Income, Net

 

Interest and other income, net increased $0.1 million for the three months ended September 28, 2014 compared to the three months ended September 29, 2013.   The increase was primarily attributable to a foreign currency gain during the three months ended September 28, 2014 compared to a foreign currency loss during the three months ended September 29, 2013.

Provision for Income Taxes

As a multinational corporation, we are subject to taxation in the United States and in foreign jurisdictions. The taxation of our business is subject to the application of multiple and sometimes conflicting tax laws and regulations as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide

earnings or losses, the tax regulations and tax holidays in each geographic region, and the availability of tax credits and carryforwards. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, and the evolution of regulations and court rulings. Consequently, taxing authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.

We are required to make our best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. We recorded a tax provision of $0.6 million and $1.2 million from continuing operations for the three months ended September 28, 2014 and September 29, 2013, respectively. The decrease in the tax provision was primarily due to a change in the geographic mix of pre-tax income. The effective tax rate for the three months ended September 28, 2014 differed from the statutory rate primarily due to the mix of foreign earnings, non-deductible stock-based compensation and research and development deduction in China. The effective tax rate could fluctuate in the future due to changes in the taxable income mix between various jurisdictions.

Although we files U.S. federal, various state, and foreign tax returns, our only major tax jurisdictions are the United States, California, Taiwan and China. The tax years 2005 to 2013 remain open in several jurisdictions.

Liquidity and Capital Resources

Since our inception, we have financed our operations primarily through issuances of equity.  As of September 28, 2014, we had cash, cash equivalents and short-term and long-term investments of $130.0 million and working capital of $182.6 million.

We believe that our current cash, cash equivalent and short-term investment balances will be sufficient to meet our operating and capital requirements for at least the next 12 months. We may use cash and cash equivalents from time to time to fund our acquisition of businesses and technologies. We may be required to raise funds through public or private financings, strategic relationships or other arrangements. We cannot assure you that such funding, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our failure to raise capital when needed could harm our ability to pursue our business strategy and achieve and maintain profitability.

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Three Months Ended September 28, 2014

Our operating activities, including cash flows from discontinued operations, provided cash of $4.3 million in the three months ended September 28, 2014, a decrease of $0.1 million, compared to the three months ended September 29, 2013.   The net cash provided by operating activities in the three months ended September 28, 2014 was primarily attributable to a net income of $0.6 million adjusted by non-cash charges of $4.3 million, partially offset by a decrease in net working capital of $0.6 million.  Non-cash charges in the three months ended September 28, 2014 included $2.5 million in depreciation and amortization and $1.6 million in stock-based compensation expense.  Net cash used by working capital related items was primarily driven by an increase in accounts receivable of $3.0 million and an increase in prepaid expense and other current assets of $2.5 million, partially offset by an increase in accrued liabilities and other abilities of $3.2 million, an increase in accounts payable of $1.1 million and a decrease in inventory of $0.6 million.

An increase in accounts receivable in the three months ended September 28, 2014 was primarily due to higher shipments in the three months ended September 28, 2014 compared to the three months ended June 29, 2014 and the timing of the shipments. We typically bill customers on an open account basis with net thirty to ninety day payment terms. We would generally expect the level of accounts receivable at the end of any quarter to reflect the level of sales in that quarter and to change from one period to another in a direct relationship to the change in the level of sales. Our level of accounts receivable would increase if shipments are made closer to the end of the quarter, if customers delayed their payments, or if we offered extended payment terms to our customers, all of which are more likely to occur during challenging economic times when our customers may have difficulty gaining access to sufficient credit on a timely basis.

An increase in prepaid expenses and other assets in the three months ended September 28, 2014 was primarily due to increases in the balance of bankers' acceptance notes.

An increase in accrued liabilities and other liabilities in the three months ended September 28, 2014 was primarily due to increases in legal and consulting fees accruals related to the process of seeking strategic alternative for Oplink Connected business and stockholders' activities and an increase in employee withholding related to our employee stock purchase plan.

