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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended April 1, 2012
   
 
Or
   
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from __________ to __________
 
Commission file number 000-31581
 

OPLINK COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
No. 77-0411346
(I.R.S. Employer
Identification No.)

46335 Landing Parkway, Fremont, CA 94538
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (510) 933-7200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R  No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  £
 
Accelerated filer R
 
Non-accelerated filer £
 
Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

The number of outstanding shares of the Registrant’s common stock, $0.001 par value, as of April 27, 2012, was 19,064,109.
 


 
 
 
 
 
 
 
 

OPLINK COMMUNICATIONS, INC.

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

Item 1.
 
 
3
 
4
 
5
 
6
Item 2.
20
Item 3.
27
Item 4.
28
     
PART II—OTHER INFORMATION
     
Item 1.
29
Item 1A.
29
Item 2.
30
Item 3.
30
Item 4.
30
Item 5.
30
Item 6.
31
32
 



PART I.  FINANCIAL INFORMATION

ITEM 1- FINANCIAL STATEMENTS

OPLINK COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

(In thousands, except share and par value data)
 
April 1,
   
July 3,
 
   
2012
   
2011
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 46,243     $ 52,644  
Short-term investments
    122,574       134,089  
Accounts receivable, net
    36,152       34,880  
Inventories
    20,187       24,719  
Deferred tax assets
    14,542       15,171  
Prepaid expenses and other current assets
    8,265       10,706  
   Total current assets
    247,963       272,209  
                 
Property, plant and equipment, net
    45,998       36,863  
Long-term investments
    7,274       --  
Goodwill and intangible assets, net
    1,775       2,948  
Deferred tax assets, non-current
    8,288       8,291  
Other assets
    4,166       493  
      Total assets
  $ 315,464     $ 320,804  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 12,353     $ 11,549  
Accrued liabilities
    13,414       11,736  
Income tax payable
    625       305  
   Total current liabilities
    26,392       23,590  
                 
Income tax payable
    4,389       4,804  
Deferred tax liabilities
    678       678  
Other non-current liabilities
    1,329       1,370  
      Total liabilities
    32,788       30,442  
                 
Commitments and contingencies (Note 16)
               
Stockholders' equity:
               
Common stock, $0.001 par value, 34,000,000 shares authorized; 19,153,852 and 20,118,319 shares issued and outstanding as of April 1, 2012 and July 3, 2011, respectively
    19       20  
Additional paid-in capital
    435,815       451,211  
Accumulated other comprehensive income
    17,981       12,858  
Accumulated deficit
    (171,139 )     (173,727 )
   Total stockholders’ equity
    282,676       290,362  
      Total liabilities and stockholders' equity
  $ 315,464     $ 320,804  
 
 
(1)  
The condensed consolidated balance sheet at July 3, 2011 has been derived from the audited consolidated financial statements at that date.

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


OPLINK COMMUNICATIONS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 (In thousands, except per share data)
 
Three Months Ended
   
Nine Months Ended
 
   
April 1,
 2012
   
April 3,
 2011
   
April 1,
 2012
   
April 3,
 2011
 
Revenues
  $ 43,978     $ 53,471     $ 130,683     $ 155,136  
Cost of revenues
    30,470       34,188       89,704       100,623  
Gross profit
    13,508       19,283       40,979       54,513  
                                 
Operating expenses:
                               
Research and development
    6,024       4,665       16,751       12,705  
Sales and marketing
    3,319       3,107       9,429       8,918  
General and administrative
    2,267       2,456       12,423       7,367  
Amortization of intangible assets
    91       451       573       1,353  
Net loss (gain) on sale and disposal of fixed assets
    19       (24 )     (366 )     (107 )
Total operating expenses
    11,720       10,655       38,810       30,236  
                                 
Operating income
    1,788       8,628       2,169       24,277  
Interest income and other, net
    93       180       408       291  
Income before provision (benefit) for income taxes
    1,881       8,808       2,577       24,568  
Provision (benefit) for income taxes
    (977 )     620       (11 )     2,312  
Net income
  $ 2,858     $ 8,188     $ 2,588     $ 22,256  
                                 
Net income per share:
                               
     Basic
  $ 0.15     $ 0.40     $ 0.13     $ 1.13  
     Diluted
  $ 0.14     $ 0.38     $ 0.13     $ 1.07  
                                 
Weighted average shares:
                               
Basic
    19,200       20,308       19,364       19,723  
Diluted
    19,795       21,595       19,982       20,792  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


OPLINK COMMUNICATIONS, INC.
 (Unaudited)

   
Nine Months Ended
 
(in thousands)
 
April 1,
2012
   
April 3,
2011
 
Cash flows provided by operating activities:
           
Net income
  $ 2,588     $ 22,256  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation expense
    4,632       3,979  
Amortization of intangible assets
    1,173       3,078  
Amortization of premium on investments
    113       289  
Net gain on sale and disposal of fixed assets
    (366 )     (107 )
Stock-based compensation expense
    4,452       4,239  
Deferred income taxes
    623       --  
Changes in assets and liabilities:
               
Accounts receivable
    (955 )     (5,900 )
Inventories
    5,456       (269 )
Prepayments and other assets
    (2,370 )     758  
Accounts payable
    194       (2,491 )
Accrued liabilities and other liabilities
    1,563       1,830  
Income tax receivable and payable
    (367 )     1,624  
Net cash provided by operating activities
    16,736       29,286  
                 
Cash flows used for investing activities
               
Purchases of available-for-sale investments
    (157,098 )     (136,275 )
Sales and maturities of available-for-sale investments
    171,631       124,646  
Purchases of held-to-maturity investments
    (7,279 )     --  
Maturities of held-to-maturity investments
    --       10,000  
Purchase of non-marketable equity security
    (200 )     --  
Proceeds from sales of property, plant and equipment
    406       272  
Purchases of property, plant and equipment
    (10,758 )     (5,577 )
Net cash used for investing activities
    (3,298 )     (6,934 )
                 
Cash flows provided by (used for) financing activities
               
Proceeds from issuance of common stock
    1,296       17,849  
Repurchases of common stock
    (19,922 )     (6,534 )
Tax withholdings related to net share settlements of restricted stock units
    (1,223 )     --  
Net cash provided by (used for) financing activities
    (19,849 )     11,315  
                 
Effect of exchange rates on cash and cash equivalents 
    10       309  
Net increase (decrease) in cash and cash equivalents
    (6,401 )     33,976  
Cash and cash equivalents at beginning of period
    52,644       40,711  
Cash and cash equivalents at end of period
  $ 46,243     $ 74,687  
                 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


OPLINK COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)

Note 1 - Description of Business

Oplink Communications, Inc. (“Oplink” or the “Company”) was incorporated in California in September 1995 and was later reincorporated in Delaware in September 2000. The Company is headquartered in Fremont, California and has manufacturing, design and research and development facilities in Zhuhai, Shanghai and Wuhan, China, in Taiwan and in Woodland Hills, California.
 
