Description
Oplink Commnctn. Chairman & CEO JOSEPH Y LIU bought 386,904 shares on 5-31-2012 at $ 4.64
BUSINESS OVERVIEW
Overview
Oplink Communications, Inc. ("we", "Oplink", or the "Company") was incorporated in California in September 1995 and was later reincorporated in Delaware in September 2000. We are headquartered in Fremont, California and have manufacturing, design and research and development facilities in Zhuhai, Shanghai and Wuhan, China and in Hsinchu, Taiwan.
We began selling our products in 1996. 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 signal connectivity and provide signal transmission and reception within an optical network. Our products enable greater and higher quality bandwidth over longer distances, which reduce network congestion, transmission costs and energy consumption 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 provide over 350 different products that are sold as components or are integrated into custom solutions. We provide customers with high quality optical subsystems and components that are used for bandwidth creation, bandwidth management and transmission products. Our products and solutions can be applied to all segments of the fiber optic network infrastructure including long-haul networks, metropolitan area networks ("MANs"), local area networks ("LANs"), wireless backhaul and fiber-to-the-home ("FTTH") networks.
We provide our solution and products to the exacting requirements of the world's leading optical networking equipment companies, and work closely with customers during the product design and development cycle. This provides us with the ability to respond to the volume production requirements of our customers when their systems are ready for commercial deployment. We are responsive to our customers' volume, quality and time-to-market requirements.
Our broad product portfolio includes solutions for next-generation, all-optical reconfigurable optical add-drop multiplexing ("ROADM"), wavelength selective switch ("WSS"), dense and coarse wavelength division multiplexing ("DWDM" and "CWDM," respectively), optical amplification, signal switching and routing, signal conditioning and monitoring, fiber interconnect/termination/ distribution and line transmission applications . Our addressable markets include long-haul networks, MANs, LANs, wireless backhaul and FTTH networks. Our customers include telecommunications, data communications and cable TV equipment manufacturers located around the globe.
As a photonic foundry, we provide design, integration and optical manufacturing solutions ("OMS") for advanced and cost-effective components and subsystem manufacturing at our principal in-house design, service and manufacturing facility in Zhuhai, China. We offer our customers expert OMS for the production and packaging of highly-integrated optical subsystems and turnkey solutions, based upon a customer's specific product design and specifications, as well as solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions. Our OMS customers include telecommunications, data communications and cable TV equipment manufacturers located around the globe.
Our product portfolio also includes optical transmission products, including fiber optic transmitters, receivers, transceivers and transponders. Optical transmission products convert electronic signals into optical signals and back into electronic signals, thereby facilitating the transmission of information over fiber optic communication networks. Our optical transmission products are used primarily in MAN, LAN, wireless backhaul and FTTH applications. Our transmission products are engineered with varying levels of integration to suit customers. The lowest level of integration involves separate transmitter and receiver modules, which provides our customers the greatest flexibility in product design by allowing them to place the transmitters and the receivers according to their design specifications. Transceivers provide the next level of integration. Transceivers place both the transmitter and receiver in the same package with a dual fiber or connector interface. We also provide transceivers with build-in transmit and receive optical multiplexing and demultiplexing optical filters so only a single fiber or connector interface is needed for bi-directional optical transmission.
We undertake research and development activities at our facilities in Wuhan and Zhuhai, China, in Hsinchu and Taipei, Taiwan, and in Fremont, California.
Our common stock has been quoted on the NASDAQ Stock Market under the symbol "OPLK" since our initial public offering in October 2000. Our Internet website address is www.oplink.com. Our website address is given solely for informational purposes; we do not intend, by this reference, that our website should be deemed to be part of this Annual Report on Form 10-K or to incorporate the information available at our Internet address into this Annual Report on Form 10-K.
We file electronically with the Securities and Exchange Commission, or SEC, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make these reports available free of charge through our Internet website as soon as reasonably practicable after we have electronically filed such material with the SEC. These reports can also be obtained from the SEC's Internet website at www.sec.gov or at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Our fiscal year ends on the Sunday closest to June 30 of each year. Interim fiscal quarters will end on the Sunday closest to each calendar quarter end. In this report, for presentation purposes, we present each fiscal year as if it ended on June 30, and each fiscal quarter as if it ended on September 30, December 31 or March 31, as the case may be. For more information, please see Note 1 of the notes to consolidated financial statements included at the end of this report.
Our Solution
Oplink is a leader in the optical industry and is uniquely positioned to provide unparalleled OMS to our customers for leading edge, integrated solutions that can be rapidly and cost effectively deployed in communications networks around the world. OMS are customized optical solutions to fit a customer's specific needs.
The customized, variety-rich and high reliability requirements of optical equipment manufacturing makes Oplink's OMS service the ideal solution for meeting the needs of system and subsystem companies for cost-effective manufacturing of optical equipment. Oplink possesses the expertise and versatility in product design and development needed to provide the high responsiveness and flexibility expected in today's markets. We are able to offer shortened design cycle times and reduced production costs with our 182,000 square feet Class-100K clean room and a 574,000 square feet manufacturing facility in Zhuhai, China.
Our Strategy
Oplink provides highly integrated optical sub-systems, pioneering design services and custom solutions to telecommunication equipment makers. By leveraging our well-established core competencies in optical design and manufacturing, we are able to serve not only equipment makers selling to end-customers, but also module and component makers in need of a manufacturing partner.
