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AFOP > SEC Filings for AFOP > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for ALLIANCE FIBER OPTIC PRODUCTS INC

Form 10-Q for ALLIANCE FIBER OPTIC PRODUCTS INC


13-Nov-2013

Quarterly Report


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

When used in this Report, the words "expects," "anticipates," "believes", "estimates," "plans," "intends," "could," "will," "may" and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include statements as to our operating results, revenues, sources of revenues, cost of revenues, gross margin, profitability, the amount and mix of investments, expenditures and expenses, our liquidity and the adequacy of our capital resources, our uses of cash, the impact of the economic environment on our business, exposure to interest rate or currency fluctuations, anticipated working capital and capital expenditures, reliance on our connectivity products, our cash flow, trends in average selling prices, our reliance on the commercial success of our optical passive products, plans for future products and enhancements of existing products, features, benefits and uses of our products, demand for our products, our success being tied to relationships with key customers, industry trends and market demand, our ability to protecting our intellectual property, the potential benefit of indemnification agreements, increases in the number of possible requests for licenses and patent infringement claims, our competitive position, sources of competition, consolidation in our industry, our international strategy, inventory management, our factory utilization levels, our employee relations, the adequacy of our internal controls, and the effect of recent, future and changing accounting pronouncements and our critical accounting policies, estimates, models, judgments and assumptions on our financial results. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, those risks discussed elsewhere in this report, as well as risks related to the development of the metropolitan, last mile access, and enterprise networks, customer acceptance of our products, our ability to retain and obtain customers, industry-wide overcapacity and shifts in supply and demand for optical components and modules, our ability to meet customer demand and manage inventory, fluctuations in demand for our products, declines in average selling prices, development of new products by us and our competitors, increased competition, inability to obtain sufficient quantities of raw materials or components, loss of a key supplier, integration of acquired businesses or technologies, financial stability in foreign markets, foreign currency exchange rates, interest rates, costs associated with being a public company, failure to meet customer requirements, our ability to license intellectual property on commercially reasonable terms, the impact of the economic environment, and the risks set forth below under Part II, Item 1A, "Risk Factors." These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.


The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto.

Critical Accounting Policies and Estimates

Management's discussion and analysis of financial condition and results of operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, asset impairments, 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 values for assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2012.

Overview

We were founded in December 1995 and commenced operations to design, manufacture and market fiber optic interconnect products, which we call our connectivity products. We started selling our optical passive products in July 2000. Since their introduction, sales of optical passive products have fluctuated with the overall market for these products. We market and sell our products predominantly through our direct sales force.

Our connectivity products contributed revenues of $17.6 million, or 76.2% and $8.3 million, or 67.0% for the three months ended September 30, 2013 and 2012, respectively. Our optical passive products contributed revenues of $5.5 million, or 23.8% and $4.1 million, or 33.0% for the three months ended September 30, 2013 and 2012, respectively.

Our connectivity products contributed revenues of $41.0 million, or 75.5% and $24.6 million, or 71.4% for the nine months ended September 30, 2013 and 2012, respectively. Our optical passive products contributed revenues of $13.3 million, or 24.5% and $9.9 million, or 28.6% for the nine months ended September 30, 2013 and 2012, respectively.

In the three months ended September 30, 2013 and 2012, our 10 largest customers comprised 79.1% and 66.3% of our revenues, respectively. For the three months ended September 30, 2013, two customers accounted for 40.1% and 11.2% of our total revenues. For the three months ended September 30, 2012, three customers accounted for 14.1%, 11.0% and 10.1% of our total revenues.

In the nine months ended September 30, 2013 and 2012, our 10 largest customers comprised 74.5% and 62.9% of our revenues, respectively. For the nine months ended September 30, 2013, two customers accounted for 32.4% and 10.4% of our revenues. For the nine months ended September 30, 2012, no customer accounted for 10% or more of our revenues.


Our cost of revenues consists of raw materials, components, direct labor, manufacturing overhead and production start-up costs. We expect that our cost of revenues as a percentage of revenues will fluctuate from period to period based on a number of factors including:

changes in manufacturing volume;

costs incurred in establishing additional manufacturing lines and facilities;

inventory write-downs and impairment charges related to manufacturing assets;

mix of products sold;

changes in our pricing and pricing from our competitors;

mix of sales channels through which our products are sold; and

mix of domestic and international sales.

Research and development expenses consist primarily of salaries and related personnel expenses, fees paid to outside service providers, materials costs, test units, facilities, overhead and other expenses related to the design, development, testing and enhancement of our products. We expense our research and development costs as they are incurred. We believe that a significant level of investment for product research and development is required to remain competitive.

Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as costs associated with trade shows, promotional activities and travel expenses. We intend to continue to invest in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. However, we cannot be certain that our expenditures will result in higher revenues. In addition, we believe that our future success depends upon establishing successful relationships with a variety of key customers.

General and administrative expenses consist primarily of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting services.