Oplink designs, manufactures and sells optical networking components and subsystems. Its 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. Its products enable greater and higher quality bandwidth over longer distances, which reduces network congestion and transmission cost per bit. Its 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.

Oplink offers its 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. Oplink also offers solutions with lower levels of component integration for customers that place more value on flexibility than would be provided with turnkey solutions.

Oplink’s product portfolio also includes optical 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 consist of a comprehensive line of high-performance fiber optic modules, including fiber optic transmitters, receivers, transceivers, and transponders, primarily for use in metropolitan area network (“MAN”), local area network (“LAN”), and fiber-to-the-home (“FTTH”) applications. Fiber optic modules are pre-assembled components that are used to build network equipment. Oplink’s transmission products convert electronic signals into optical signals and back into electronic signals, thereby facilitating the transmission of information over fiber optic communication networks.

Oplink also offers 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.

Note 2 - Basis of Presentation

The unaudited condensed consolidated financial statements included herein have been prepared by the Company in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, these unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of the Company as of April 1, 2012, the results of its operations for the three and nine months ended April 1, 2012 and April 3, 2011 and its cash flows for the nine months ended April 1, 2012 and April 3, 2011. The results of operations for the periods presented are not necessarily indicative of those that may be expected for the full year. The condensed consolidated financial statements presented herein have been prepared by management, without audit by independent auditors who do not express an opinion thereon, and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2011. The July 3, 2011 condensed consolidated balance sheet data was derived from audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2011 but does not include all disclosures required for annual periods. Certain reclassifications have been made to conform to the current period’s presentation.

The Company operates and reports using a fiscal year, which ends on the Sunday closest to June 30. Interim fiscal quarters end on the Sundays closest to each calendar quarter end.  Fiscal 2012 will consist of 52 weeks, while fiscal 2011 was a 53 week period.
 
 
The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. With the exception of the Company’s Optical Communication Products, Inc. (“OCP”) subsidiaries, the Company presents the financial information of its consolidated foreign operating subsidiaries in its consolidated financial statements utilizing accounts as of a date one month earlier than the accounts of its parent company, U.S. subsidiary and its non-operating non-U.S. subsidiaries to ensure timely reporting of consolidated results.

The Company conducts its business within one business segment and has no organizational structure dictated by product, service lines, geography or customer type.

There have been no significant changes in the Company’s significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended July 3, 2011.

Note 3 - Risks and Uncertainties

There are a number of risks and uncertainties facing the Company that could have a material adverse effect on the Company’s financial condition, operating results or cash flows. These risks and uncertainties include, but are not limited to, a further and sustained downturn in the telecommunications industry or the overall economy in the United States and other parts of the world, possible further reductions in customer orders, intense competition in the Company’s target markets and potential pricing pressure that may arise from changing supply or demand conditions in the industry. In addition, the Company obtains most of its critical materials from a single or limited number of suppliers and generally does not have long-term supply contracts with them. The Company could experience discontinuation of key components, price increases and late deliveries from its suppliers. Also, substantially all of the Company’s manufacturing operations are located in China and are subject to laws and regulations of China. These and other risks and uncertainties facing the Company are described from time to time in the Company’s periodic reports filed with the SEC.

Note 4 - Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) issued and amended Accounting Standards Update (“ASU”) No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which simplifies how entities test goodwill for impairment. Previous guidance under Topic 350 required an entity to test goodwill for impairment using a two-step process on at least an annual basis. First, the fair value of a reporting unit was calculated and compared to its carrying amount, including goodwill. Second, if the fair value of a reporting unit was less than its carrying amount, the amount of impairment loss, if any, was required to be measured. Under the amendments in this update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads the entity to determine that it is more likely than not that its fair value is less than its carrying amount. If after assessing the totality of events or circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then the two-step impairment test is unnecessary. If the entity concludes otherwise, then it is required to test goodwill for impairment under the two-step process. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. The Company does not believe that the adoption of this guidance will have a material impact on its consolidated financial positions, results of operations or cash flow.

Note 5 - Net Income Per Share

Basic net income per share is computed by dividing the net income by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and dilutive potential common shares outstanding during the period, if dilutive. Potentially dilutive common equivalent shares are composed of the incremental common shares issuable upon the exercise of stock options, the vesting of awards and purchases under the employee stock purchase plan. The following is the computations of the basic and diluted net income per share and the anti-dilutive common stock equivalents excluded from the computations for the periods presented (in thousands, except per share data):
 

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
Numerator:
                       
   Net income
  $ 2,858     $ 8,188     $ 2,588     $ 22,256  
                                 
Denominator:
                               
   Weighted average common shares outstanding
    19,200       20,308       19,364       19,723  
   Dilutive effect of employee stock options and restricted stock units
    595       1,287       618       1,069  
   Weighted average common shares outstanding, assuming dilution
    19,795       21,595       19,982       20,792  
                                 
Net income per share:
                               
   Basic
  $ 0.15     $ 0.40     $ 0.13     $ 1.13  
   Diluted
  $ 0.14     $ 0.38     $ 0.13     $ 1.07  
                                 
Anti-dilutive stock options and awards not included in net income per share calculation
    970       80       1,034       927  

Note 6 - Comprehensive Income

Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The components of comprehensive income consist of foreign currency translation adjustments, foreign currency transaction gains and losses from intercompany transactions and balances for which settlement is not planned or anticipated in the foreseeable future, and changes in unrealized gains and losses on investments. For presentation purposes, cumulative translation adjustment includes foreign currency transaction gains and losses from intercompany transactions and balances for which settlement is not planned or anticipated in the foreseeable future.

