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AFOP > SEC Filings for AFOP > Form 10-Q on 9-May-2014All Recent SEC Filings

Show all filings for ALLIANCE FIBER OPTIC PRODUCTS INC

Form 10-Q for ALLIANCE FIBER OPTIC PRODUCTS INC


9-May-2014

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 anticipated investments, expenditures and expenses, our liquidity and the adequacy of our capital resources, our uses of cash, our intent and ability to pay dividends in the future and the amount of future dividends, if any, 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 protect 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 related to 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, data center 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, pricing pressure from customers or potential customers, development of new products by us and our competitors, increased competition, inability to obtain sufficient quantities of a raw material component, 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, 2013.

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 $19.6 million, or 78.7%, and $9.0 million, or 73.8%, for the three months ended March 31, 2014 and 2013, respectively. Our optical passive products contributed revenues of $5.3 million, or 21.3%, and $3.2 million, or 26.2%, for the three months ended March 31, 2014 and 2013, respectively.

In the three months ended March 31, 2014 and 2013, our 10 largest customers comprised 72.6% and 68.5% of our total revenues, respectively. For the three months ended March 31, 2014, one customer accounted for 40.6% of our total revenues. For the three months ended March 31, 2013, three customers accounted for 16.2%, 10.5% and 10.3% of our total 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 total 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. We expect research and development expenses may increase as we intend to continue to invest in our research and product development efforts during 2014.

Sales, marketing, and administrative expenses consist of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as the costs associated with trade shows, promotional activities and travel expenses. It also consists of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting support. We intend to continue to invest amounts similar to our spending levels in 2013 in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. We expect administrative expenses will increase in absolute dollars to support our revenue growth, higher insurance premiums, and costs associated with compliance with
Section 404 of the Sarbanes-Oxley Act of 2002 and with being a public company.


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 Mar. 31,
                                                      2014               2013
    Revenues                                            100.0 %            100.0 %

    Cost of revenues                                     60.2               63.7
       Gross profit                                      39.8               36.3
    Operating expenses:
       Research and development                           4.4                6.7
       Selling, marketing and administrative              9.4               15.1
          Total operating expenses                       13.8               21.8

    Income from operations                               26.0               14.5
    Interest and other income, net                        0.6                1.1
    Net income before tax                                26.6 %             15.6 %
    Provision for income taxes                           (6.4 )             (0.4 )
    Net income                                           20.2 %             15.2 %

Revenues. Revenues were $24.88 million and $12.15 million for the three months ended March 31, 2014 and 2013, respectively. Revenues increased 104.7% in the quarter ended March 31, 2014 from the same period in 2013, primarily due to increased volume shipments of products into telecom and datacom market applications.

Cost of Revenues. Cost of revenues was $15.0 million and $7.7 million for the three months ended March 31, 2014 and 2013, respectively. Cost of revenues as a percentage of revenues decreased to 60.2% for the three months ended March 31, 2013 from 63.7% for the three months ended March 31, 2013. The lower percentage cost of revenues for the three months ended March 31, 2014 resulted from increased factory utilization due to higher product sales.

Gross Profit. Gross profit increased to $9.9 million, or 39.8% of revenues, for the three months ended March 31, 2014 from $4.4 million, or 36.3% of revenues, for the same period in 2013. The higher gross profit was due to the higher utilization of our factories for the increased volume shipments of our products. However, decreasing average selling prices will have a negative impact our gross profit and may offset benefits, if any, from improved absorption.

Research and Development Expenses. Research and development expenses were $1.1 million and $0.8 million for the three months ended March 31, 2014 and 2013, respectively. As a percentage of revenues, research and development expenses decreased to 4.4% in the three months ended March 31, 2014 from 6.7% for the same period in 2013 as a result of increased revenues. We expect research and development expenses will increase as we intend to continue to invest in our research and product development efforts.

Sales, Marketing and Administrative Expenses. Sales, marketing and administrative expenses were $2.3 million and $1.8 million for the three months ended March 31, 2014 and 2013, respectively. As a percentage of revenues, sales and marketing expenses decreased to 9.4% in the three months ended March 31, 2014 from 15.1% in the three months ended March 31, 2013 as a result of increased revenues. We expect sales, marketing and administrative expenses will increase as we intend to invest in our sales, marketing and administrative efforts. Our administrative expenses will also increase to support our revenue growth, higher insurance premiums, and costs associated with compliance with
Section 404 of the Sarbanes-Oxley Act of 2002 and with being a public company. Stock-Based Compensation. Stock based compensation expense increased to $0.7 million for the three months ended March 31, 2014 from $0.3 million for the same period in 2013. This increase was due to stock options and RSUs granted in the second quarter of 2013.

Interest and Other Income, Net. Interest and other income, net, was $0.15 million and $0.13 million for the three months ended March 31, 2014 and 2013, respectively. 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 $1.6 million and $0.05 million for the three months ended March 31, 2014 and 2013, respectively.

Liquidity and Capital Resources

At March 31, 2014, we had cash and cash equivalents of $19.5 million, short-term investments of $31.8 million and long-term investments of $10.5 million.

Net cash provided by operating activities was $5.5 million for the three months ended March 31, 2014. Net cash provided by operating activities was primarily due to net income of $5.0 million, a decrease in deferred tax assets of $0.7 million, an increase in accrued expenses of $0.5 million, a decrease in inventory of $0.3 million, and contribution from adjustments for non-cash charges, including depreciation, and amortization and stock based compensation of $1.4 million. These were offset by an increase in accounts receivable of $2.4 million.

Net cash provided by operating activities was $0.1 million for the three months ended March 31, 2013. Net cash provided by operating activities was primarily due to net income of $1.9 million and total depreciation and amortization expenses of $0.7 million, which was offset by a $1.0 million increase in accounts receivable, an $0.8 million increase in inventory, and a $0.4 million each decrease in accounts payable and accrued expenses.

Net cash used in investing activities was $4.5 million for the three months ended March 31, 2014. In the three months ended March 31, 2014, we spent a net of $3.8 million for the purchase of short-term and long-term investments, and we used $0.6 million to purchase equipment.

Net cash provided by investing activities was $0.1 million for the three months ended March 31, 2013. In the three months ended March 31, 2013, we had a net of $0.6 million from the proceeds from sales and maturities of short-term investments, and we used $0.5 million to purchase equipment.

Net cash provided by financing activities was $0.1 million for the three months ended March 31, 2014. Net cash provided by financing activities was from the exercise of options to purchase shares of our common stock.

Net cash used in financing activities was $0.6 million for the three months ended March 31, 2013. Net cash used in financing activities was primarily due to $0.8 million used to repurchase common stock pursuant to our stock repurchase program, which was offset by $0.2 million from the exercise of options to purchase shares of our common stock.

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 financing may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain additional funding, 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 March 31, 2014.


Contractual Obligations

The lease on our corporate headquarters in Sunnyvale, California, has 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 34,406 square feet in one facility located in Tu-Cheng City, Taiwan. This lease expires at various times from December 2014 to January 2016. In December 2000, we purchased 10,623 square feet of space immediately adjacent to our leased facility for $0.8 million, In November 2013, we purchased 6,960 square feet of space we previous leased for $1.6 million. In April 2014, we also purchased 10,633 square feet of space we previous leased for $1.6 million, bringing the total square footage to 62,622 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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