| ALLIANCE FIBER OPTIC PRODUCTS INC Item 1A Risk Factors 7 Item 1A Risk Factors We have a history of losses, expect future losses and may not be able to generate sufficient revenues in the future to achieve and sustain profitability |
| We incurred net losses of approximately dlra2dtta6 million, dlra9dtta3 million and dlra8dtta5 million in fiscal year 2005, 2004 and 2003, respectively, and expect that our net losses and negative cash flows will continue for the foreseeable future as we continue to invest in our business |
| As of December 31, 2005, we had an accumulated deficit of approximately dlra72dtta5 million |
| Although we continue to experience fluctuating demand for our products, we are hopeful that demand for our products will increase in the future |
| If this happens, we expect to incur significant and increasing expenses for expansion of our manufacturing operations, research and development, sales and marketing, and administration, and in developing direct sales and distribution channels |
| Given the rate at which competition in our industry intensifies and the significant fluctuations in demand for our products, we may not be able to adequately control our costs and expenses or achieve or maintain adequate operating margins |
| As a result, to achieve and maintain profitability, we will need to generate and sustain substantially higher revenues while maintaining reasonable cost and expense levels |
| We may not be able to achieve and sustain profitability on a quarterly or an annual basis |
| 7 _________________________________________________________________ Our quarterly and annual financial results have historically fluctuated due primarily to introduction of, demand for, and sales of our products, and future fluctuations may cause our stock price to decline |
| We believe that period-to-period comparisons of our operating results are not a good indication of our future performance |
| Our quarterly operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a number of factors |
| For example, the timing and expenses associated with product introductions and establishing additional manufacturing lines and facilities, changes in manufacturing volume, declining average selling prices of our products, the timing and extent of product sales, the mix of domestic and international sales, the mix of sales channels through which our products are sold, the mix of products sold and significant fluctuations in the demand for our products have caused our operating results to fluctuate in the past |
| Because we incur operating expenses based on anticipated revenue trends, and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing revenues or any decrease in revenues could significantly harm our quarterly results of operations |
| Other factors, many of which are more fully discussed in other risk factors below, may also cause our results to fluctuate |
| If our quarterly or annual operating results do not meet the expectations of investors and securities analysts, the trading price of our common stock could significantly decline |
| Our Optical Path Management Solution (OPMS) products have historically represented substantially all of our revenues, and if we are unsuccessful in commercially selling our DWDM-related products, our business will be seriously harmed |
| Sales of our OPMS products accounted for 67dtta2prca and 73dtta0prca of our revenues in the fiscal years ended December 31, 2005 and 2004, respectively and substantially all of our historical revenues |
| We expect to substantially depend on our OPMS products for our near-term revenues |
| Any significant decline in the demand for these products, or failure to increase their market acceptance, would seriously harm our business |
| Declining average selling prices of our products during 2005 have negatively impacted our revenues |
| We believe that our future growth and a significant portion of our future revenues will depend on the commercial success of our DWDM-related products, which we began shipping commercially in July 2000 |
| If demand does not continue to increase and our target customers do not continue to adopt and purchase our DWDM-related products, our revenues may decline and we may have to write-off additional inventory that is currently on our books |
| We are experiencing fluctuations in market demand due to overcapacity in our industry and an economy that is stymied by international terrorism, war and political instability |
| Since 2001, the United States economy has experienced and continues to experience significant fluctuations in consumption and demand |
| During the past few years, telecommunication companies have mostly decreased their spending, which has resulted in excess inventory, overcapacity and a decrease in demand for our products |
| We may experience further decreases in the demand for our products due to a weak domestic and international economy as the fiber optics industry copes with the effects of oversupply of products, international terrorism, war and political instability |
| Even if the general economy experiences a full recovery, the activity of the United States telecommunications industry may lag behind the recovery of the overall United States economy |
| If we cannot attract more optical communications equipment manufacturers to purchase our products, we may not be able to increase or sustain our revenues |
| Our future success will depend on our ability to migrate existing customers to our new products and our ability to attract additional customers |
| Some of our present customers are relatively new companies |
| The growth of our customer base could be adversely affected by: 8 _________________________________________________________________ o customer unwillingness to implement our products; o any delays or difficulties that we may incur in completing the development and introduction of our planned products or product enhancements; o the success of our customers; o excess inventory in the telecommunications industry; o new product introductions by our competitors; o any failure of our products to perform as expected; or o any difficulty we may incur in meeting customers &apos delivery requirements or product specifications |