The reconciliation of net income to comprehensive income for the three and nine months ended April 1, 2012 and April 3, 2011 was as follows (in thousands):

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
Net income
  $ 2,858     $ 8,188     $ 2,588     $ 22,256  
Currency translation adjustments
    1,030       1,070       2,320       3,273  
Change in net unrealized gain on investments
    2,763       3       2,803       22  
Comprehensive income
  $ 6,651     $ 9,261     $ 7,711     $ 25,551  

The balance of accumulated other comprehensive income, net of tax, was as follows (in thousands):

   
April 1,
2012
   
July 3,
2011
 
Cumulative translation adjustment
  $ 15,154     $ 12,834  
Unrealized gain on investments, net
    2,827       24  
 Total accumulated other comprehensive income
  $ 17,981     $ 12,858  

Note 7 - Cash and Cash Equivalents

 The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The Company’s cash equivalents consist primarily of money market funds and corporate commercial paper.



 
Note 8 - Investments

The Company generally invests its excess cash in certificates of deposit, debt instruments of the U.S. Treasury, government agencies, corporations with strong credit ratings and equity securities in publicly traded companies. Such investments are made in accordance with the Company’s investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The available-for-sale investments are reported at their fair value. Unrealized gains and losses on these securities are reported as a separate component of accumulated other comprehensive income until realized. The investment securities which the Company has the ability and intent to hold until maturity are classified as held-to-maturity investments and are stated at amortized cost.

Investments at April 1, 2012 and July 3, 2011 were as follows (in thousands):

   
April 1, 2012
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
Short-term investments:
 
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-sale:
                       
   Corporate commercial paper
  $ 62,977     $ --     $ (2 )   $ 62,975  
   U.S. treasury securities
    27,990       3       (1 )     27,992  
   Public company equity securities
    12,675       2,828       --       15,503  
   Certificates of deposit
    11,105       --       --       11,105  
   U.S. government agency securities
    5,000       --       (1 )     4,999  
       Total short-term investments
  $ 119,747     $ 2,831     $ (4 )   $ 122,574  
                                 
Long-term investments:
                               
Held-to-maturity:
                               
   Corporate debt securities
  $ 7,274     $ --     $ (10 )   $ 7,264  
       Total long-term investments
  $ 7,274     $ --     $ (10 )   $ 7,264  
                                 
Total investments
  $ 127,021     $ 2,831     $ (14 )   $ 129,838  

   
July 3, 2011
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
Short-term investments:
 
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-sale:
                       
   Corporate commercial paper
  $ 39,984     $ 1     $ --     $ 39,985  
   U.S. treasury securities
    52,936       34       --       52,970  
   Certificates of deposit
    10,002       --       --       10,002  
   U.S. government agency securities
    14,002       --       (1 )     14,001  
   Corporate debt securities
    17,141       1       (11 )     17,131  
       Total short-term investments
  $ 134,065     $ 36     $ (12 )   $ 134,089  
                                 
Total investments
  $ 134,065     $ 36     $ (12 )   $ 134,089  

The gross unrealized losses related to available for sale and held to maturity investments were primarily due to changes in market interest rates.  The Company has determined that (i) it does not have the intent to sell any of these investments and (ii) it is not more likely than not that it will be required to sell any of these investments before recovery of the entire amortized cost basis to meet its cash or working capital requirements or contractual or regulatory obligations.
 
 
The following tables show the gross unrealized losses and fair value of the Company’s investments, aggregated by length of time that individual securities have been in a continuous unrealized loss position (in thousands):

   
April 1, 2012
 
   
Less Than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Loss
   
Value
   
Loss
 
Available-for-sale:
                       
   Corporate commercial paper
  $ 25,482     $ (2 )   $ 25,482     $ (2 )
   U.S. treasury securities
    4,996       (1 )     4,996       (1 )
   U.S. government agency securities
    4,999       (1 )     4,999       (1 )
       Total short-term investments
  $ 35,477     $ (4 )   $ 35,477     $ (4 )
                                 
Total investments
  $ 35,477     $ (4 )   $ 35,477     $ (4 )

   
July 3, 2011
 
   
Less Than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Loss
   
Value
   
Loss
 
Available-for-sale:
                       
   U.S. government agency securities
  $ 4,996     $ (1 )     4,996       (1 )
   Corporate debt securities
    13,582       (11 )     13,582       (11 )
       Total short-term investments
  $ 18,578     $ (12 )   $ 18,578     $ (12 )
                                 
Total investments
  $ 18,578     $ (12 )   $ 18,578     $ (12 )

As of April 1, 2012 and July 3, 2011, there were no individual securities that had been in a continuous loss position for 12 months or longer.

The amortized cost and estimated fair value of investments at April 1, 2012 and July 3, 2011 by contractual maturities are shown below (in thousands):
 
   
April 1, 2012
   
July 3, 2011
 
   
Amortized
   
Estimated
   
Amortized
   
Estimated
 
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
Available-for-sale investments:
                       
Due in one year or less
  $ 119,747     $ 122,574     $ 134,065     $ 134,089  
Total available-for-sale investments
  $ 119,747     $ 122,574     $ 134,065     $ 134,089  
                                 
Held-to-maturity investments:
                               
Due in one year to five years
  $ 7,274     $ 7,264     $ --     $ --  
Total held-to-maturity investments
  $ 7,274     $ 7,264     $ --     $ --  
                                 
Total investments
  $ 127,021     $ 129,838     $ 134,065     $ 134,089  

Non-Marketable Equity Securities

The Company accounts for its equity investments in privately held companies under the cost method.  These investments are subject to periodic impairment review and measured and recorded at fair value when they are deemed to be other-than-temporarily impaired. In determining whether a decline in value of its investment has occurred and is other than temporary, an assessment was made by considering available evidence, including the general market conditions, the investee’s financial condition, near-term prospects, market comparables and subsequent rounds of financing.   The valuation also takes into account the investee’s capital structure, liquidation preferences for its capital and other economic variables. The valuation methodology for determining the decline in value of non-marketable equity securities is based on inputs that require
 
 
10

 
management judgment. The aggregate carrying value of the Company’s non-marketable equity securities was approximately $0.6 million and $0.4 million, and was classified within other assets on the Company’s condensed consolidated balance sheets as of April 1, 2012 and July 3, 2011.  The Company did not recognize any impairment loss during the three and nine months ended April1, 2012 and April 3, 2011, respectively.