An increase in accounts payable in the three months ended September 28, 2014 was due to the timing of payments to our vendors and a lower level of inventory purchases.

Our investing activities provided cash of $15.0 million in the three months ended September 28, 2014 primarily due to sales and maturities of investments of $31.0 million, partially offset by purchases of investments of $14.6 million and equipment purchases of $1.4 million. We expect net capital expenditures to be approximately $10 million in fiscal 2015.

Our financing activities used cash of $12.6 million in the three months ended September 28, 2014 due to $12.6 million of cash spent on the repurchase of our common stock, $0.9 million in dividend payments to stockholders and $0.4 million in tax withholding payments related to net share settlements of restricted stock units, partially offset by $1.3 million in proceeds from issuance of common stock in connection with the exercise of stock options.

Three Months Ended September 29, 2013

Our operating activities provided cash of $4.4 million in the three months ended September 29, 2013.   The net cash provided by operating activities in the three months ended September 29, 2013 was primarily attributable to a net income of $2.2 million adjusted by non-cash charges of $4.4 million, partially offset by a decrease in working capital of $2.2 million.  Non-cash charges in the three months ended September 29, 2013 included $2.1 million in depreciation and amortization and $2.1 million in stock-based compensation expense.  Net cash used by working capital related items was primarily driven by an increase in inventory of $5.8 million, partially offset by an increase in accrued liabilities and other liabilities of $2.1 million and an increase in accounts payable of $1.8 million.

 

The increase in inventory in the three months ended September 29, 2013 was primarily attributable to an increase in material purchases in anticipation of future revenue increase.

The increase in accrued liabilities and other liabilities in the three months ended September 29, 2013 was primarily due to increases in salary payable and business taxes payable in China and employee withholding related to our employee stock purchase plan.

The increase in accounts payable in the three months ended September 29, 2013 was due to a timing of payments to our vendors and an increase in our inventory purchases.

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Our investing activities used cash of $13.8 million in the three months ended September 29, 2013 primarily due to purchases of investments of $56.7 million, partially offset by cash proceeds from sales and maturities of investments of $48.4 million.  In addition, we used $5.5 million to purchase property and equipment.

Our financing activities used cash of $0.5 million in the three months ended September 29, 2013 due to $1.1 million in tax withholding payments related to net share settlements of restricted stock units, partially offset by $0.6 million in proceeds from issuance of common stock in connection with the exercise of stock options.

Off-Balance Sheet Arrangements

As of September 28, 2014, we did not have any off-balance sheet financing arrangements and have never established any special purpose entities as defined under SEC Regulation S-K Item 303(a)(4)(ii).

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, please see "Note 3 - Recent Accounting Pronouncements" in the Notes to the Condensed Consolidated Financial Statements of this Form 10-Q.

Contractual Obligations

Contractual obligations as of September 28, 2014 have been summarized below (in thousands):

					Contractual Obligations Due by Period
	Total				Less than 1 year				1-3 years				4-5 years				After 5 years
Purchase obligations		$	24,828			$	24,409			$	419			$	--			$	--
Operating leases			219				164				52				3				--
Total		$	25,047			$	24,573			$	471			$	3			$	--

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ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are exposed to market risk related to fluctuations in interest rates, in foreign currency exchange rates and marketable and non-marketable equity security prices as follows:

Interest Rate Exposure

The primary objective of our investment activities is to preserve principal while maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in are subject to market risk. To minimize this risk, we maintain our portfolio of cash equivalents and investments primarily in highly liquid debt instruments of commercial paper, money market funds, government and non-government debt securities and corporate bonds. We invest our excess cash in short-term and long term investments to utilize higher yields generated by these investments. The majority of these investments pay a fixed rate of interest. Investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. We do not hold any instruments for trading purposes. As of September 28, 2014 and June 29, 2014, the gross unrealized losses on our debt securities classified as available-for-sale and held-to-maturity securities were immaterial. We have the intent and the ability to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investments. We expect to realize the full value of all of these investments upon maturity. In addition, we do not believe that we will be required to sell these securities to meet our cash or working capital requirements or contractual or regulatory obligations. Therefore, we have determined that the gross unrealized losses on our debt securities as of September 28, 2014 and June 29, 2014 were temporary in nature. However, liquidating investments before maturity could have a material impact on our interest income. Declines in interest rates could have a material impact on interest income for our investment portfolio.