The core elements of our strategy are:
Strengthening and expanding our leadership in passive optical products. Oplink has successfully transformed from a pure components maker from its inception through IPO to a supplier today offering a comprehensive product portfolio encompassing passive components, modules and subsystems. We believe that our dedication to developing a diversified product line together with our manufacturing efficiency has well-positioned Oplink to provide system equipment makers with state-of-the-art tools, e.g., Reconfigurable Optical Add-Drop Multiplexer (ROADM) or its building blocks such as wavelength selective switch (WSS), optical amplifier, tunable filter and optical performance monitor, for enhancing bandwidth provisioning and lowering network costs. It is projected that with the ever-increasing demand for bandwidth fueled by peer-to-peer networking traffic, file sharing, IPTV, internet video content, online gaming, music downloading and a myriad of other applications, the network infrastructure build-out will continue over the coming years. Oplink believes that a focus on strengthening and expanding our leadership in passive optical products, which unlike the active products are agnostic to the data rate evolution to 40G/100G, is central to our business success in the future.
Innovation through integration and miniaturization based on commercially available technology platforms . Oplink understands that developing new products requires substantial investment with long and uncertain profitability cycles. As such, Oplink seeks to leverage its product development spending through incremental integration/hybridization and miniaturization based on existing technology platforms that are already widely available, including optical thin-film coating, free-space micro-optics, fused fiber optics, Micro-Electro-Mechanical Systems (MEMS), Planar Lightwave Circuit (PLC) or Arrayed-Waveguide Grating (AWG) and Liquid Crystal (LC). In addition, Oplink is proactively exploring optical technologies established outside the telecom industry to cultivate product ideas which could benefit our core business growth.
Growing market share in 10G and higher speed transceivers for metro applications. Oplink is focused on seeking to offer our customers best-in-class pluggable transceivers for 10G and higher data rate metro/aggregation DWDM and CWDM optical networking applications, capitalizing on the increasing demand for bandwidth upgrade and industry-wide transition from traditional larger footprint, higher power consumption 300-pin transponders to smaller, low power dissipating XFP and SFP+ form factors. We believe that our global product development model with integrated engineering teams both in the US and China will enable our worldwide customers to improve time-to-market with best features and performance. To address diverse customer network deployment conditions, we offer a broad portfolio of 10G DWDM and CWDM XFP and SFP+ products with a wide range of operating temperature ranges.
Enhancing engineering capabilities in China . In parallel to building solid manufacturing operations in China, Oplink has recognized the equal importance of leveraging the local talent in product design and development and significantly increased the engineering workforce in our facilities in Zhuhai and Wuhan. While R&D resources in the US participate in customer application support and focuses on developing advanced IP and prototypes, engineering teams in China have taken on an increasingly larger role in new product introduction. As a result, we are able to maintain relative lower overhead expense to better compete in the marketplace and deliver shareholder value.
One-Stop-Shop OMS solution provider. As a founder and leader of the OMS or photonic foundry model, Oplink offers a one-stop-shop approach or turnkey solutions that are customized to our customers' specific needs. One-stop-shopping is being increasingly demanded by our customers, the telecommunications network vendors. Our customers are increasingly requiring optical component suppliers to take advantage of developments in product integration to provide solutions incorporating multiple optical components on a single subsystem or module, thereby reducing the need for component assembly and additional testing. Therefore, we believe that suppliers like Oplink who are able to offer a more integrated manufacturing solution to customers will have an advantage over suppliers who can only offer discrete optical components. The vertical integration of our design and manufacturing capability enables us to consistently deliver the highest quality, lowest cost products to our customers as well as to respond rapidly to design or specification changes which would shorten our customer's time-to-market. We believe that offering a broad range of solutions increases our penetration of existing and new customers.
Continuous focus on our cost structure . Oplink maintains vertically integrated photonic manufacturing facilities in low-cost overseas locations. Our low-cost manufacturing facilities allow us to do full design work in-house which enables us to supply cutting edge products at the lowest possible cost in the industry.
In an industry characterized by intense price competition and at times price erosion, our low-cost structure is a source of sustainable competitive advantage. The source of this sustainability comes from the fact that we believe our design and manufacturing facilities are difficult and expensive to replicate by other firms. Despite our existing streamlined cost structure, we continuously identify and implement cost-saving programs across our organization.
The increase in the worldwide demand for broadband increases the demand for our products. With our vertically integrated cost structure, it further leads to greater capacity utilization and therefore greater operating leverage as fixed costs are spread over a greater number of manufactured units, resulting in improved gross margins.
Customer satisfaction . Oplink places a high value on our relationships with our customers around the world, large and small. To date, Oplink has created well over 10,000 customized product specifications to fulfill customers' exacting requirements. We believe building a long-term mutual trust with our customers is instrumental to nurture sustainable business growth and cultivate a healthy ecosystem.
Products and Technologies
We provide a broad line of fiber optic subsystems and components designed to satisfy the needs of communications equipment suppliers. We categorize our products by the functionalities provided within a network, namely, bandwidth creation, bandwidth management, optical interconnect and transmission products. Some of our products have attributes that combine multiple functions. Some of our bandwidth creation and bandwidth management products utilize telecommunication interfaces to provide local or remote reporting and control to enhance their function in an optical network.