Note 9 - Fair Value Measurements

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, the Company considers the principal or most advantageous market in which the Company 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 Company applies the fair value hierarchy which has the following three levels of inputs to measure fair value:
 
    Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date;
   
    Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
 
    Level 3 inputs are unobservable inputs for the asset or liability.

The Company’s Level 1 financial assets generally include money market funds and public company equity securities. The Company’s Level 2 financial assets generally include United States Treasury securities, United States government agency debt securities, certificates of deposit, corporate commercial paper, and corporate bonds.

The Company bases the fair value of its financial assets on pricing from third party sources of market information obtained through the Company’s investment brokers. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from brokers. The Company’s investment brokers obtain pricing data from a variety of industry standard data providers (e.g., Bloomberg), and rely on comparable pricing of other securities because the Level 2 securities that the Company holds are not actively traded and have fewer observable transactions. The Company considers this the most reliable information available for the valuation of the securities. There were no changes in valuation techniques or related inputs during the three and nine months ended April 1, 2012.

Items Measured at Fair Value on a Recurring Basis

The following table presents the Company’s financial assets which were measured at fair value on a recurring basis at April 1, 2012 and July 3, 2011 (in thousands):

   
April 1, 2012
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial assets
                       
Cash equivalents:
                       
Money market funds
  $ 15,668     $ -     $ --     $ 15,668  
Corporate commercial paper
    --       11,999       --       11,999  
Short-term investments:
                               
Public company equity securities
    15,503       --               15,503  
Corporate commercial paper
    --       62,975       --       62,975  
U.S. treasury securities
    --       27,992       --       27,992  
Certificates of deposit
    --       11,105       --       11,105  
U.S. government agencies securities
    --       4,999       --       4,999  
          Total financial assets
  $ 31,171     $ 119,070     $ --     $ 150,241  
                                 
Financial liabilities
  $ --     $ --     $ --     $ --  
 
 
 
   
July 3, 2011
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial assets
                       
Cash equivalents:
                       
Money market funds
  $ 12,462     $ --     $ --     $ 12,462  
Corporate commercial paper
    --       19,997       --       19,997  
Short-term investments:
                               
Corporate commercial paper
    --       39,985       --       39,985  
U.S. treasury securities
    --       52,970       --       52,970  
Certificates of deposit
    --       10,002       --       10,002  
U.S. government agencies securities
    --       14,001       --       14,001  
Corporate debt securities
    --       17,131       --       17,131  
          Total financial assets
  $ 12,462     $ 154,086     $ --     $ 166,548  
                                 
Financial liabilities
  $ --     $ --     $ --     $ --  

As of April 1, 2012 and July 3, 2011, the Company did not have any assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between Level 1 and Level 2 of the fair value measurement hierarchy during the three and nine months ended April 1, 2012 and July 3, 2011.

Note 10 - Inventories

Inventories are stated at the lower of cost or market. Inventory cost is determined using standard costs, which approximates actual cost on a first-in, first-out basis. Inventories consist of (in thousands):

   
April 1,
2012
   
July 3,
2011
 
Inventories:
           
Raw materials
  $ 12,286     $ 12,927  
Work-in-process
    6,133       6,166  
Finished goods
    1,768       5,626  
    $ 20,187     $ 24,719  

Note 11 - Goodwill and Intangible Assets, Net
 
The following table presents details of the intangible assets acquired as a result of acquisitions as of April 1, 2012 and July 3, 2011 (in thousands):

     
Estimated
             
     
Useful Life
   
Gross
   
Accumulated
     
April 1, 2012
   
(in Years)
   
Amount
   
Amortization
   
Net
 
Technology
    4-6     $ 9,592     $ 8,976     $ 616  
Customer relationships
    3-7       5,671       5,557       114  
Trade name
    3-6       1,775       1,330       445  
   Total
          $ 17,038     $ 15,863     $ 1,175  


     
Estimated
             
     
Useful Life
   
Gross
   
Accumulated
       
July 3, 2011
   
(in Years)
   
Amount
   
Amortization
   
Net
 
Technology
    4-6     $ 9,592     $ 8,357     $ 1,235  
Customer relationships
    3-7       5,671       5,247       424  
Trade name
    3-6       1,775       1,086       689  
   Total
          $ 17,038     $ 14,690     $ 2,348  
 
 

The following table presents details of the amortization expense of intangible assets as reported in the condensed consolidated statements of operations (in thousands):

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
Cost of revenues
  $ 36     $ 575     $ 600     $ 1,725  
Operating expenses
    91       451       573       1,353  
  Total
  $ 127     $ 1,026     $ 1,173     $ 3,078  

The future amortization of intangible assets is as follows (in thousands):

Fiscal year
 
Amount
 
Remainder of FY 2012
  $ 128  
2013
    484  
2014
    247  
2015
    177  
2016
    87  
After 2016
    52  
    $ 1,175  

The Company had goodwill of $0.6 million on its condensed consolidated balance sheet at April 1, 2012 and July 3, 2011 as a result of the acquisitions of Emit Technology Co., Ltd and Oridus, Inc. in fiscal 2010. During the three and nine months ended April 1, 2012 and April 3, 2011, there were no indicators of impairment for the goodwill.
 
Note 12 - Accrued Liabilities
 
Accrued liabilities consist of (in thousands):
 
   
April 1,
2012
   
July 3,
2011
 
Payroll and related expenses
  $ 6,445     $ 5,128  
Employee withholdings and related expenses
    1,959       1,333  
Accrued professional fees
    957       1,649  
Accrued sales commission
    573       519  
Advance deposits from customers
    465       234  
Accrued warranty
    360       360  
Accrued sales return
    313       438  
Other
    2,342       2,075  
Total accrued liabilities
  $ 13,414     $ 11,736  


 
Note 13 - Product Warranties

        The Company provides reserves for the estimated cost of product warranties at the time revenue is recognized based on its historical experience of known product failure rates and expected material and labor costs to provide warranty services. The Company generally provides a one-year warranty on its 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, the Company may reverse a portion of such provisions in future periods.