| The fluctuations in the economy have affected the telecommunications industry |
| Telecommunications companies have cut back on their capital expenditure budgets, which has and may continue to further decrease demand for equipment and parts, including our products |
| This decrease has had and may continue to have an adverse effect on the demand for fiber optic products and negatively impact the growth of our customer base |
| The market for fiber optic components is increasingly competitive, and if we are unable to compete successfully our revenues could decline |
| The market for fiber optic components is intensely competitive |
| We believe that our principal competitors are the major manufacturers of optical components and integrated modules, including vendors selling to third parties and business divisions within communications equipment suppliers |
| Our principal competitors in the components market include Avanex Corp, DiCon Fiberoptics, Inc, JDS Uniphase Corp, Oplink Communications Inc, Stratos International, Inc |
| and Tyco Electronics Corporation |
| We believe that we primarily compete with diversified suppliers for the majority of our product line and to a lesser extent with niche companies that offer a more limited product line |
| Competitors in any portion of our business may also rapidly become competitors in other portions of our business |
| In addition, our industry has recently experienced significant consolidation, and we anticipate that further consolidation will occur |
| This consolidation has further increased competition |
| Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing, manufacturing and other resources than we do |
| As a result, these competitors may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, to devote greater resources to the development, promotion and sale of products, to negotiate lower prices on raw materials and components, or to deliver competitive products at lower prices |
| Several of our existing and potential customers are also current and potential competitors of ours |
| These companies may develop or acquire additional competitive products or technologies in the future and subsequently reduce or cease their purchases from us |
| In light of the consolidation in the optical networking industry, we also believe that the size of suppliers will be an increasingly important part of a purchaser’s decision-making criteria in the future |
| We may not be able to compete successfully with existing or new competitors, and we cannot ensure that the competitive pressures we face will not result in lower prices for our products, loss of market share, or reduced gross margins, any of which could harm our business |
| New and competing technologies are emerging due to increased competition and customer demand |
| The introduction of products incorporating new or competing technologies or the emergence of new industry standards could make our existing products noncompetitive |
| For example, there are technologies for the design of wavelength division multiplexers that compete with the technology that we incorporate in our products |
| If our products do not incorporate technologies demanded by customers, we could lose market share causing our business to suffer |
| If we fail to effectively manage our operations, specifically given the past history of sudden and dramatic downturn in demand for our products, our operating results could be harmed |
| We rapidly expanded our operations domestically and internationally in the final two quarters of 2000 |
| We had to carefully manage and re-evaluate this expansion given the sudden and dramatic downturn in demand for our products experienced in 2001 and 2002 |
| Additionally, we implemented a reduction in force to reduce employees during the second, third and fourth quarters of 2002 to match our operations to this decreased demand for our products |
| As of December 31, 2005, we had a total of 48 full-time employees in Sunnyvale, California, 304 full-time employees in Taiwan, and 229 full-time employees in China |
| Matching the scale of our operations with demand fluctuations, combined with the challenges of expanding and managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management and resources |
| To manage the expected fluctuations in our operations and personnel, we will be required to: 9 _________________________________________________________________ o improve existing and implement new operational, financial and management controls, reporting systems and procedures; o hire, train, motivate and manage additional qualified personnel, especially if we experience a significant increase in demand for our products; o effectively expand or reduce our manufacturing capacity, attempting to adjust it to customer demand; and o effectively manage relationships with our customers, suppliers, representatives and other third parties |
| In addition, we will need to coordinate our domestic and international operations and establish the necessary infrastructure to implement our international strategy |
| If we are not able to manage our operations in an efficient and timely manner, our business will be severely harmed |
| Our success also depends, to a large degree, on the efficient and uninterrupted operation of our facilities |
| We have expanded our manufacturing facilities in Taiwan and manufacture many of our products there |
| Our facility in China also houses a substantial portion of our manufacturing operations |
| There is significant political tension between Taiwan and China |
| If there is an outbreak of hostilities between Taiwan and China, our manufacturing operations may be disrupted or we may have to relocate our manufacturing operations |
| Tensions between Taiwan and China may also affect our facility in China |
| Relocating a portion of our employees could cause temporary disruptions in our operations and divert management’s attention |
| Because of the time it takes to develop fiber optic components, we incur substantial expenses for which we may not earn associated revenues |
| The development of new or enhanced fiber optic products is a complex and uncertain process |