Bandwidth Creation Products
Communications equipment suppliers use our bandwidth creation products to expand the capacity and/or extend the coverage of their customers' networks. Other bandwidth creation products enable optical signals to travel along more complex network architectures such as mesh networks and metro networks, or enable optical signals to travel greater distances over traditional long haul networks.
Wavelength Expansion Products. In fiber optic communications, different signals are transmitted over multiple wavelengths. With increases in the number of wavelengths and data rates, spacing between the channel wavelengths narrows and it becomes increasingly difficult to separate and combine them. We offer wavelength expansion products that are designed to enable the combination and separation of individual wavelengths in all parts of the network including emerging access, metro networks and long haul networks. We offer the following products to handle these tasks :
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Dense Wavelength Division Multiplexers . A dense wavelength division multiplexer, or DWDM, is a solution for scalable, reliable, protocol independent bandwidth creation. A DWDM is an integrated optical module or subsystem that combines two or more wavelengths for transmission over a single fiber or separates these wavelengths at the receiving end. Our DWDM module and subsystem solutions are derived from an array of high performance technologies including thin-film filters and arrayed waveguide grating, or AWG. Our solutions are available in a variety of channel spacings.
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Coarse Wavelength Division Multiplexers . A coarse wavelength division multiplexer, or CWDM, is a solution for cost-effective bandwidth creation in the mobile backhaul, access, cable TV and metro environments. A CWDM is an integrated Mux/Demux module or subsystem that combines/separates, respectively, two or more wavelengths at a channel spacing that is defined much wider than that for standard DWDM.
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Band Wavelength Division Multiplexers. Band wavelength division multiplexer, or BWDM, products help manage multiple International Telecommunication Union, or ITU, channels within Mux/Demux or optical add/drop applications. BWDM products facilitate the design of flexible (pay as you grow) low loss architectures as well as enable the design of complex mesh and ring networks. We offer a variety of BWDM products for the 50, 100 and 200 GHz channel spacing plans.
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DWDM Interleavers . A DWDM interleaver is an optical component that combines two sets of light signals each spaced at alternating ITU channel numbers from two separate fibers into a single fiber, which effectively doubles the capacity of the optical network system, or conversely, separates a single light source into two sets of alternately spaced signals. This unique bandwidth doubling capability, together with the AWG module, enables a cost-effective Mux/Demux solution for network operators with the pay-as-you-grow upgrade option for today's 50GHz grid network. Our interleaver has also facilitated the deployment of network that is founded on Photonic Integrated Circuit (PIC).
Optical Interconnect Products
The acquisition of Emit Technology Co., Ltd. ("Emit") in early 2010 enabled Oplink to offer communications system equipment makers a broadened suite of precision-made, cost-effective and reliable optical connectivity products to establish multiple-use, quick pluggable fiber links among network devices for bandwidth deployment, as well as in a test and measurement environment for a wide range of system design and service applications.
Connectors and Adapters . Offered in different types and form factors to meet the varying application needs, optical connectors provide a precise and reliable means to terminate the fiber end, whereas adapters provide a pluggable solution for a pair of connectors to be physically coupled repeatedly at consistently low optical power loss.
Fixed Attenuators . Designed to reduce a pre-determined amount of light through the fiber to the exact level for added tolerance in system link budget, these in-line pluggable style fixed attenuators offer a compact, high accuracy solution for facile integration into existing systems.
Transmission Products
The acquisition of Optical Communication Products, Inc. ("OCP") in 2007 and continuing product development have enabled Oplink to offer a portfolio of transmission products that broaden the addressable markets as well as the range of solutions that Oplink can now offer its customers. Oplink's transmission products consists of a comprehensive line of high-performance fiber optic modules, including fiber optic transmitters, receivers, transceivers, and transponders, primarily for use in MAN, LAN, and FTTH applications. Fiber optic modules are integrated optoelectronic components and integrated circuits with embedded control and software that are used to enable network equipment to transmit data over long distance of optical fiber. Our transmission products convert electronic signals into optical signals and back into electronic signals often with build-in microcontroller based signal monitoring and conditioning, facilitating the transmission of information over fiber optic communication networks.
SFP Transceivers. Small form-factor pluggable, or SFP, transceivers are "hot-pluggable" optical transceivers that can be removed or inserted into the equipment without turning off the power of the system. This feature allows Oplink's customers to readily reconfigure their systems without interrupting their network services, thereby, eliminating system downtime during upgrades and maintenance. SFP Transceivers are for 4Gbps transmission speed or below. Oplink's cam latches are color coded to provide the end-user with an easy way to identify module types in an installed system.
SFP+ Transceivers. Enhanced small form-factor pluggable, or SFP+, transceivers are similar products to SFP while delivering the signal at 6-10Gbps. It is also "hot-pluggable" that can be removed or inserted into the equipment without turning off the power of the system. They are initially deployed for 10Gbps LAN, SAN (storage area network) and datacenter applications. With most efficient measurement in Gbps per watt per cubic centimeters, they are increasingly deployed for broader range of applications, including MAN and WDM optical networking applications.