Changes in the warranty liability, which is included as a component of “Accrued liabilities” on the condensed consolidated balance sheets as disclosed in Note 12, is as follows (in thousands):

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
Balance as of beginning of period
  $ 360     $ 500     $ 360     $ 421  
Accruals for warranties issued during the period
    49       80       147       323  
Adjustments related to pre-existing warranties including expirations and changes in estimates
    (6 )     (99 )     (17 )     (31 )
Cost of warranty repair
    (43 )     (41 )     (130 )     (273 )
Balance as of end of period
  $ 360     $ 440     $ 360     $ 440  

Note 14 - Stock-Based Compensation
 
 Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the employee requisite service period. The Company’s stock-based compensation is generally accounted for as an equity instrument.

The following table represents details of stock-based compensation expense by function line item for the three and nine months ended April 1, 2012 and April 3, 2011 (in thousands):

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
Cost of revenues
  $ 92     $ 123     $ 290     $ 342  
Research and development
    359       343       1,063       992  
Sales and marketing
    506       482       1,520       1,353  
General and administrative
    377       404       1,579       1,552  
  Total stock-based compensation expense
  $ 1,334     $ 1,352     $ 4,452     $ 4,239  

Stock-based compensation of $8,000 was capitalized as inventory as of April 1, 2012 and April 3, 2011.
 
Forfeitures are estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.

Valuation Assumptions

The Company estimates the fair value of stock options and purchase rights under the Company’s employee stock purchase plan using a Black-Scholes valuation model.
 
 
 
The fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model and the straight-line attribution approach with the following weighted-average assumptions:

   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
     Expected Term
 
4.6 years
   
4.6 years
   
4.6 years
   
4.6 years
 
     Risk-free interest rate
    0.71 %     2.17 %     0.81 %     1.30 %
     Volatility
    49 %     59 %     57 %     51 %
     Dividend Yield
    0 %     0 %     0 %     0 %
     Weighted average grant-date fair value
  $ 7.66     $ 12.98     $ 8.04     $ 8.28  

The estimated fair value of purchase rights under the Company’s employee stock purchase plan is determined using the Black-Scholes valuation model with the following weighted-average assumptions:

   
Three months ended
     
Nine months ended
 
   
April1,
2012
     
April 3,
2011
     
April 1,
2012
     
April 3,
2011
 
     Expected Term
 
1.3 years
   
1.3 years
   
1.3 years
   
1.3 years
 
     Risk-free interest rate
    0.15 %     0.25 %     0.15 %     0.25 %
     Volatility
    58 %     47 %     58 %     47 %
     Dividend Yield
    0 %     0 %     0 %     0 %

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options or purchase rights. The expected term calculation for stock options is based on the observed historical option exercise behavior and post-vesting forfeitures of options by the Company’s employees. The expected term assumption for purchase rights is based on the average exercise date for four purchase periods in each 24-month offering period.

Equity Incentive Program

Oplink adopted the 2000 Equity Incentive Plan (the “2000 Plan”) in July 2000. The 2000 Plan was terminated in November 2009 immediately upon the effectiveness of the Company’s new 2009 Equity Incentive Plan (the “2009 Plan”). No further awards will be granted under the 2000 Plan. However, the 2000 Plan will continue to govern awards previously granted under that plan.

The 2009 Plan was adopted by the Company in September 2009 and became effective upon approval by the Company’s stockholders at the annual meeting held in November 2009. The 2009 Plan provides for the grant of equity awards to employees, directors and consultants. These equity awards include stock options, RSAs, RSUs, stock appreciation rights, performance units, and performance shares. The maximum aggregate number of shares of common stock that may be issued under the 2009 Plan is 2,500,000 shares, plus any shares subject to equity awards granted under 2000 Plan that expire or otherwise terminate without having been exercised in full, or that are forfeited to or repurchased by the Company. Shares subject to “full value” awards (RSUs, RSAs, performance shares and performance units) will count against the 2009 Plan’s share reserve as 1.3 shares for every one share subject to such awards. Accordingly, if such awards are forfeited or repurchased by the Company, 1.3 times the number of shares forfeited or repurchased will return to the 2009 Plan. The maximum term of stock options and stock appreciation rights under the 2009 Plan is 7 years.
 
 
 
The following table summarizes activity under the equity incentive plans for the indicated periods:

         
Options
   
Awards
 
               
Weighted
   
Restricted
   
Weighted
 
   
Shares
   
Number of
   
Average
   
Stock
   
Average
 
   
Available
   
Options
   
Exercise
   
Awards/Units
   
Grant Date
 
   
for Grant
   
Outstanding
   
Price
   
Outstanding
   
Fair Value
 
Balance, July 3, 2011
    2,063,721       2,087,696     $ 13.55       692,533     $ 15.52  
Granted
    (167,400 )     14,000       17.34       118,000       16.90  
Exercised or vested
    --       (45,336 )     12.09       (259,372 )     14.28  
Canceled
    42,242       (15,500 )     16.90       (18,566 )     16.98  
Expired
    (1,436 )     (4,306 )     25.52       --       --  
Balance, April 1, 2012
    1,937,127       2,036,554     $ 13.55       532,595     $ 16.38  

The Company settles employee stock option exercises and RSUs with newly issued common shares.
 
As of April 1, 2012, the unrecognized stock-based compensation expense related to stock options to purchase the Company’s common stock was $1.1 million, which is expected to be recognized over a weighted average period of 1.6 years. The unrecognized stock-based compensation expense related to unvested RSUs was $5.2 million, which is expected to be recognized over a weighted average period of 2.1 years.

During the nine months ended April 1, 2012, 0.3 million restricted stock units vested. A majority of these vested restricted stock units were net share settled. During the nine months ended April 1, 2012, the Company withheld 0.1 million shares, based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities. Total payments for the employees’ tax obligations to the relevant taxing authorities were $1.2 million for the nine months ended April 1, 2012, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

Employee Stock Purchase Plan
 
The Company’s employee stock purchase plan authorizes the granting of stock purchase rights to eligible employees during an offering period not more than 27 months with exercise dates approximately every six months. Shares are purchased through employee payroll deductions at purchase prices equal to 85% of the lesser of the fair market value of the Company’s common stock at either the first day of each offering period or the date of purchase. During the nine months ended April 1, 2012, the Company issued 0.1 million shares of common stock under the plan. As of April 1, 2012, 1.5 million shares were available for issuance under the Company’s employee stock purchase plan.