| We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements |
| Development costs and expenses are incurred before we generate revenues from sales of products resulting from these efforts |
| Our total research and development expenses were approximately dlra3dtta4 million, dlra5dtta6 million and dlra5dtta6 million for the fiscal years 2005, 2004 and 2003, respectively |
| We intend to continue to invest in our research and product development efforts, which could have a negative impact on our earnings in future periods if we do not earn associated revenue from such efforts |
| If we are unable to develop new products and product enhancements that achieve market acceptance, sales of our fiber optic components could decline, which could reduce our revenues |
| The communications industry is characterized by rapidly changing technology, frequent new product introductions, changes in customer requirements, evolving industry standards and, more recently, significant variations in customer demand |
| Our future success depends on our ability to anticipate market needs and develop products that address those needs |
| As a result, our products could quickly become obsolete if we fail to predict market needs accurately or develop new products or product enhancements in a timely manner |
| Our failure to predict market needs accurately or to develop new products or product enhancements in a timely manner will harm market acceptance and sales of our products |
| If the development or enhancement of these products or any other future products takes longer than we anticipate, or if we are unable to introduce these products to market, our sales will not increase |
| Even if we are able to develop and commercially introduce them, these new products may not achieve the widespread market acceptance necessary to provide an adequate return on our investment |
| Current and future demand for our products depends on the continued growth of the Internet and the communications industry, which is experiencing rapid consolidation, realignment, oversupply of product inventory and fluctuating demand for fiber optic products |
| Our future success depends on the continued growth of the Internet as a widely used medium for communications and commerce, and the growth of optical networks to meet the increased demand for capacity to transmit data, or bandwidth |
| If the Internet does not continue to expand as a medium for communications and commerce, the need to significantly increase bandwidth across networks and the market for fiber optic components may not continue to develop |
| If this growth does not continue, sales of our products may continue to decline, which would adversely affect our revenues |
| Our customers have experienced an oversupply of inventory due to fluctuating demand for their products that has resulted in inconsistent demand for our products |
| Future demand for our products is uncertain and will depend heavily on the continued growth and upgrading of optical networks, especially in the metropolitan, last mile, and enterprise access segments of the networks |
| 10 _________________________________________________________________ Inconsistent spending by telecommunication companies over the past three years has resulted in fluctuating demand for our products |
| The rate at which communication service providers and other fiber optic network users have built new fiber optic networks or installed new systems in their existing fiber optic networks has fluctuated in the past and these fluctuations may continue in the future |
| These fluctuations may result in reduced demand for new or upgraded fiber optic systems that utilize our products and therefore, may result in reduced demand for our products |
| Declines in the development of new networks and installation of new systems have resulted in the past in a decrease in demand for our products, an increase in our inventory, and erosion in the average selling prices of our products |
| The communications industry is experiencing rapid consolidation and realignment, as industry participants seek to capitalize on the rapidly changing competitive landscape developing around the Internet and new communications technologies such as fiber optic networks |
| As the communications industry consolidates and realigns to accommodate technological and other developments, our customers may consolidate or align with other entities in a manner that results in a decrease in demand for our products |
| The optical networking component industry has in the past, is now, and may in the future experience declining average selling prices, which could cause our gross margins to decline |
| The optical networking component industry has in the past experienced declining average selling prices as a result of increasing competition and greater unit volumes as communication service providers continue to deploy fiber optic networks |
| Average selling prices are currently decreasing and may continue to decrease in the future in response to product introductions by competitors, price pressures from significant customers, greater manufacturing efficiencies achieved through increased automation in the manufacturing process and inventory build-up due to decreased demand |
| Average selling price declines may contribute to a decline in our gross margins which could harm our results of operations |
| We will not attract new orders for our fiber optic components unless we can deliver sufficient quantities of our products to optical communications equipment manufacturers |
| Communications service providers and optical systems manufacturers typically require that suppliers commit to provide specified quantities of products over a given period of time |
| If we are unable to commit to deliver quantities of our products to satisfy a customer’s anticipated needs, we will lose the order and the opportunity for significant sales to that customer for a lengthy period of time |
| In addition, we would be unable to fill large orders if we do not have sufficient manufacturing capacity to enable us to commit to provide customers with specified quantities of products |
