Summary of FINISAR CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ substantially from those anticipated in these forward-looking statements as a result of many factors, including those referred to in "Part II, Item 1A. Risk Factors" below. The following discussion should be read together with our consolidated financial statements and related notes thereto included elsewhere in this report. Business Overview
Finisar Corporation is a leading provider of optical subsystems and components that provide the fundamental optical-electrical interface for connecting equipment used in building a wide range of communication networks including local area networks, or LANs, storage area networks, or SANs, metropolitan area networks, or MANs, fiber-to-home networks, or FTTx, cable television networks, or CATV, and wide area networks, or WANs. Our optical subsystems consist primarily of transceivers and transponders These products rely on the use of digital and analog RF semiconductor lasers in conjunction with integrated circuit design and novel packaging technology to provide a cost-effective means for transmitting and receiving digital signals over fiber optic cable using a wide range of network protocols, transmission speeds and physical configurations over distances of 70 meters to 200 kilometers. We also provide wavelength selective switch reconfigurable optical add/drop multiplexer products, or WSS ROADMs, and linecards that enable network operators to switch wavelengths in MAN and WAN networks without the need for converting to an electrical signal. Our line of optical components consists primarily of packaged lasers and photodetectors used in transceivers, primarily for LAN and SAN applications. Our manufacturing operations are vertically integrated and include an internal manufacturing, assembly and test capability. We sell our optical subsystem and component products to manufacturers of storage and networking equipment such as Brocade, Cisco Systems, EMC, Emulex, Ericsson, Hewlett-Packard Company, Huawei, IBM, Tellabs and Qlogic.
We also provide network test systems primarily to leading storage equipment manufacturers such as Brocade, EMC, Emulex, Hewlett-Packard Company and Qlogic for testing and validating equipment designs.
On August 29, 2008, we completed a business combination with Optium Corporation, a leading designer and manufacturer of high performance optical subsystems for use in telecommunications and cable TV network systems (see note 2 to condensed consolidated financial statements). The combination was consummated as a merger of Optium with a wholly-owned subsidiary of Finisar. We have accounted for the combination of Finisar and Optium using the purchase method of accounting and as a result have included the operating results of Optium in our consolidated financial results since the August 29, 2008 merger date. The Optium results are included in our optical subsystems and components segment. We believe that the combination of the two companies created the world's largest supplier of optical components, modules and subsystems for the communications industry and will leverage the Company's leadership position in the storage and data networking sectors of the industry and Optium's leadership position in the telecommunications and CATV sectors to create a more competitive industry participant.
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes. Actual results could differ from those estimates. We believe there have been no significant changes in our critical accounting policies as discussed in our Annual Report on Form 10-K for the year ended April 30, 2008 other than the adoption of SFAS No. 157 (see note 1 to condensed consolidated financial statements).

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Results of Operations
   The following table sets forth certain statement of operations data as a
percentage of revenues for the periods indicated:

                                                     Three Months Ended                                     Six Months Ended
                                           November 2,                October 28,                November 2,                October 28,
                                              2008                       2007                       2008                       2007
                                                                                   (Unaudited)
Revenues
Optical subsystems and components                  92.6 %                     90.3 %                     91.4 %                     90.7 %
Network test systems                                7.4                        9.7                        8.6                        9.3

Total revenues                                    100.0                      100.0                      100.0                      100.0
Cost of revenues                                   68.9                       66.7                       65.2                       67.3
Amortization of acquired developed
technology                                          0.9                        1.7                        1.0                        1.7

Gross profit                                       30.2                       31.6                       33.8                       31.0


Operating expenses:
Research and development                           15.6                       17.5                       15.8                       17.0
Sales and marketing                                 6.6                        9.1                        7.2                        9.3
General and administrative                          7.4                       11.8                        7.7                       10.0
Acquired in-process research and
development                                         6.6                        0.0                        3.6                        0.0
Amortization of purchased intangibles               0.5                        0.5                        0.4                        0.5
Impairment of goodwill                            112.1                        0.0                       62.0                        0.0

Total operating expenses                          148.8                       38.9                       96.7                       36.8

Loss from operations                             (118.6 )                     (7.3 )                    (62.9 )                     (5.8 )
Interest income                                     0.4                        1.5                        0.6                        1.4
Interest expense                                   (1.8 )                     (4.3 )                     (2.4 )                     (4.2 )
Other income (expense), net                        (2.1 )                      0.1                       (1.1 )                      0.0