The following table summarizes our investment in debt securities:

Foreign Currency Exchange Rate Exposure

We operate in the United States, primarily manufacture in China, and the majority of our sales to date have been made in U.S. dollars. The majority of expenses from our China operations are incurred in the Chinese Renminbi ("RMB"). As a result, currency fluctuations between the U.S. dollar and the RMB could cause foreign currency transaction gains or losses that we would recognize in the period incurred. A 10% fluctuation in the dollar at September 28, 2014 would have an immaterial impact on our net dollar position in outstanding trade receivables and payables.

We use the U.S. dollar as the reporting currency for our consolidated financial statements. Any significant revaluation of the RMB may materially and adversely affect our results of operations upon translation of our Chinese subsidiaries' financial statements into U.S. dollars. We generate a significant amount of our revenue in RMB and the majority of our labor and manufacturing overhead expenses are in RMB. Additionally, a significant portion of our operating expenses are in RMB. Therefore, a fluctuation in RMB against the U.S. dollar could impact our gross profit, gross profit margin and operating expenses upon translation to U.S. dollars. A 10% appreciation or depreciation in RMB against the U.S. dollar would have an immaterial impact on our results of operations for the three months ended September 28, 2014 and September 29, 2013.

We expect our international revenues to continue to be denominated largely in U.S. dollars. We also believe that our China operations will likely expand in the future if our business continues to grow. As a result, we anticipate that we may experience increased exposure to the risks of fluctuating currencies and may choose to engage in currency hedging activities to reduce these risks. However, we cannot be certain that any such hedging activities will be effective, or available to us at commercially reasonable rates.

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Equity Price Risk

The privately held companies in which we invested are in the startup or development stage. These investments are inherently risky because the market for the technologies or products these companies are developing is in the early stages and may never materialize. We could lose our entire investments. Our evaluation of the investment in privately held companies is based on the general market conditions, the investee's financial condition, near-term prospects, market comparables and subsequent rounds of financing. The valuation also takes into account the investees' capital structure, liquidation preferences for its capital and other economic variables. As of September 28, 2014 and June 29, 2014, the aggregate cost of investments in privately held companies was $4.9 million, and was included in other assets on our condensed consolidated balance sheets.

 

ITEM 4 - CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the quarterly period covered by this report. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting that occurred during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

None

Item 1A—RISK FACTORS

There have been no material changes from the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 29, 2014.

 

ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Repurchase of Common Stock

The following table sets forth information with respect to repurchases of our common stock during the three months ended September 28, 2014 (in thousands, except per share data):

On May 8, 2014, our Board of Directors approved a program to repurchase up to $40 million of our outstanding common shares. On July 28, 2014, our Board of Directors approved an increase of $40 million to this stock repurchase program to a total of $80 million. In fiscal 2014, we repurchased 0.6 million shares at an average price of $16.87 per share for a total purchase price of $10.1 million. During the three months ended September 28, 2014, we repurchased 0.7 million shares at an average price of $18.39 per share for a total purchase price of $12.1 million under the program.  As of September 28, 2014, approximately $57.8 million was available for future purchase under this share repurchase program. Repurchases under the program will be made in open market or privately negotiated transactions in compliance with the Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors.

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 - MINE SAFETY DISCLOSURES

 

None.

ITEM 5 - OTHER INFORMATION

None.

ITEM 6 - EXHIBITS

 

Exhibit Index

See "Exhibit Index" appearing at the end of this Quarterly Report.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

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Exhibit Index

 

 

*	The certifications attached as Exhibits 32.1 and 32.2 accompanies this Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed "filed" by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

**

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, and are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under these sections.

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