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FINISAR CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We use words like "anticipates," "believes," "plans," "expects," "future," "intends" and similar expressions to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events; however, our business and operations are subject to a variety of risks and uncertainties, and, consequently, actual results may materially differ from those projected by any forward-looking statements. As a result, you should not place undue reliance on these forward-looking statements since they may not occur. Certain factors that could cause actual results to differ from those projected are discussed in "Part II. Other Information, Item 1A. Risk Factors." We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events. The following discussion should be read together with our condensed consolidated financial statements and related notes thereto included elsewhere in this report. Business Overview We are a leading provider of optical subsystems and components that are used in data communication and telecommunication applications. Our optical subsystems consist primarily of transmitters, receivers, transceivers, transponders and active optical cables, which provide the fundamental optical-electrical or optoelectronic interface for interconnecting the electronic equipment used in building these networks, including the switches, routers and servers used in wireline networks as well as antennas and base stations for wireless networks. These products rely on the use of semiconductor lasers and photodetectors in conjunction with integrated circuits and novel optoelectronic packaging to provide a cost-effective means for transmitting and receiving digital signals over fiber optic cable at speeds ranging from less than 1 gigabit per second, or Gbps, to more than 100 Gbps, over distances of less than 10 meters to more than 2,000 kilometers using a wide range of network protocols and physical configurations. We supply optical transceivers and transponders that allow point-to-point communications on a fiber using a single specified wavelength or, bundled with multiplexing technologies, can be used to supply multi-Gbps bandwidth over several wavelengths on the same fiber. We also provide products known as wavelength selective switches, or WSS. In long-haul and metro networks, each fiber may carry 50 to 100 different high-speed optical wavelengths. WSS are switches that are used to dynamically switch network traffic from one optical fiber to multiple other fibers without first converting to an electronic signal. The wavelength selective feature means that WSS enable any wavelength or combination of wavelengths to be switched from the input fiber to the output fibers. WSS products are sometimes combined with other components and sold as linecards that plug into a system chassis, referred to as reconfigurable optical add/drop multiplexers, or ROADMs. Our line of optical components consists primarily of packaged lasers and photodetectors for data communication and telecommunication applications. Demand for our products is largely driven by the continually growing need for additional network bandwidth created by the ongoing proliferation of data and video traffic driven by video downloads, Internet protocol TV, social networking, on-line gaming, file sharing, enterprise IP/Internet traffic, cloud computing, and data center virtualization that must be handled by both wireline and wireless networks. Mobile traffic is increasing as the result of proliferation of smart phones, tablet computers, and other mobile devices. Our manufacturing operations are vertically integrated and we produce many of the key components used in making our products including lasers, photo-detectors and integrated circuits, or ICs, designed by our internal IC engineering teams. We also have internal assembly and test capabilities that make use of internally designed equipment for the automated testing of our optical subsystems and components. We sell our optical products to manufacturers of storage systems, networking equipment and telecommunication equipment such as Alcatel-Lucent, Brocade, Ciena, Cisco Systems, Coriant, EMC, Emulex, Ericsson, Fujitsu, Hewlett-Packard Company, Huawei, IBM, Juniper, Nokia and Qlogic, and to their contract manufacturers. These customers, in turn, sell their systems to businesses and to wireline and wireless telecommunication service providers and CATV operators, collectively referred to as carriers. 16-------------------------------------------------------------------------------- Table of Contents Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, inventory adjustments for obsolete and excess inventory and the amortization of acquired developed technology associated with acquisitions that we have made. As a result of building a vertically integrated business model, our manufacturing cost structure has become more fixed. While this can be beneficial during periods when demand is strong, it can be more difficult to reduce costs during periods when demand for our products is weak, product mix is unfavorable or selling prices are generally lower. While we have undertaken measures to reduce our operating costs there can be no assurance that we will be able to reduce our cost of revenues enough to achieve or sustain profitability. Since October 2000, we have completed the acquisition of two publicly-held companies. We have also completed the acquisition of 13 privately-held companies and certain businesses and assets from seven other companies in order to broaden our product offerings and provide new sources of revenue, production capabilities and access to advanced technologies that we believe will enable us to reduce our product costs and develop innovative and more highly integrated product platforms while accelerating the timeframe required to develop such products. 