Loss before income taxes                         (122.1 )                    (10.0 )                    (65.8 )                     (8.6 )
Provision for (benefit from) income
taxes                                              (4.9 )                      0.7                       (2.4 )                      0.6

Net loss                                         (117.2 )%                   (10.7 )%                   (63.4 )%                    (9.2 )%

Revenues. Revenues increased $58.8 million, or 58.4%, to $159.5 million in the quarter ended November 2, 2008 compared to $100.7 million in the quarter ended October 28, 2007. Sales of optical subsystems and components and network performance test systems represented 92.6% and 7.4%, respectively, of total revenues in the quarter ended November 2, 2008, compared to 90.3% and 9.7%, respectively, in the quarter ended October 28, 2007.
Revenues increased $81.8 million, or 39.6%, to $288.2 million in the six months ended November 2, 2008 compared to $206.4 million in the six months ended October 28, 2007. Sales of optical subsystems and components and network performance test systems represented 91.4% and 8.6%, respectively, of total revenues in the six months ended November 2, 2008, compared to 90.7% and 9.3%, respectively, in the six months ended October 28, 2007.
Optical subsystems and components revenues which include $36.5 million from Optium, increased $56.8 million, or 62.5%, to $147.7 million in the quarter ended November 2, 2008 compared to $90.9 million in the quarter ended October 28, 2007. Excluding the Optium revenues, optical subsystem revenues increased $20.3 million, or 22.3%, to $111.2 million compared to $90.9 million in the quarter ended October 28, 2007. Of this increase, sales of new products for 10/40 Gbps applications for both LAN/SAN and longer distance MAN applications increased $11.4 million while sales of products for shorter distance LAN/SAN applications less than 10 Gbps increased $9.0 million due primarily to increased sales of 4 and 8 Gbps products for storage applications. Of the $56.8 million increase in revenues including the results of Optium, sales of products for 10/40 Gbps applications increased $35.8 million, sales of products for shorter distance LAN/SAN applications less than 10 Gbps increased $9.0 million, sales of ROADM products increased $8.8 million, and sales of CATV products increased $3.2 million.
Optical subsystems and components revenues which include $36.5 million from Optium, increased $76.2 million, or 40.7%, to $263.5 million in the six months ended November 2, 2008 compared to $187.3 million in the six months ended October 28, 2007. Excluding the Optium revenues, optical subsystem revenues increased $39.7 million, or 21.2%, to $227.0 million compared to $187.3 million in the six months ended October 28, 2007. Of this increase, sales of new products for 10/40 Gbps applications for both LAN/SAN and longer distance MAN applications increased $25.4 million and sales of products for shorter distance LAN/SAN applications less than 10 Gbps increased $13.5 million. Including the results of Optium, sales of products for 10/40 Gbps applications increased $49.7 million, sales of products for shorter distance LAN/SAN applications less than 10 Gbps increased $15.0 million, sales of ROADM products increased $8.8 million, and sales of CATV products increased $3.3 million.
Network test systems revenues increased $2.0 million, or 20.4%, to $11.8 million in the quarter ended November 2, 2008 compared to $9.8 million in the quarter ended October 28, 2007 and increased $5.6 million, or 29.0%, to $24.7 million in the six months ended November 2, 2008 compared to $19.1 million in the six months ended October 28, 2007. These increases were