XFP Transceivers. 10 Gigabit small form-factor pluggable is a hot-pluggable, protocol-independent optical transceiver with build-in clock and data recovery circuits for 10 Gigabit per second SONET/SDH, Fiber Channel, gigabit Ethernet, 10 gigabit Ethernet and other applications, including CWDM and DWDM optical networks. It includes digital diagnostics and the electrical interface specification is a portion of the XFP Multi Source Agreement specification.
CWDM Transceivers. Coarse wavelength division multiplexing, or CWDM, transceivers allow the aggregation of multiple channels of optical signals onto a single optical fiber by utilizing different wavelengths. The CWDM transceivers use lasers with wide channel wavelength spacing, typically 20 nm, which allows the equipment to achieve a lower overall system cost. This lower cost is the result of a lower transmitter cost with relaxed temperature and wavelength control, as well as a lower optical MUX/DMUX cost due to wider tolerance on the wavelength stability and bandwidth.
Oplink's CWDM transceivers are available in all the common industry standard transceiver footprints of 1x9, 2x9, GBIC, SFF, SFP, XFP and SFP+, and provide up to 16 wavelength channels at nominally 1271nm, 1291nm, 1311nm, 1331nm, 1351nm, 1371nm, 1391nm, 1411nm, 1471 nm, 1491 nm, 1511 nm, 1531 nm, 1551 nm, 1571 nm, 1591 nm, and 1611 nm. They are available in a multi-rate format that allows operation at all speeds from 125 Mb/s Fast Ethernet up to 10Gb/s 10GbE and OC-192 SONET/SDH. Oplink's CWDM transceiver products are available in industrial operating temperature option (-40 to +85 degrees Celsius).
CEO BACKGROUND
Chieh Chang . Mr. Chang has been a member of our Board of Directors since September 1995. Mr. Chang has served as Chief Executive Officer of BCD Semiconductor Manufacturing Ltd., a NASDAQ-listed analog device company, since September 2008. Mr. Chang served on the board of directors of Genesis Microchip Inc., a NASDAQ-listed semiconductor company, from November 2004 until its acquisition by STMicroelectronics in January 2008. From February 2000 to February 2003, Mr. Chang served as Chief Executive Officer of Programmable Microelectronics Company, Inc. (now Chingis Technology Corporation), a fabless semiconductor design company. From April 1992 to August 1996, Mr. Chang was the Director of Technology at Cirrus Logic, Inc., a semiconductor company. Mr. Chang received his B.S. in Electrical Engineering from the National Taiwan University and his M.S. in Electrical Engineering from University of California, Los Angeles. Mr. Chang’s qualifications to serve on our Board include his extensive knowledge of the Company and its business, having served on our Board since our inception, as well as his superior technical expertise and his more than twenty-five years of management and engineering experience in the semiconductor and optoelectronics industry.
Hua Lee . Dr. Lee has been a member of our Board of Directors since February 2006. Dr. Lee has been Professor of Electrical and Computer Engineering at the University of California, Santa Barbara since 1990, and served as Chairman of the Electrical and Computer Engineering department from 1998 to 2002. Prior to his tenure at the University of California, Santa Barbara, Dr. Lee was on the faculty of the University of Illinois at Urbana-Champaign. Dr. Lee completed the Director Education and Certification Program at UCLA’s Anderson School of Management in May 2007. Dr. Lee received his B.S. degree in Electrical Engineering from the National Taiwan University, and M.S. and PhD in Electrical Engineering from University of California, Santa Barbara. Dr. Lee’s qualifications to serve on our Board include his deep knowledge of optoelectronics, as well as a keen knowledge of our industry, which brings unique observations and insights relevant to our business and to the technical aspects of our products and opportunities, as well as insight into anticipated future technological and industry trends.
MANAGEMENT DISCUSSION FROM LATEST 10K
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.
Our fiscal year ends on the Sunday closest to June 30. For presentation purposes, we present each fiscal year as if it ended on June 30. Fiscal years 2010 and 2009 consisted of 52 weeks. Fiscal 2011 is a 53-week fiscal year, one week more than a typical fiscal year. The extra week was included in the first quarter of fiscal 2011.
Revenues . We generate substantially all of our revenues from the sale of fiber optic components and subsystems. Our products are generally categorized into the four following major groups: (1) bandwidth creation products, which include wavelength expansion and optical amplification products; (2) bandwidth management products, which include optical switching products and wavelength performance monitoring and protection products; (3) transmission products, which include fiber optic transmitters, receivers, transceivers and transponders; and (4) optical interconnect products, which include signal connectivity and distribution products.
Cost of Revenues. Our cost of revenues consists of raw material, salaries including stock compensation expense and related personnel expenses, manufacturing overhead, provisions for excess and obsolete inventories, amortization of intangible assets, and warranty costs. We expect cost of revenues, as a percentage of revenues, to fluctuate from period to period. Our gross margins will primarily be affected by mix of products sold, salaries and related personnel expenses, manufacturing volume, pricing policies, production yield, costs incurred in improving manufacturing processes, provisions for excess and obsolete inventories and warranty costs.
Research and Development Expenses . Our research and development expenses consist primarily of salaries including stock compensation expense and related personnel costs, depreciation, non-recurring engineering charges and prototype costs, patent filing costs and fees paid to consultants and outside service providers, all of which relate to the design, development, testing, pre-manufacturing and significant improvement of our products. We expense our research and development costs as they are incurred.