Results of Operations

The following table sets forth the relationship between various components of
operations as a percentage of revenues for the periods indicated:

                                   Three Months Ended September 30,               Nine Months Ended September 30,
                                      2013                   2012                   2013                   2012
Revenues                                   100.0 %               100.0 %                100.0 %                100.0 %
Cost of revenues                            61.6                  64.4                   62.1                   65.9
   Gross profit                             38.4                  35.6                   37.9                   34.1
Operating expenses:
   Research and development                  4.5                   6.6                    5.0                    7.1
   Sales and marketing                       3.6                   5.0                    4.3                    5.7
   General and administrative                5.8                   8.7                    6.7                    9.5
      Total operating expenses              13.9                  20.3                   16.0                   22.3
Income from operations                      24.5                  15.3                   21.9                   11.8
Interest and other income, net               0.8                   1.6                    0.9                    1.4
Net income before tax                       25.3                  16.9                   22.8                   13.2
Income tax                                  (0.9 )                (1.6 )                 (1.1 )                 (1.5 )
Net income                                  24.4 %                15.3 %                 21.7 %                 11.7 %


Revenues. Revenues were $23.1 million and $12.4 million for the three months ended September 30, 2013 and 2012, respectively. Revenues increased 86.2% in the three months ended September 30, 2013 from the same period in 2012. Revenues were $54.3 million and $34.5 million for the nine months ended September 30, 2013 and 2012, respectively. Revenues increased 57.5% in the nine months ended September 30, 2013 from the same period in 2012. The increase for the three and nine months ended September 30, 2013 was mainly due to increased orders from our existing customers and higher volume shipments of telecom and enterprise applications related products.

Cost of Revenues. Cost of revenues was $14.2 million and $8.0 million for the three months ended September 30, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues decreased to 61.6% for the three months ended September 30, 2013 from 64.4% for the three months ended September 30, 2012. Cost of revenues was $33.7 million and $22.7 million for the nine months ended September 30, 2013 and 2012, respectively. Cost of revenues as a percentage of revenues decreased to 62.1% for the nine months ended September 30, 2013 from 65.9% for the nine months ended September 30, 2012. The lower cost of revenues percentage for the three and nine months ended September 30, 2013 resulted from increased factory utilization due to higher product sales.

Gross Profit. Gross profit increased to $8.9 million, or 38.4% of revenues, for the three months ended September 30, 2013 from $4.4 million, or 35.6% of revenues, for the same period in 2012. Gross profit increased to $20.5 million, or 37.9% of revenues, for the nine months ended September 30, 2013 from $11.8 million, or 34.1% of revenues, for the same period in 2012. For the three and nine months ended September 30, 2013, the higher gross profit was due to the higher utilization of our factories as a result of increased volume shipments to our customers.

Research and Development Expenses. Research and development expenses were $1.0 million and $0.8 million for the three months ended September 30, 2013 and 2012, respectively. Research and development expenses increased to $2.7 million for the nine months ended September 30, 2013 from $2.5 million for the same period in 2012. The higher research and development expenses were due to higher capital investments for new product development, higher costs associated with testing our products and higher stock based compensation charges.

As a percentage of revenues, research and development expenses decreased to 4.5% in the three months ended September 30, 2013 from 6.6% for the same period in 2012. As a percentage of revenues, research and development expenses decreased to 5.0% in the nine months ended September 30, 2013 from 7.1% for the same period in 2012. The lower research and development expenses as a percentage of revenues were mainly due to increased revenue levels. We expect research and development expenses will increase as we intend to continue to invest in our research and product development efforts.

Sales and Marketing Expenses. Sales and marketing expenses increased to $0.8 million for the three months ended September 30, 2013 compared to $0.6 million for the three months ended September 30, 2012. Sales and marketing expenses increased to $2.3 million for the nine months ended September 30, 2013 from $2.0 million for the same period in 2012. The higher sales and marketing expenses were due to new hires and stock based compensation charges.

As a percentage of revenues, sales and marketing expenses were decreased to 3.6% in the three months ended September 30, 2013 from 5.0% for the same period in 2012. As a percentage of revenues, sales and marketing expenses decreased to 4.3% in the nine months ended September 30, 2013 from 5.7% for the same period in 2012. The lower sales and marketing expenses as a percentage of revenues was mainly due to increased revenue levels. We expect sales and marketing expenses will remain relatively flat in the next quarter.

General and Administrative Expenses. General and administrative expenses increased to $1.3 million for the three months ended September 30, 2013 compared to $1.1 million for the three months ended September 30, 2012. General and administrative expenses increased to $3.6 million for the nine months ended September 30, 2013 from $3.3 million for the same period in 2012. The increases were mainly due to higher stock based compensation charges.