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primarily due to the recent introduction of several new products for testing 8 Gbps Fibre Channel, 3/6 Gbps SAS/SATA, and 10 Gbps Fibre Channel over Ethernet products being developed and used at OEM system manufacturers.
Amortization of Acquired Developed Technology. Amortization of acquired developed technology, a component of cost of revenues, decreased $226,000, or 13.1%, to $1.5 million in the quarter ended November 2, 2008 compared to $1.7 million in the quarter ended October 28, 2007 and decreased $709,000, or 20.5%, to $2.8 million in the six months ended November 2, 2008 compared to $3.5 million in the six months ended October 28, 2007. These decreases were primarily due to the full amortization during fiscal 2008 of certain assets associated with the Honeywell, Infineon, and InterSan acquisitions, partially offset by $403,000 of amortization of Optium assets.
Gross Profit. Gross profit increased $16.3 million, or 51.4 %, to $48.1 million in the quarter ended November 2, 2008 compared to $31.8 million in the quarter ended October 28, 2007. The increase in gross profit was primarily due to the Optium merger. Gross profit as a percentage of total revenue was 30.2% in the quarter ended November 2, 2008 compared to 31.6% in the quarter ended October 28, 2007. We recorded charges of $3.8 million for obsolete and excess inventory in the quarter ended November 2, 2008 compared to $3.6 million in the quarter ended October 28, 2007. We sold inventory that was written-off in previous periods resulting in a benefit of $1.3 million in the quarter ended November 2, 2008 and $1.7 million in the quarter ended October 28, 2007. As a result, we recognized a net charge of $2.5 million in the quarter ended November 2, 2008 compared to $1.9 million in the quarter ended October 28, 2007. Manufacturing overhead includes stock-based compensation charges of $863,000 in the quarter ended November 2, 2008 and $703,000 in the quarter ended October 28, 2007. Excluding amortization of acquired developed technology, the net impact of excess and obsolete inventory charges and stock-based compensation charges, gross profit would have been $53.0 million, or 33.2% of revenue, in the quarter ended November 2, 2008 compared to $36.1 million, or 35.9% of revenue in the quarter ended October 28, 2007. The decrease in adjusted gross profit margin was primarily due to the inclusion of two months of Optium's operating results during the quarter ended November 2, 2008.
Gross profit increased $33.5 million, or 52.2 %, to $97.6 million in the six months ended November 2, 2008 compared to $64.1 million in the six months ended October 28, 2007. The increase in gross profit was partially due to the Optium merger. Gross profit as a percentage of total revenue was 33.8% in the six months ended November 2, 2008 compared to 31.0% in the six months ended October 28, 2007. We recorded charges of $6.4 million for obsolete and excess inventory in the six months ended November 2, 2008 compared to $7.4 million in the six months ended October 28, 2007. We sold inventory that was written-off in previous periods resulting in a benefit of $3.1 million in the six months ended November 2, 2008 and $3.4 million in the six months ended October 28, 2007. As a result, we recognized a net charge of $3.3 million in the six months ended November 2, 2008 compared to $4.0 million in the six months ended October 28, 2007. Manufacturing overhead includes stock-based compensation charges of $1.7 million in the six months ended November 2, 2008 and $1.4 million in the six months ended October 28, 2007. Excluding amortization of acquired developed technology, the net impact of excess and obsolete inventory charges and stock-based compensation charges, gross profit would have been $105.3 million, or 36.5% of revenue, in the six months ended November 2, 2008 compared to $73.0 million, or 35.4% of revenue in the six months ended October 28, 2007. The increase in adjusted gross profit margin was primarily due to a more favorable product mix resulting from increased sales of higher margin network performance test systems and optical subsystems for 10/40 Gbps applications, as well as cost efficiencies associated with higher shipment volumes, partially offset by lower gross margins on sales of Optium products that were included for two months during the six month period ended November 2, 2008.
Research and Development Expenses. Research and development expenses increased $7.3 million, or 41.1%, to $24.9 million in the quarter ended November 2, 2008 compared to $17.6 million in the quarter ended October 28, 2007. The increase was primarily due to $4.2 million in additional expenses as a result of the Optium merger, an increase in employee related expenses of $1.2 million and increases in the costs of development materials of $724,000. Included in research and development expenses were stock-based compensation charges of $1.7 million in the quarter ended November 2, 2008 and $1.0 million in the quarter ended October 28, 2007. Research and development expenses as a percent of revenues decreased to 15.6% in the quarter ended November 2, 2008 compared to 17.5% in the quarter ended October 28, 2007.
Research and development expenses increased $10.5 million, or 29.9%, to $45.6 million in the six months ended November 2, 2008 compared to $35.1 million in the six months ended October 28, 2007. The increase was primarily due to $4.2 million in additional expenses as a result of the Optium merger, an increase in employee related expenses of $2.8 million and increases in the costs of development materials of $2.1 million. Included in research and development expenses were stock-based compensation charges of $2.8 million in the six months ended November 2, 2008 and $2.0 million in the six months ended October 28, 2007. Research and development expenses as a percent of revenues decreased to 15.8% in the six months ended November 2, 2008 compared to 17.0% in the six months ended October 28, 2007.
Sales and Marketing Expenses. Sales and marketing expenses increased $1.4 million, or 15.0%, to $10.6 million in the quarter ended November 2, 2008 compared to $9.2 million in the quarter ended October 28, 2007. The increase in sales and marketing expenses was primarily due to $832,000 in additional expense as a result of the Optium merger. Included in sales and marketing expenses were stock-based compensation charges of $516,000 in the quarter ended November 2, 2008 and $442,000 in the quarter