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 from those described in our Annual Report on Form 10-K for the fiscal year ended April 27, 2014. Results of Operations RevenuesThe following table sets forth changes in revenues by market application: Three Months Ended (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Datacom revenue $ 241,231 $ 184,431 $ 56,800 30.8 % Telecom revenue 86,407 81,637 4,770 5.8 % Total revenues $ 327,638 $ 266,068 $ 61,570 23.1 % The increase in datacom revenue was primarily due to an increase in market demand for our 10 Gbps and higher Ethernet transceivers as enterprises upgraded their technology infrastructure driving demand for our products. The increase in telecom revenue was primarily due to the acquisition of u2t in the fourth quarter of fiscal 2014. Amortization of Acquired Developed Technology (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 1,435 $ 1,593 $ (158 ) (9.9 )% The decrease was primarily due to roll-off of amortization of certain intangible assets related to our prior acquisitions. Gross Profit (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 98,819 $ 91,373 $ 7,446 8.1 % As a percentage of revenues 30.2 % 34.3 % The decrease in gross margin primarily reflected a decline in average selling prices. Research and Development Expenses (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 51,007 $ 43,530 $ 7,477 17.2 % 17-------------------------------------------------------------------------------- Table of Contents The increase was primarily due to increases in employee compensation related expenses, principally as the result of additional hiring related to new product development activities. Sales and Marketing Expenses (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 11,965 $ 11,805 $ 160 1.4 % The increase was primarily due to increases in employee compensation related expenses principally as the result of additional activities required as we expand our product offering and customer base. General and Administrative Expenses (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 14,719 $ 8,340 $ 6,379 76.5 % The increase was primarily due to a non-recurring gain of $6.5 million recognized during the first quarter of fiscal 2014 related to the settlement of the stock option litigation. Amortization of Purchased Intangibles (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 761 $ 595 $ 166 27.9 % The increase was due to the amortization of the intangibles related to the u2t acquisition in the fourth quarter of fiscal 2014. Interest Income (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 612 $ 217 $ 395 182.0 % The increase was primarily due to higher cash and investments balances during fiscal 2015 period compared to fiscal 2014 period. Interest Expense (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 3,133 $ 552 $ 2,581 467.6 % The increase was primarily due to the issuance of the 2033 Notes during the third quarter of fiscal 2014. Other Income (Expense), Net (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ (2,026 ) $ 488 $ (2,514 ) (515.2 )% The decrease was primarily due to foreign currency exchange losses. Non-controlling Interest (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ - $ 176 $ (176 ) 100.0 % Non-controlling interest for the three months ended July 28, 2013 represents minority shareholders' proportionate share of the net loss of our majority-owned subsidiary, Finisar Korea, prior to its divestiture in the fourth quarter of fiscal 2014. 18-------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes (in thousands, except percentages) July 27, 2014 July 28, 2013 Change % Change Three months ended $ 1,577 $ 1,421 $ 156 11.0 % The income tax provisions for the three month periods ended July 27, 2014 and July 28, 2013 primarily represent current state and foreign income taxes arising in certain jurisdictions in which we conduct business. Liquidity and Capital Resources Three Months Ended (in millions) July 27, 2014 July 28, 2013 Net cash provided by operating activities $ 26.0 $ 20.7 Net cash used in investing activities $ (47.8 ) $ (27.5 ) Net cash provided by financing activities $ 6.1 $ 6.1 Operating Cash Flows Net cash provided by operating activities in the three months ended July 27, 2014 consisted of our net income, as adjusted to exclude depreciation, amortization and other non-cash items totaling $35.8 million, and a $24.0 million increase in working capital primarily related to increases in accounts receivable, inventory, other assets and a decrease in accrued compensation, offset by an increase in accounts payable. Accounts receivable increased by $5.8 million primarily due to the increase in revenues during the quarter. Inventory increased by $6.8 million primarily due to increased purchases to support the increased sales level. Accrued compensation decreased by $14.2 million primarily due to payment of annual employee bonus for fiscal 2014. Other assets increased by $17.8 million primarily due to increased sales of raw material components to our manufacturing subcontractors. Net cash provided by operating activities in the three months ended July 28, 2013 consisted of our net loss, as adjusted to exclude depreciation, amortization and other non-cash items totaling $24.8 million, and a $29.9 million increase in working capital primarily related to increases in accounts receivable and other assets, offset by an increase in accounts payable. Accounts receivable increased by $24.3 million primarily due to an increase in revenues during the three months ended July 28, 2013. Inventory increased by $12.5 million due to increased purchases to support the increased sales level. Other assets increased by $17.3 million primarily due to the settlement of stock option derivative litigation. Investing Cash Flows Net cash used in investing activities in the three month periods ended July 27, 2014 and July 28, 2013 primarily consisted of expenditures for capital equipment. Financing Cash Flows Net cash provided by financing activities for the three month periods ended July 27, 2014 and July 28, 2013 primarily consisted of proceeds from the issuance of shares under our employee stock option and stock purchase plans. Sources of Liquidity and Capital Resource Requirements At July 27, 2014, our principal sources of liquidity consisted of approximately $497 million of cash and cash equivalents and short-term investments, of which approximately $68 million was held by our foreign subsidiaries. We believe that our existing balances of cash, cash equivalents and short-term investments, together with the cash expected to be generated from future operations, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future, to finance future acquisitions that we may propose to undertake or to repay or otherwise retire all of our outstanding 2029 Notes, in the aggregate principal amount of $40.0 million, which are subject to redemption by the holders in October 2014, 2016, 2019 and 2024, or our 2033 Notes, in the aggregate principal amount of $258.8 million, which are subject to redemption by the holders in December 2018, 2023 and 2028. A significant contraction in the capital markets, particularly in the technology sector, may make it difficult for us to raise additional capital if and when it is required, especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, our business, financial condition and results of operations will be adversely affected. 19-------------------------------------------------------------------------------- Table of Contents Off-Balance-Sheet Arrangements At July 27, 2014 and April 27, 2014, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Related Party Transactions The material set forth in "Part I, Item 1, Financial Statements - Note 12, Related Parties" of this Quarterly Report on Form 10-Q is incorporated herein by reference. |