| However, if we build our manufacturing capacity and inventory in excess of demand, as we have done in the past, we may produce excess inventory that may have to be reserved or written off |
| We depend on a limited number of third parties to supply key materials, components and equipment, such as ferrules, optical filters and lenses, and if we are not able to obtain sufficient quantities of these items at acceptable prices, our ability to fill orders would be limited and our operating results could be harmed |
| We depend on third parties to supply the raw materials and components we use to manufacture our products |
| To be competitive, we must obtain from our suppliers, on a timely basis, sufficient quantities of raw materials and components at acceptable prices |
| We obtain most of our critical raw materials and components from a single or limited number of suppliers and generally do not have long-term supply contracts with them |
| As a result, our suppliers could terminate the supply of a particular material or component at any time without penalty |
| Finding alternative sources may involve significant expense and delay, if these sources can be found at all |
| Difficulties in obtaining raw materials or components in the future may delay or limit our product shipments, which could result in lost orders, increase our costs, reduce our control over quality and delivery schedules and require us to redesign our products |
| If a supplier became unable or unwilling to continue to manufacture or ship materials or components in required volumes, we would have to identify and qualify an acceptable replacement |
| A delay or reduction in shipments or any need to identify and qualify replacement suppliers would harm our business |
| All of our graded index, or GRIN, lenses, which are incorporated into substantially all of our filter-based DWDM products, are obtained from one supplier, Nippon Sheet Glass |
| Nippon Sheet Glass is the only known supplier of GRIN lenses |
| 11 _________________________________________________________________ Because we experience long lead times for materials and components, we may not be able to effectively manage our inventory levels and manufacturing capacity, which could harm our operating results |
| Because we experience long lead times for materials and components and are often required to purchase significant amounts of materials and components far in advance of product shipments, we may not effectively manage our inventory levels, which could harm our operating results |
| We recorded significant charges for excess and obsolete inventory in the years ended December 31, 2004 and December 31, 2002, respectively |
| Alternatively, if we underestimate our raw material requirements, we may have inadequate inventory, which could result in delays in shipments and loss of customers |
| If we purchase raw materials and increase production in anticipation of orders that do not materialize or that shift to another quarter, we will, as we have in the past, have to carry or write off excess inventory and our gross margins will decline |
| Either situation could cause our results of operations to be below the expectations of investors and public market analysts, which could, in turn, cause the price of our common stock to decline |
| The time our customers require to incorporate our products into their own can vary significantly and generally exceeds several months, which further complicates our planning processes and reduces the predictability of our forecasts |
| Even if we receive these orders, the additional manufacturing capacity that we add to meet our customer’s requirements may be underutilized in a subsequent quarter, and we may be required to record impairment charges related to manufacturing assets |
| We are exposed to risks and increased expenses as a result of recent legislation requiring companies to evaluate internal controls over financial reporting |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent auditors to attest to, the effectiveness of our internal controls over financial reporting beginning with our year ending December 31, 2007 |
| We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements |
| This legislation is relatively new and neither companies nor accounting firms have significant experience in complying with its requirements |
| As a result, we expect to incur increased expense and to devote additional management resources to Section 404 compliance |
| In the event that our chief executive officer, chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and could cause a decline in the market price of our stock |
| Changes to financial accounting standards may affect our results of operations and cause us to change our business practices |
| We prepare our financial statements to conform with generally accepted accounting principles, or GAAP, in the United States |
| These accounting principles are subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies |
| A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced |
| Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business |
| For example, accounting policies affecting many aspects of our business, including rules relating to employee stock option grants, have recently been revised or are under review |
| The Financial Accounting Standards Board and other agencies have finalized changes to US generally accepted accounting principles that will require us, starting in our first quarter of 2006, to record a charge to earnings for employee stock option grants and other equity incentives |
| We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could reduce our overall net income |
| In addition, since we historically have used equity-related compensation as a component of our total employee compensation program, the accounting change could make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain employees |
| We depend on key personnel to operate our business effectively in the rapidly changing fiber optic components market, and if we are unable to hire and retain appropriate management and technical personnel, our ability to develop our business could be harmed |