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ended October 28, 2007. Sales and marketing expenses as a percent of revenues decreased to 6.6% in the quarter ended November 2, 2008 compared to 9.1% in the quarter ended October 28, 2007.
Sales and marketing expenses increased $1.5 million, or 7.6%, to $20.7 million in the six months ended November 2, 2008 compared to $19.2 million in the six months ended October 28, 2007. The increase in sales and marketing expenses was primarily due to $832,000 in additional expense as a result of the Optium merger. Included in sales and marketing expenses were stock-based compensation charges of $1.0 million in the six months ended November 2, 2008 and $893,000 in the six months ended October 28, 2007. Sales and marketing expenses as a percent of revenues decreased to 7.2% in the six months ended November 2, 2008 compared to 9.3% in the six months ended October 28, 2007.
General and Administrative Expenses. General and administrative expenses decreased $186,000, or 1.6%, to $11.7 million in the quarter ended November 2, 2008 compared to $11.9 million in the quarter ended October 28, 2007. The decrease was primarily due to a $3.0 million decrease in legal and consulting fees as a result of the completion of our stock option investigation. This decrease was partially offset by the addition of $1.8 million in expenses as a result of the Optium merger, and an increase in employee related expenses of $741,000. Included in general and administrative expenses were stock-based compensation charges of $720,000 in the quarter ended November 2, 2008 and $350,000 in the quarter ended October 28, 2007. General and administrative expenses as a percent of revenues decreased to 7.4% in the quarter ended November 2, 2008 compared to 11.8% in the quarter ended October 28, 2007.
General and administrative expenses increased $1.5 million, or 7.2%, to $22.2 million in the six months ended November 2, 2008 compared to $20.7 million in the six months ended October 28, 2007. The increase was primarily due to $1.8 million in additional expenses as a result of the Optium merger, an increase in employee related expenses of $1.2 million, and a non-cash charge of $919,000 related to the sale of a product line. These increases were partially offset by a $4.0 million decrease in legal and consulting fees as a result of the completion of our stock option investigation. Included in general and administrative expenses were stock-based compensation charges of $1.3 million in the six months ended November 2, 2008 and $981,000 in the six months ended October 28, 2007. General and administrative expenses as a percent of revenues decreased to 7.7% in the six months ended November 2, 2008 compared to 10.0% in the six months ended October 28, 2007.
Acquired In-process Research and Development. In-process research and development, or IPR&D, expenses were $10.5 million in the quarter and six month period ended November 2, 2008, compared to $0 in the quarter and six month period ended October 28, 2007. The IPR&D charges were related to the Optium merger.
Amortization of Purchased Intangibles. Amortization of purchased intangibles increased $263,000, or 53.7%, to $753,000 in the quarter ended November 2, 2008 compared to $490,000 in the quarter ended October 28, 2007 and increased $41,000, or 4.2%, to $1.0 million in the six months ended November 2, 2008 compared to $980,000 in the six months ended October 28, 2007. The increase was primarily due the addition of amortization associated with the Optium merger offset by the reduction in amortization of certain assets associated with our AZNA and Kodeos acquisitions. The amortization related to the Optium merger for the two months included in the quarter and six month periods ended November 2, 2008 was $485,000.
Impairment of Goodwill. As a result of the ongoing financial liquidity crisis, the current economic recession, reductions to our internal revenue forecasts, changes to our internal operating forecasts and a drastic reduction in our market capitalization, during the period, we performed an analysis to determine if there was an indication of impairment of our intangible assets. As a result of this analysis, we determined that the goodwill related to our optical subsystems and components reporting unit was impaired and had an implied fair value of $59.6 million. As a result, we recorded an estimated impairment charge of $178.8 million during the quarter ended November 2, 2008. As of November 2, 2008 we had not completed the goodwill impairment analysis but expect to do so during the third quarter of fiscal 2009.
Interest Income. Interest income decreased $880,000, or 57.3%, to $657,000 in the quarter ended November 2, 2008 compared to $1.5 million in the quarter ended October 28, 2007 and decreased $1.3 million, or 45.0%, to $1.6 million in the six months ended November 2, 2008 compared to $3.0 million in the six months ended October 28, 2007. These decreases were due primarily to a decrease in our cash balance as a result of the principal repayment of $92.0 million on our 5 1/4% convertible notes due October 15, 2008.
Interest Expense. Interest expense decreased $1.5 million, or 34.0%, to $2.9 million in the quarter ended November 2, 2008 compared to $4.4 million in the quarter ended October 28, 2007. The decrease was primarily related to the principal repayment of $92.0 million on our 5 1/4% convertible notes due October 15, 2008. Of the total interest expense for the quarters ended November 2, 2008 and October 28, 2007, approximately $2.2 million and $3.1 million, respectively, was related to our convertible subordinated notes due in 2008 and 2010 and other borrowings, and $671,000 and $1.3 million, respectively, represented a non-cash charge to amortize the beneficial conversion feature of the notes due in 2008.