Sales and Marketing Expenses . Our sales and marketing expenses consist primarily of salaries including stock compensation expense and related expenses for marketing, sales, customer service and application engineering support personnel, commissions paid to internal and external sales representatives, as well as costs associated with trade shows and other marketing expenses.
General and Administrative Expenses . Our general and administrative expenses consist primarily of salaries including stock compensation expense and related expenses for executive, finance, accounting, and human resources personnel, professional fees and other corporate expenses.
Stock Compensation Expense . We account for stock-based compensation in accordance with the provisions of FASB Accounting Standards Codification (ASC) Topic 718, "Compensation-Stock Compensation" ("ASC 718"), which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. Our stock compensation is generally accounted for as an equity instrument. Stock compensation expense recorded in cost of revenues, research and development, sales and marketing, and general and administrative is the amortization of the fair value of share-based payments made to employees and members of our board of directors, primarily in the form of stock options, restricted stock awards and units ("RSAs" and "RSUs") and purchases under the employee stock purchase plan pursuant to the provisions of ASC 718.
As of June 30, 2011, the unrecorded deferred stock compensation balance related to stock options to purchase Oplink common stock was $2.2 million which will be recognized over an estimated weighted average amortization period of 1.7 years. The unrecorded deferred stock compensation balance related to RSUs was $5.7 million which will be recognized over an estimated weighted average amortization period of 2.4 years. Approximately $8,000 of stock compensation was capitalized as inventory at June 30, 2011 and 2010. During the year ended June 30, 2011, we granted 87,000 stock options and 248,300 restricted stock awards and units, with a total grant-date fair value of $723,000 and $4.7 million, respectively.
Use of Estimates and Critical Accounting Policies
The preparation of our 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 disclosures. On an ongoing basis, we evaluate our estimates, including those related to product returns, accounts receivable, inventories, tangible and intangible assets, warranty obligations, stock compensation, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying 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 at the end of each quarter prior to the public release of our financial results. We believe the following critical accounting policies, and our procedures relating to these policies, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our consolidated financial statements and requires us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. These policies may require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations. Our critical accounting policies cover the following areas:
Revenue Recognition and Product Returns
We recognize revenue from product sales upon delivery of the product or customer acceptance, whichever is later, provided that persuasive evidence of an arrangement exists, delivery has occurred and no significant obligations remain, the fee is fixed or determinable and collectibility is reasonably assured. We recognize revenue associated with contract-related cancellation payments from customers when a formal agreement is signed or a purchase order is issued by the customer covering these payments and we determine the collectibility of the cancellation payments to be reasonably assured. In addition, we estimate future product returns based upon actual historical return rates and reduce our revenue by these estimated future returns. If the historical data we use to calculate these estimates does not properly reflect future returns, future estimates could be revised accordingly.
Depreciation and Amortization Expenses
Depreciation expenses are computed using the straight-line method based upon the useful lives of the assets. Estimated useful lives of 20 to 30 years are used for buildings and 3 to 10 years are used for manufacturing and engineering equipment. Estimated useful lives of 2 to 5 years are used for computer hardware and software. In addition, we have land occupancy rights for a period of 50 years. Leasehold improvements are amortized using the straight-line method based upon the shorter of the estimated useful lives or the lease term of the respective assets. Land and construction in progress are not depreciated. Improvements and betterments are capitalized if they extend the useful life of the asset. Repair and maintenance costs are charged to expense as incurred. (Gain) loss on sale or disposal of fixed assets is recognized in the period which the (gain) loss occurs.
Accrued Warranty
We provide reserves for the estimated cost of product warranties at the time revenue is recognized based on historical experience of known product failure rates and expected material and labor costs to provide warranty services. We generally provide a one-year warranty on our products. Additionally, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Alternatively, if estimates are determined to be greater than the actual amounts necessary, we may reverse a portion of such provisions in future periods.
Allowance for Doubtful Accounts
Our accounts receivable are derived from revenue earned from customers located in the United States, Canada, Europe, China, Japan and other countries. We perform ongoing credit evaluations of our customer's financial condition and currently require no collateral from our customers. We maintain an allowance for doubtful accounts for estimated losses in anticipation of the inability or unwillingness of customers to make required payments. When we become aware that a specific customer is unable to meet its financial obligations, such as the result of bankruptcy or deterioration in the customer's operating results or financial position, we record a specific allowance equal to the amount due to reflect the level of credit risk in the customer's outstanding receivable balance. We are not able to predict changes in the financial condition of customers, nor are we able to predict whether a customer experiencing financial difficulties will ultimately pay us the amounts owed. If the condition or circumstances of our customers deteriorates, estimates of the recoverability of trade receivables could be materially affected and we may be required to record additional allowances, which would negatively affect our operating results in that period. Alternatively, if our estimates are determined to be greater than the actual amounts necessary, we may reverse a portion of such allowance in future periods based on actual collection experience, which would positively increase our operating results in future periods.