As a percentage of revenues, general and administrative expenses decreased to 5.8% in the three months ended September 30, 2013 from 8.7% for the same period in 2012. As a percentage of revenues, general and administrative expenses decreased to 6.7% in the nine months ended September 30, 2013 from 9.5% for the same period in 2012. The lower general and administrative expenses as a percentage of revenues was mainly due to increased revenue levels. We expect general and administrative expenses will remain relatively flat in the next quarter.


Stock-Based Compensation. Total stock-based compensation increased to $0.6 million for the three months ended September 30, 2013 compared to $0.3 million for the three months ended September 30, 2012. Total stock-based compensation increased to $1.3 million for the nine months ended September 30, 2013 from $0.8 million for the same period in 2012. This increase was due to RSUs granted in June 2013 and amortization stock option granted in April and October 2012, and resulted in higher stock-based compensation expense.

Interest and Other Income, Net. Interest and other income, net, was $0.2 million for each of the three months ended September 30, 2013 and 2012. Interest and other income, net, was $0.5 million for each of the nine months ended September 30, 2013 and 2012. These amounts consisted primarily of interest income which fluctuated based on cash balances and changes in interest rates.

Income Tax Expense. Income tax expense was approximately $0.2 million for each of the three months ended September 30, 2013 and 2012. Income tax expense was $0.5 million for each of the nine months ended September 30, 2013 and 2012.

Liquidity and Capital Resources

At September 30, 2013, we had cash and cash equivalents of $15.2 million and short-term investments of $30.4 million. Long-term investments at September 30, 2013 were $10.4 million.

Net cash provided by operating activities was $12.2 million for the nine months ended September 30, 2013. The increase in net cash provided by operating activities was primarily due to net income of $11.8 million, an increase in accounts payable of $5.7 million, an increase in accrued expenses of $1.9 million, and contribution from adjustment for non-cash charges, including depreciation and amortization and stock based compensation of $2.8 million. These were offset by a $4.3 million increase in accounts receivable, a $3.3 million increase in inventory, a $1.0 million increase in prepaid expenses and $1.3 million of deferred compensation expenses related to RSUs.

Net cash provided by operating activities was $5.3 million for the nine months ended September 30, 2012. Net cash provided by operating activities was primarily due to net income of $4.0 million, an increase in accounts payable of $2.6 million, an increase in accrued expenses and other liabilities of $0.7 million, and contribution from adjustment for non-cash charges, including depreciation and amortization and stock based compensation of, $2.0 million. These were offset by a $1.7 million increase in accounts receivable, a $1.1 million increase in prepaid expenses, a $0.5 million increase in inventory and $0.6 million of deferred compensation expenses related to RSUs.

Net cash used in investing activities was $6.1 million for the nine months ended September 30, 2013. This resulted from $2.1 million in net purchases of short-term investments and $4.0 million of equipment purchases.

Net cash used in investing activities was $9.2 million for the nine months ended September 30, 2012. This resulted primarily from $8.3 million in net purchases of short-term investments and $0.7 million of equipment purchases.

Net cash provided by financing activities was $4.5 million for the nine months ended September 30, 2013. Net cash provided by financing activities was primarily due to proceeds of $5.4 million from the exercise of options to purchase our common stock and the sale of our common stock through our ESPP, which was offset by a $0.9 million used to repurchase common stock pursuant to our stock repurchase program.

Net cash used in financing activities was $1.9 million for the nine months ended September 30, 2012. Net cash used in financing activities was primarily due to $2.4 million used to repurchase common stock pursuant to our stock repurchase program and the repayment of $0.2 million in bank borrowings, which was offset in part by proceeds from the sale of our common stock through our ESPP.

We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.


However, our future growth, including any potential acquisitions, may require additional funding. If cash generated from operations is insufficient to satisfy our long-term liquidity requirements, we may need to raise capital through additional equity or debt financings, additional credit facilities, strategic relationships or other arrangements. If additional funds are raised through the issuance of securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of any debt facility could impose restrictions on our operations. The sale of additional equity or debt securities could result in additional dilution to our stockholders, and additional funding may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of our planned product development and marketing efforts. Strategic arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies or products. Our failure to raise capital when needed could harm our business, financial condition and operating results.

Off Balance Sheet Arrangements

We did not have any off-balance sheet arrangements at September 30, 2013.

Contractual Obligations

The lease on our corporate headquarters in Sunnyvale, California, had a six-year term commencing on July 22, 2004. In June 2010, we renewed the lease for an 18,088 square foot facility in the same building, which lease will expire in January 2016.

In Taiwan, we lease a total of approximately 38,800 square feet in one facility located in Tu-Cheng City, Taiwan. These leases expire at various times from December 2014 to December 2018. In December 2000, we purchased approximately 8,200 square feet of space immediately adjacent to our leased facility for $0.8 million, bringing the total square footage to approximately 47,000 square feet.

We lease a 132,993 square foot facility in Shenzhen, China, which lease will expire in October 2014.

Recent Accounting Pronouncements

See Note 2 of our Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for information on recent accounting pronouncements.

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