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Interest expense decreased $1.7 million, or 20.0%, to $6.9 million in the six months ended November 2, 2008 compared to $8.6 million in the six months ended October 28, 2007. The decrease was primarily related to the principal repayment of $92.0 million on our 5 1/4% convertible notes due October 15, 2008. Of the total interest expense for the six months ended November 2, 2008 and October 28, 2007, approximately $5.1 million and $6.2 million, respectively, was related to our convertible subordinated notes due in 2008 and 2010 and other borrowings and $1.8 million and $2.5 million, respectively, represented a non-cash charge to amortize the beneficial conversion feature of the notes due in 2008.
Other Income (Expense), Net. Other expense was $3.3 million in the quarter ended November 2, 2008 compared to other income of $85,000 in the quarter ended October 28, 2007. Other expense was $3.3 million in the six months ended November 2, 2008 compared to $48,000 in the six months ended October 28, 2007. Other expense in the quarter and six month periods ended November 2, 2008 was primarily related to a $1.7 million non-cash foreign exchange loss related to the remeasurement of a $19.8 million note re-payable in U.S. dollars which is recorded on the books of our subsidiary in Malaysia whose functional currency is the Malaysian Ringgit and a $1.2 million other-than-temporary write-down of a minority investment during the period.
Provision for Income Taxes. We recorded an income tax benefit of $7.7 million and an income tax provision of $655,000, respectively, for the quarters ended November 2, 2008 and October 28, 2007 and an income tax benefit of $7.0 million and an income tax provision of $1.3 million, respectively, for the six months ended November 2, 2008 and October 28, 2007. The income tax benefit for the quarter ended November 2, 2008 includes a non-cash benefit of $8.4 million from the reversal of previously recorded deferred tax liabilities as a result of the impairment of goodwill in the current quarter and current tax expense of $655,000 for minimum federal and state taxes and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. The income tax provision for the quarter ended October 28, 2007 includes a non-cash charge $544,000 for deferred tax liabilities that were recorded for tax amortization of goodwill for which no financial statement amortization has occurred under generally accepted accounting principles as promulgated by SFAS 142 and current tax expense of $111,000 for minimum federal and state taxes and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. The income tax benefit for the six month period ended November 2, 2008 includes a non-cash benefit of $7.8 million from the reversal of previously recorded deferred tax liabilities as a result of the impairment of goodwill in the current quarter and current tax expense of $849,000 for minimum federal and state taxes and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. The income tax provision for the six months ended October 28, 2007 includes a non-cash charge $1.1 million for deferred tax liabilities that were recorded for tax amortization of goodwill for which no financial statement amortization has occurred under generally accepted accounting principles as promulgated by SFAS 142 and current tax expense of $188,000 for minimum federal and state taxes and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. Due to the uncertainty regarding the timing and extent of our future profitability, we have recorded a valuation allowance to offset our deferred tax assets which represent future income tax benefits associated with our operating losses. There can be no assurance that our deferred tax assets subject to the valuation allowance will ever be realized.
Liquidity and Capital Resources
At November 2, 2008, cash, cash equivalents and short-term and long-term available-for-sale investments were $51.9 million compared to $119.3 million at April 30, 2008. Of this amount, long-term available-for-sale investments totaled $326,000, which consisted of readily saleable debt securities. At November 2, 2008, total short- and long-term debt was $174.4 million, compared to $257.6 million at April 30, 2008.
Net cash provided by operating activities totaled $1.4 million in the six months ended November 2, 2008, compared to $1.6 million in the six months ended October 28, 2007. Cash provided by operating activities in the six months ended November 2, 2008 primarily consisted of operating loss adjusted for depreciation, amortization and other non-cash related items in the income statement totaling $35.6 million and offset by $34.2 million in additional working capital which was primarily related to increases in inventory, accounts receivable, and other assets and a decrease in accrued compensation, offset by an increase in accounts payable and deferred revenue. Cash provided by operating . . .