Note 15 - Repurchase of Common Stock
 
 On May 25, 2010, the Company announced that its Board of Directors authorized a program to repurchase up to $40 million of its outstanding common stock. $16.0 million and $5.5 million of its common stock were repurchased under this repurchase program during the fiscal year ended July 3, 2011 and June 27, 2010, respectively. During the three months ended October 2, 2011, the Company repurchased 1.2 million shares at an average price of $15.98 per share for a total purchase price of $18.5 million. This program was completed as of October 2, 2011.  On October 27, 2011, the Company announced that its Board of Directors approved a program to repurchase up to $40 million of its outstanding common shares. During the three months ended April 1, 2012, the Company repurchased 0.1 million shares at an average price of $15.92 per share for a total purchase price of $1.4 million.  As of April1, 2012, approximately $38.6 million was available for future purchase under this share repurchase program. Repurchases under the program will be made in open market or privately negotiated transactions in compliance with the Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors.


Note 16 - Commitments and Contingencies

Contractual Obligations
 
Contractual obligations as of April 1, 2012 have been summarized below (in thousands):
 
         
Contractual Obligations Due by Period
 
   
Total
   
Less than
1 year
   
1-3
years
   
4-5
years
   
After 5
years
 
Purchase obligations
  $ 13,014     $ 12,784     $ 230     $ --     $ --  
Operating leases
    365       243       122       --       --  
Capital expenditure
    1,400       1,288       112       --       --  
   Total
  $ 14,779     $ 14,315     $ 464     $ --     $ --  

Litigation
 
Patent Litigation with Finisar Corporation

On December 20, 2010, Finisar Corporation filed a complaint in the United States District Court for the Northern District of California against the Company and its subsidiary, Optical Communication Products, Inc. ("OCP"). In the complaint, Finisar alleged infringement of certain of its U.S. patents arising from the Company’s and OCP’s manufacture, importation, use, sale of or offer to sell certain optical transceiver products in the United States. Finisar sought to recover unspecified damages, up to treble the amount of actual damages, together with attorneys' fees, interest and costs. On January 24, 2011 the Company filed an answer to the complaint, denying all material allegations and asserting numerous affirmative defenses.  On March 7, 2011, the Company's subsidiary OCP filed a complaint against Finisar in the United States District Court for the Eastern District of Texas, alleging infringement by Finisar of certain U.S. patents owned by OCP primarily relating to vertical-cavity surface-emitting laser ("VCSEL") technology. On April 29, 2011, Finisar filed an answer to the complaint, denying all material allegations, asserting numerous affirmative defenses and asserting counterclaims against OCP alleging infringement by OCP of certain U.S. patents owned by Finisar primarily relating to pluggable transceiver latch mechanisms.
 
On December 14, 2011, the Company and OCP entered into a Settlement and Cross License Agreement with Finisar, which agreement resolved and settled all pending litigation between the parties and their respective affiliates.  As part of the settlement, the Company paid $4 million to Finisar for a fully paid-up license to the Finisar patents asserted against the Company in the various lawsuits, the Company granted a license to Finisar to the Company’s patents asserted against Finisar in the various lawsuits, and all legal proceedings initiated by each party in all jurisdictions were dismissed. The Company determined that the portion of the $4 million attributable to past damage was approximately $3.3 million and was included in general and administrative expenses in the condensed consolidated statement of operations for the nine months ended April 1, 2012. The remaining amount of $0.7 million was recorded as a prepaid royalty, of which $0.1 million was included in prepaid and other current assets and $0.6 million was included in other assets on the Company’s condensed consolidated balance sheets as of April 1, 2012. Amortization expense will be charged to cost of sales over the period which the Company expects to benefit from the patents.
 
IPO Securities Litigation

In November 2001, the Company and certain of its officers and directors were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York. In the amended complaint, the plaintiffs alleged that the Company, certain of its officers and directors and the underwriters of the Company’s initial public offering ("IPO") violated Section 11 of the Securities Act of 1933 based on allegations that the Company’s registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. Similar complaints were filed by plaintiffs against hundreds of other public companies that went public in the late 1990s and early 2000s and their IPO underwriters (collectively, the "IPO Lawsuits"). During the summer of 2008, the parties engaged in a formal mediation process to discuss a global resolution of the IPO Lawsuits. Ultimately, the parties reached an agreement to settle all 309 cases against all defendants, and entered into a settlement agreement in April 2009. The settlement provides for a $586 million recovery in total, divided among the 309 cases. The Company’s share of the settlement is roughly $327,458, which is the amount the Company will be required to pay if the settlement is finally approved. In October 2009, the Court certified the settlement class in each case and granted final approval to the settlement. A number of appeals have been filed with the Second Circuit Court of Appeals, challenging the fairness of
 
 
 
17

 
the settlement. A number of shareholder plaintiffs have also filed petitions for leave to appeal the class certification portion of Judge Scheindlin's ruling. On January 12, 2012, the last of these appeals was dismissed with prejudice.

IPO 16(b) Claim

In October 2007, Vanessa Simmonds, a purported Oplink shareholder, filed a complaint in the U.S. District Court for the Western District of Washington, against the underwriters involved in our 2000 initial public offering (IPO), alleging violations of Section 16(b) of the Exchange Act of 1934, as amended. The complaint alleged that the combined number of shares of the Company’s common stock beneficially owned by the lead underwriters and certain unnamed officers, directors, and principal shareholders exceeded ten percent of our outstanding common stock for a period following our IPO. The complaint further alleges that those entities and individuals were thus subject to the reporting requirements of Section 16(a) and the short-swing trading prohibition of Section 16(b) and failed to comply with those provisions. The complaint seeks to recover from the lead underwriters any “short-swing profits” obtained by them in violation of Section 16(b). Oplink was named as a nominal defendant in the action, but has no liability for the asserted claims. In March 2009, the District Court granted a joint motion by Oplink and other issuer defendants to dismiss the complaint without prejudice on the grounds that the plaintiff had failed to make an adequate demand on us prior to filing her complaint. In its order, the District Court stated it would not permit the plaintiff to amend her demand letters while pursuing her claims in the litigation.