Excess and Obsolete Inventory
We regularly assess the valuation of inventories and write down those inventories which are obsolete or in excess of forecasted usage to their estimated realizable value. Estimates of realizable value are based upon our analysis and assumptions including, but not limited to, forecasted sales levels by product, expected product lifecycle, product development plans and future demand requirements. If market conditions are less favorable than our forecast or actual demand from customers is lower than our estimates, we may be required to record additional inventory write-downs. At the point of write down, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase inventory write-downs, and our gross margin could be adversely affected. If demand is higher than expected, we may sell inventories that had previously been written down as was the case in the years ended June 30, 2011, 2010 and 2009. In such instances, our gross margins were positively impacted by the utilization of previously reserved inventory of $5.4 million, $5.8 million and $4.0 million in fiscal 2011, 2010 and 2009, respectively.
Impairment of Investments
We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation as of each balance sheet date. Our marketable securities may be classified as either held-to-maturity or available-for-sale. Held-to-maturity securities represent those securities that we have both the intent and ability to hold to maturity and are carried at amortized cost. Available-for-sale securities represent those securities that do not meet the classification of held-to-maturity or trading securities and are carried at fair value. Should a decline in the fair value of an individual security or securities be judged to be other than temporary, the cost basis of the security would be written down to fair value and the amount of the write-down would be accounted for as a realized loss. Factors considered in determining whether a loss is temporary include the magnitude of the decline in market value, the length of time the fair value has been below the cost basis of the security, our ability and intent to hold the security for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the cost of the security, and whether a credit loss exists.
Impairment of Long-Lived Asset
We evaluate the recoverability of the carrying value of property, plant and equipment and identifiable intangible assets, whenever certain events or changes in circumstances indicate that the carrying amount may not be recoverable. These events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in our market value, or significant reductions in projected future cash flows. In assessing the recoverability of long-lived assets, we generally compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we would write down such assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon our weighted average cost of capital, and specific appraisal in certain instances. Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including long-term forecasts of the amounts and timing of overall market growth and our percentage of that market, groupings of assets, discount rate and terminal growth rates. Changes in these estimates could have a material adverse effect on the assessment of long-lived assets, thereby requiring us to write down the assets. There was no impairment charge related to long-lived assets recorded in fiscal 2011, 2010 or 2009.
Impairment of Goodwill and Other Intangible Assets
Goodwill represents the excess of the consideration paid for a business acquisition over the fair value of net tangible and intangible assets acquired. Goodwill and intangible assets with indefinite useful lives should not be amortized but rather be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. The impairment test is a two-step process. In the event that we determine that the value of goodwill has become impaired, we will record an impairment loss during the fiscal quarter in which the determination is made.
Application of the goodwill impairment test requires us to make estimates and assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment. In fiscal 2009, we recorded an impairment charge of $10.8 million related to goodwill acquired as part of Oplink'sacquisition of Optical Communication Products, Inc. ("OCP") in fiscal 2008 and 2007 and F3 and Fibercom Optics Communication Corp ("Fibercom") in fiscal 2006. We did not record any goodwill impairment charge in fiscal 2011 or 2010.
Fair Value Accounting
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, we consider the principal or most advantageous market in which we 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 fair value of our Level 1 financial assets is based on quoted prices in active markets for identical underlying securities and generally include money market funds. Determining fair value for Level 1 instruments generally does not require significant management judgment.
The fair value of our Level 2 financial assets is based on inputs observable for the underlying securities other than quoted prices included within Level 1 and generally include United States Treasury securities, United States government agency debt securities, certificates of deposit, commercial paper, and corporate bonds. These Level 2 instruments require more management judgment and subjectivity compared to Level 1 instruments which include determining which instruments are most similar to the instrument being priced, determining whether the market is active and determining which model-derived valuations are to be used when calculating fair value. We do not hold any financial assets or liabilities measured at fair value using Level 3 inputs, which requires significant management judgment.
Business Combinations
In fiscal 2010, we adopted ASC Topic 805, "Business Combination" ("ASC 805"), which revised the accounting guidance that we used to account for our acquisitions prior to fiscal 2010. In accordance with ASC 805, we recognize separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interests in the acquiree generally at their fair values as defined by ASC Topic 820, "Fair Value Measurements and Disclosures" ("ASC 820"). Goodwill as of the acquisition date is measured as the excess of consideration transferred, which is generally measured at fair value, and the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed. Acquisition-related transaction costs and costs associated with restructuring activities initiated by us are accounted for as expenses in the periods in which the costs are incurred. We record the values of assets and liabilities based on independent valuations and internal estimate. The determination of fair value requires our management to make significant estimates and assumptions, and accordingly, our financial position or results of operations may be affected by changes in these estimates and assumptions.
Income Taxes
We account for income taxes under the liability method, which recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts, and for net operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance against deferred tax assets when it is more likely than not that such assets will not be realized.
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 subject to income tax audits by the respective tax authorities in all of the jurisdictions in which we operate. The determination of tax liabilities in each of these jurisdictions requires the interpretation and application of complex and sometimes uncertain tax laws and regulations. We recognize liabilities for uncertain tax positions based on the provisions of ASC Topic 740, "Income Taxes" ("ASC 740"). If we ultimately determine that the payment of such a liability is not necessary, then we reverse the liability and recognize a tax benefit during the period in which the determination is made that the liability is no longer necessary. See Note 10 - "Income Taxes" in the consolidated financial statements for additional information.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
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.