Because the District Court dismissed the case on the grounds that it lacked subject matter jurisdiction, it did not specifically reach the issue of whether the plaintiff’s claims were barred by the applicable statute of limitations. However, the District Court also granted a Joint Motion to Dismiss by the underwriter defendants in the action with respect to cases involving nonmoving issuers, holding that the cases were barred by the applicable statute of limitations because the issuers’ shareholders had notice of the potential claims more than five years prior to filing suit. The plaintiff appealed. On December 2, 2010, the Ninth Circuit Court of Appeals affirmed the District Court’s decision to dismiss the moving issuers’ cases (including Oplink’s) on the grounds that plaintiff’s demand letters were insufficient to put the issuers on notice of the claims asserted against them and further ordered that the dismissals be made with prejudice. The Ninth Circuit, however, reversed and remanded the District Court’s decision on the underwriters’ motion to dismiss as to the claims arising from the non-moving issuers’ IPOs, finding plaintiff’s claims were not time-barred under the applicable statute of limitations. On January 18, 2011, the Ninth Circuit denied various parties’ petitions for rehearing and for rehearing en banc but stayed its rulings to allow for appeals to the United States Supreme Court.  On April 5, 2011, the plaintiff filed a Petition for Writ of Certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit's decision relating to the adequacy of the pre-suit demand.  On April 15, 2011, underwriter defendants filed a Petition for Writ of Certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit's decision relating to the statute of limitation issue. On June 27, 2011, the Supreme Court denied the plaintiff's petition regarding the demand issue but granted the underwriters' petition relating to the statute of limitations issue.  The Supreme Court heard oral arguments on November 29, 2011. On March 26, 2012, the Supreme Court reversed the Ninth Circuit’s decision, holding that the plaintiff’s claims were barred by the two year statute of limitations established in Section 16.

Other Matters
 
The Company is subject to legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 
Note 17 - Segment Reporting
 
The Company has determined that it has one reportable segment: fiber optic component and subsystem product sales. This segment consists of organizations located in the United States and China, which develop, manufacture, and/or market fiber optic networking components.

The geographic breakdown of revenues by customers’ bill-to location is as follows (in thousands):
 
   
Three months ended
   
Nine months ended
 
   
April 1,
2012
   
April 3,
2011
   
April 1,
2012
   
April 3,
2011
 
United States
  $ 16,367     $ 21,733     $ 44,491     $ 58,640  
China
    8,922       11,160       31,702       33,840  
Europe
    6,931       6,875       21,037       26,320  
Japan
    5,043       5,210       12,356       15,186  
Other
    6,715       8,493       21,097       21,150  
     Total consolidated revenues
  $ 43,978     $ 53,471     $ 130,683     $ 155,136  

Top five customers, although not the same five customers together accounted for 44% and 59% of revenues for the three months ended April 1, 2012 and April 3, 2011, respectively, and 44% and 54% of revenues for the nine months ended April 1, 2012 and April 3, 2011, respectively.

The breakdown of property, plant and equipment, net by geographical location is as follows (in thousands):
 
   
April 1,
2012
   
July 3,
2011
 
China
  $ 35,819     $ 26,273  
United States
    5,766       5,974  
Taiwan
    4,413       4,616  
   Total
  $ 45,998     $ 36,863  

Note 18 - Income Taxes

The Company accounts for income taxes under the asset and 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 Company records a valuation allowance against deferred tax assets when it is more likely than not that such assets will not be realized.   The Company continues to monitor the likelihood that it will be able to recover its deferred tax assets.  If recovery is not likely, the Company must increase its provision for taxes by recording a valuation allowance against the deferred tax assets.
 
The Company accounts for uncertain tax positions in accordance with the authoritative guidance on income taxes under which the Company may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense.

As of April 1, 2012, the Company’s total unrecognized tax benefits were $11.1 million, of which $8.9 million, if recognized, would affect the Company’s effective tax rate. The Company had accrued interest and penalties related to unrecognized tax benefits of approximately $1.2 million as of April 1, 2012.

The Company is required to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. The Company recorded a tax benefit of $1.0 million and a tax provision of $0.6 million for the three months ended April 1, 2012 and April 3, 2011, respectively, and a tax benefit of $11,000 and tax provision of $2.3 million for the nine months ended April 1, 2012 and April 3, 2011, respectively.  The decrease in tax provision for the three and nine months ended April 1, 2012 compared to the three and nine months ended April 3, 2011 was primarily due to lower income before taxes and change in the geographic mix of pre-tax income.  The effective tax rate for the third quarter of fiscal 2012 differs from the statutory rate primarily due to the mix of foreign earnings, non-deductible stock-based compensation and research & development deduction in China. The effective tax rate could fluctuate in the future due to changes in the taxable income mix between various jurisdictions.

Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, California, Taiwan and China. The tax years 2004 to 2010 remain open in several jurisdictions.


 
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-looking statements

This report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” ”estimate” or “assume” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information set forth below and under the captions “Risk Factors” in addition to the other information set forth herein. We caution you that our business and financial performance are subject to substantial risks and uncertainties. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Report on Form10-Q.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and accompanying notes in this report, and management’s discussion and analysis of financial condition and results of operations, related financial information and audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011 filed with the Securities and Exchange Commission (“SEC”).

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.

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 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;
·  
depreciation and amortization;
·  
warranty obligations;
·  
allowance for doubtful accounts;
·  
excess and obsolete inventory;
·  
impairment of investments;
·  
impairment of long-lived asset;
·  
impairment of goodwill and other intangible assets;
·  
fair value accounting;
·  
business combination;
·  
income taxes;
·  
stock-based compensation; and
·  
loss contingencies.

This is not a comprehensive list of all of our accounting policies.

As of the date of the filing of this quarterly report, we believe there have been no material changes to our critical accounting policies and estimates during the three and nine months ended April 1, 2012 compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011 as filed with the SEC. Additional information about these critical accounting policies may be found in the “Management’s Discussion & Analysis of Financial Condition and Results of Operations” section included in our Annual Report on Form 10-K for the fiscal year ended July 3, 2011.

Results of Operations

Revenues

    Three Months Ended    
 
   
 
    Nine Months Ended  
 
   
 
 
   
April 1,
2012
   
April 3,
2011
   
Change
      Percentage
Change
   
April 1,
2012
   
April 3,
2011
    Change       Percentage
Change
 
    (In thousands, except percentage)  
Revenues
  $ 43,978     $ 53,471     $ (9,493 )     (17.8 )%   $ 130,683     $ 155,136     $ (24,453 )     (15.8 )%

Revenues decreased for the three months ended April 1, 2012 compared to the three months ended April 3, 2011, primarily due to decreased unit shipments in our ROADM optical switching and routing product, multiplexer product and monitoring and conditioning product, partially offset by an increase in revenues in our amplification product.  A decline in average selling prices also contributed to the decrease in revenues in the three months ended April 1, 2012 compared to the three months ended April 3, 2011. The decreases in unit shipments and average selling price were driven by the softness in the telecommunications market.

Revenues decreased for the nine months ended April 1, 2012 compared to the nine months ended April 3, 2011, primarily due to a decrease in revenues in our ROADM optical switching and routing products, optical amplification product, monitoring and conditioning product and multiplexer product, partially offset by an increase in revenues in our line transmission application product.

Historically, a relatively small number of customers have accounted for a significant portion of our revenues. Our top five customers, although not necessarily the same five customers, together accounted for 44% and 59% of revenues for the three months ended April 1, 2012 and April 3, 2011, respectively, and 44% and 54% of revenues for the nine months ended April 1, 2012 and April 3, 2011, respectively.

For the three months ending July 1, 2012, we expect our revenues to be in the range of $42 million to $46 million.



Gross Profit
 
    Three Months Ended        
 
    Nine Months Ended  
 
   
 
 
   
April 1,
2012
   
April 3,
2011
   
Change
      Percentage
Change
   
April 1,
2012
   
April 3,
2011
   
Change
      Percentage
Change
 
   
(In thousands, except percentage)
 
Gross profit
  $ 13,508     $ 19,283     $ (5,775 )     (29.9 )%   $ 40,979     $ 54,513     $ (13,534 )     (24.8 )%
Gross profit margin
    30.7 %     36.1 %                     31.4 %     35.1 %                

Gross profit decreased for the three months ended April 1, 2012 compared to the three months ended April 3, 2011 primarily driven by lower revenues, higher manufacturing overhead expenses and labor costs, partially offset by higher utilization of previously reserved inventory and lower amortization expense of intangible assets as certain intangible assets acquired from previous acquisitions were fully amortized. The gross profit was positively impacted by the sale of previously reserved inventory of $1.1 million and $0.9 million for the three months ended April 1, 2012 and April 3, 2011, respectively. The decrease in gross profit for the nine months ended April 1, 2012 compared to the nine months ended April 3, 2011 was primarily driven by lower revenues, higher manufacturing overhead expense and lower utilization of previously reserved inventory.  The sale of previously reserved inventory was $3.1 million and $4.4 million for the nine months ended April 1, 2012 and April 3, 2011, respectively.

The decrease in gross profit margin for the three months ended April 1, 2012 compared to the three months ended April 3, 2011 was primarily driven by higher manufacturing overhead expense, increased labor and material costs as a percentage of revenues, partially offset by higher utilization of previously reserved inventory.  The decrease in gross profit margin for the nine months ended April 1, 2012 compared to the nine months ended April 3, 2011 was primarily driven by higher manufacturing overhead expense and labor costs as a percentage of revenues and lower utilization of previously reserved inventory, partially offset by the lower material costs as a percentage of revenues .

We expect our gross profit margin for the three months ending July 1, 2012 to remain at the same level compared to the three months ended April 1, 2012.
 
Research and Development

   
Three Months Ended
       
 
   
Nine Months Ended
     
 
 
   
April 1,
2012
   
April 3,
2011
   
Change
    Percentage
Change
   
April 1,
2012
   
April 3,
2011
   
Change
    Percentage
Change
 
    (In thousands, except percentage)  
Research and development
  $ 5,665     $ 4,322     $ 1,343       31.1 %   $ 15,688     $ 11,713     $ 3,975       33.9 %
Stock-based Compensation
    359       343       16       4.7 %     1,063       992       71       7.2 %
   Total expenses
  $ 6,024     $ 4,665     $ 1,359       29.1 %   $ 16,751     $ 12,705     $ 4,046       31.8 %

Research and development expenses increased $1.4 million and $4.0 million for the three and nine months ended April 1, 2012 compared to the three and nine months ended April 3, 2011. The increase was primarily due to higher salary and other employee related compensation expenses associated with an increase in headcount and higher R&D material and consulting expenses primarily attributable to the increased new product development activities.

We expect our research and development expenses, excluding stock compensation expense, to increase for the three months ending July 1, 2012 compared to the three months ended April 1, 2012 due to increased headcount and higher R&D material expenses as a result of increased new product development activities.


 
 
Sales and Marketing

   
Three Months Ended
       
 
   
Nine Months Ended
       
 
 
   
April 1,
2012
   
April 3,
2011
   
Change
      Percentage
Change
   
April 1,
2012
   
April 3,
2011
   
Change
      Percentage
Change
 
    (In thousands, except percentage)  
Sales and marketing
  $ 2,813     $ 2,625     $ 188       7.2 %   $ 7,909     $ 7,565     $ 344       4.5 %
Stock-based Compensation
    506       482       24       5.0 %     1,520       1,353       167       12.3 %
   Total expenses
  $ 3,319     $ 3,107     $ 212       6.8 %   $ 9,429     $ 8,918     $ 511       5.7 %

Sales and marketing expenses increased $0.2 million and $0.5 million for the three and nine months ended April 1, 2012 compared to the three and nine months ended April 3, 2011. The increase was primarily due to an increase in salary and other employee related compensation expenses. The increase in stock based compensation expense in the nine months ended April 1, 2012 compared to the nine months ended April 3, 2011 was primarily due to additional grants to new and existing employees.

We expect our sales and marketing expenses, excluding stock compensation expense, to increase slightly for the three months ending July 1, 2012 compared to the three months ended April 1, 2012.

General and Administrative

   
Three Months Ended
       
 
   
Nine Months Ended
       
 
 
   
April 1,
2012
   
April 3,
2011
     
Change
       Percentage
Change
   
April 1,
2012
   
April 3,
2011
     
Change
       Percentage
Change
 
    (In thousands, except percentage)  
General and administrative
  $ 1,890     $ 2,052     $ (162 )     (7.9 % )   $ 10,844     $ 5,815     $ 5,029       86.5 %
Stock-based Compensation
    377       404       (27 )     (6.7 % )     1,579       1,552       27       1.7 %
   Total expenses
  $ 2,267     $ 2,456     $ (189 )     (7.7 % )   $ 12,423