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 (“U.S. 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. We believe the following critical accounting policies and our procedures relating to these policies, affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through issuances of equity, which totaled approximately $319.5 million in aggregate net proceeds, partially offset by $84.2 million in common stock repurchases, net of proceeds from exercise of stock options, employee stock purchase plan and warrants through April 1, 2012. As of April 1, 2012, we had cash, cash equivalents and short-term and long-term investments of $176.1 million and working capital of $221.6 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.
Nine Months Ended April 1, 2012
Our operating activities provided cash of $16.7 million for the nine months ended April 1, 2012, primarily attributable to a net income of $2.6 million adjusted by non-cash charges of $4.6 million in depreciation expenses, $4.5 million in stock-based compensation expenses, $1.2 million in amortization of intangible assets and $0.6 million in deferred income tax. Net cash provided by working capital related items was $3.5 million for the nine months ended April 1, 2012.
For the nine months ended April 1, 2012, the change in working capital was primarily driven by a decrease in inventories of $5.5 million, an increase in accrued and other liability of $1.6 million partially offset by an increase in prepaid and other assets of $2.4 million and an increase in accounts receivable of $1.0 million.
The decrease in inventory in the nine months ended April 1, 2012 was primarily attributable to a decrease in revenues and our efforts to align our inventory levels to meet current and future demand. In order to maintain an adequate supply of product for our customers, we must carry a certain level of inventory. Our inventory level may vary based primarily upon orders received from our customers, our forecast of demand for these products and lead-time for materials. These considerations are balanced against risk of obsolescence or potentially excess inventory levels. We generally expect the level of inventory to vary from one period to another as a result of changes in the level of sales.
The increase in accrued and other liabilities in the nine months ended April 1, 2012 was primarily due to increased salary and other employee related benefit accrual, higher accrued R&D bonus, partially offset by lower legal and other professional service expense related accruals.
The increase in prepaid and other assets in the nine months ended April 1, 2012 was primarily due to increases in balance of bankers’ acceptance notes, employee benefits related receivable and a $0.6 million prepaid license fees resulting from the litigation settlement with Finisar.
The increase in accounts receivable in the nine months ended April 1, 2012 was primarily due to the longer payment terms extended to our customers. Days sales outstanding (“DSO”) was 75 days for the three months ended April 1, 2012 compared to 73 days for the fourth quarter of fiscal 2011. 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, both 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
For the nine months ended April 1, 2012, our investing activities used cash of $3.3 million due to purchase of property and equipment of $10.8 million and purchase of available for sale and held to maturity investments of $164.3 million, partially offset by sales and maturities of available for sale investments of $171.6 million and proceeds from sales of equipment of $0.4 million, respectively. In addition, we used $0.2 million to purchase non-marketable equity securities in the nine months ended April 1, 2012. We expect our capital expenditure to be approximately $12 million for fiscal 2012.
For the nine months ended April 1, 2012, our financing activities used cash of $19.8 million due to $19.9 million cash used to repurchase our common stock and $1.2 million in tax withholding payments related to net share settlements of restricted stock units partially offset by $1.3 million cash proceeds from the exercise of employee stock options and the issuance of stock under our employee stock purchase plan.
Nine Months Ended April 3, 2011
Our operating activities provided cash of $29.3 million in the nine months ended April 3, 2011 primarily as a result of a net income of $22.3 million for the period adjusted by non-cash charges of $4.0 million in depreciation expense, $3.1 million in amortization of intangible assets, $4.2 million in stock-based compensation expense, partially offset by a decrease in cash of $4.4 million as a result of a change in net working capital.
For the nine months ended April 3, 2011, the change in net working capital was primarily the result of an increase in accounts receivables and inventory of $5.9 million and $0.3 million, an increase in income tax receivable and payable of $1.6 million and a decrease in accounts payable of $2.5 million, partially offset by an increase in accrued liabilities and other liabilities of $1.8 million and a decrease in prepaid expenses and other assets of $0.8 million.
The increase in accounts receivable was primarily due to higher shipments in the nine months ended April 3, 2011. Days sales outstanding (“DSO”) was 62 days for the third quarter of fiscal 2011 compared to 70 days for the fourth quarter of fiscal 2010.
The increase in inventory in the nine months ended April 3, 2011 was primarily attributable to our efforts to maintain an adequate supply of product for our customers.
The decrease in prepaid expenses and other assets in the nine months ended April 3, 2011 were primarily due to a decrease in balance of bankers’ acceptance notes.
The decrease in accounts payable in the nine months ended April 3, 2011 was largely due to the change in the level of inventory purchase and the timing of payments to our vendors.
The increase in accrued liabilities and other liabilities in the nine months ended April 3, 2011 was primarily due to increases in accrued bonus and commission as a result of higher revenue.
Our investing activities used cash of $6.9 million in the nine months ended April 3, 2011 primarily due to purchase of investment of $136.2 million and purchase of property, plant and equipment of $5.3 million, net of proceeds from sales of property and equipment, partially offset by maturities of marketable investment securities of $134.6 million.
Our financing activities provided cash of $11.3 million in the nine months ended April 3, 2011 due to $17.9 million in proceeds from issuance of common stock in connection with the exercise of stock options and the employee stock purchase plan, partially offset by $6.5 million of cash spent on the repurchase of our common stock.
Off-Balance Sheet Arrangements
As of April 1, 2012, 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 consolidated condensed financial statements, please see “Note 4 Recent Accounting Pronouncement” in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q.
CONF CALL
Matt Hunt
Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us on today’s conference call to discuss Oplink’s first quarter fiscal year 2011 financial results. This call is being simultaneously webcast on the Investor Relations section of the company’s website at www.oplink.com. Joining me on the call today are Joe Liu, Chairman and CEO of Oplink, and Shirley Yin, CFO of Oplink.
Before we get started, I would like to remind you that the following discussion contains forward-looking statements that involve risks and uncertainties, and that Oplink’s actual results may vary materially from those discussed here. Information concerning factors that could cause actual results to differ from the forward-looking statements can be found in Oplink’s periodic filings with the SEC.
Forward-looking statements made on this conference call are based on current expectations, and Oplink assumes no responsibility to, and does not intend to, update or revise them, whether as a result of new developments or otherwise.
Now I would like to turn the call over to Joe Liu, President and CEO of Oplink. Please go ahead, Joe.
Joe Liu
Thank you Matt. Hello, and thanks to all of you for joining us today as we report our first quarter of fiscal 2011 results. We're pleased to report a record quarter, with revenue reaching almost $50 million. Revenue increased about 48% year-over-year, and about 28% sequentially. We reported non-GAAP EPS of $0.41 as compared to $0.28 in the prior quarter and $0.21 in the prior year first quarter.
We did not increase [inaudible] headcount during the quarter. Our factory capacity is now at a level that we believe can efficiently handle current demand, and we believe that we have the production flexibility to meet a meaningful increase in demand without any further significant increase in headcount.
We increased our R&D engineering headcount during the quarter by about 30 to help broaden our product offerings, and we have introduced several new devices during the quarter.
Our 10% customers for the quarter we Huawei and Tellabs, and together those two account for approximately 37% of our total revenue. We continue to believe that video streaming and other bandwidth-intensive applications are driving long-term demand for fiber optics across the network, particularly in the access and metro] equipment market overall. FTTx is growing and so are the metro core, metro edge, and Long-Haul markets.
Our outlook for the second quarter is positive, but we are seeing a bit of softness in demand for selected product lines. Production lead times of selected parts and modules have been shortened to our previous normal level of four to six weeks. We remain focused on controlling expenses and meeting normalized demand.
We look forward to reporting to you again next quarter. Now I will turn the call over to Shirley for a detailed financial review. Shirley, please go ahead.
Shirley Yin
Thanks Joe, and thanks to all of you for joining us today. Revenue for the first quarter was $49.6 million, up 28% from the prior quarter and 48% over the prior year. GAAP net income was $5.6 million, for $0.28 per diluted share, which includes $1.7 million in stock-based compensation and $1 million in amortization of intangibles.
On a non-GAAP basis, net income was $8.3 million, or $0.41 per diluted share, compared to $6 million, or $0.28 per diluted share reported in the prior quarter. Non-GAAP gross margin for the first quarter was 33.9%, up slightly over the 33.5% reported in the prior quarter.
Margins were improved in the quarter as a result of scaling revenue. We also increased labor costs in China. However, our revenue and volume increases were able to offset these increases. We expect margins to be at a similar level next quarter.
Turning to our operating performance, total non-GAAP operating expenses were $7.7 million, up from $7.4 million reported in the fourth quarter as we continue to invest in R&D and new product initiatives. Sales and marketing costs also increased, primarily due to higher commission expense, driven by higher revenue. These increases were partially offset by decreases in G&A expenses. We expect total operating expenses to remain at a similar level in the second quarter.
Interest and other income net was $57,000. Gross interest income for the first quarter was $130,000, largely offset by foreign currency losses. Our provision for income taxes in the quarter was $881,000, primarily due to an increase in taxable income in foreign tax jurisdictions. We expect our provision for income taxes in the current quarter to be at a similar level.
Total headcount at September 30 was 3,855, up from 3,821 in the prior quarter. Our increases were primarily in R&D.
Turning to the balance sheet, we closed the quarter with cash, cash equivalents, and investments of $160 million, down only slightly over the prior quarter. We generated $5.5 million from operations and repurchased 6.5 million of our common stock. Actual shares outstanding at the end of the quarter were approximately 19.4 million.
Accounts receivable at the end of the quarter were $34.2 million, up over 29.7% in the prior quarter. DSOs were 67 days, as compared to 70 days in the prior quarter, due to improved collections and timing of shipments during the quarter. Inventory was $24.3 million, up significantly over $20.9 million in the prior quarter. While we continue to improve our lead time and prepare to meet higher product demand, we strategically increased buffer inventory to be able to capture sales opportunities.
For the second quarter ending December 31, we expect revenue to be in the range of $50 million to $53 million. GAAP net income for the second quarter of fiscal 2011 is expected to be in the range of $0.28 to $0.34 per diluted share, and non-GAAP net income is expected to be in the range of $0.41 to $0.47 per diluted share, excluding amortization of intangible assets, stock-based compensation, and other non-cash and non-recurring items.
Now we will take your questions through the operator. Please go ahead operator.
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Fund Letters