| 12 _________________________________________________________________ Our success depends to a significant degree upon the continued contributions of the principal members of our technical sales, marketing, engineering and management personnel, many of whom perform important management functions and would be difficult to replace |
| We particularly depend upon the continued services of our executive officers, particularly Peter Chang, our President and Chief Executive Officer; David Hubbard, our Vice President, Sales and Marketing; Wei-shin Tsay, our senior Vice President of Product Development; Anita Ho, our Acting Chief Financial Officer and Corporate Controller; and other key engineering, sales, marketing, finance, manufacturing and support personnel |
| In addition, we depend upon the continued services of key management personnel at our Taiwanese subsidiary |
| None of our officers or key employees is bound by an employment agreement for any specific term, and may terminate their employment at any time |
| In addition, we do not have “key person” life insurance policies covering any of our employees |
| Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future |
| We may have difficulty hiring skilled engineers at our manufacturing facilities in the United States, Taiwan, and China |
| If we are not successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, our business may be harmed |
| If we are not able to achieve acceptable manufacturing yields and sufficient product reliability in the production of our fiber optic components, we may incur increased costs and delays in shipping products to our customers, which could impair our operating results |
| Complex and precise processes are required for the manufacture of our products |
| Changes in our manufacturing processes or those of our suppliers, or the inadvertent use of defective materials, could significantly reduce our manufacturing yields and product reliability |
| Because the majority of our manufacturing costs are relatively fixed, manufacturing yields are critical to our results of operations |
| Lower than expected production yields could delay product shipments and impair our operating results |
| In some cases, existing manufacturing techniques, which involve substantial manual labor, may not allow us to cost-effectively meet our production goals so that we maintain acceptable gross margins while meeting the cost targets of our customers |
| We may not achieve adequate manufacturing cost efficiencies |
| Because we plan to introduce new products and product enhancements, we must effectively transfer production information from our product development department to our manufacturing group and coordinate our efforts with those of our suppliers to rapidly achieve volume production |
| In our experience, our yields have been lower during the early stages of introducing new product to manufacturing |
| If we fail to effectively manage this process or if we experience delays, disruptions or quality control problems in our manufacturing operations, our shipments of products to our customers could be delayed |
| Because the qualification and sales cycle associated with fiber optic components is lengthy and varied, it is difficult to predict the timing of a sale or whether a sale will be made, which may cause us to have excess manufacturing capacity or inventory and negatively impact our operating results |
| In the communications industry, service providers and optical systems manufacturers often undertake extensive qualification processes prior to placing orders for large quantities of products such as ours, because these products must function as part of a larger system or network |
| This process may range from three to six months and sometimes longer |
| Once they decide to use a particular supplier’s product or component, these potential customers design the product into their system, which is known as a design-in win |
| Suppliers whose products or components are not designed in are unlikely to make sales to that customer until at least the adoption of a future redesigned system |
| Even then, many customers may be reluctant to incorporate entirely new products into their new systems, as this could involve significant additional redesign efforts |
| If we fail to achieve design-in wins in our potential customers’ qualification processes, we will lose the opportunity for significant sales to those customers for a lengthy period of time |
| In addition, some of our customers require that our products be subjected to standards-based qualification testing, which can take up to nine months or more |
| While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses, expend significant management efforts, increase manufacturing capacity and order long lead-time supplies |
| Even after the evaluation process, it is possible a potential customer will not purchase our products |
| In addition, product purchases are frequently subject to unplanned processing and other delays, particularly with respect to larger customers for which our products represent a very small percentage of their overall purchase activity |
| Accordingly, our revenues and operating results may vary significantly and unexpectedly from quarter to quarter |
| 13 _________________________________________________________________ If our customers do not qualify our manufacturing lines for volume shipments, our optical networking components may be dropped from supply programs and our revenues may decline |
| Customers generally will not purchase any of our products, other than limited numbers of evaluation units, before they qualify our products, approve our manufacturing process and approve our quality assurance system |
| Our existing manufacturing lines, as well as each new manufacturing line, must pass through various levels of approval with our customers |
| For example, customers may require that we be registered under international quality standards |
| Our products may also have to be qualified to specific customer requirements |
| This customer approval process determines whether the manufacturing line achieves the customers’ quality, performance and reliability standards |
| Delays in product qualification may cause a product to be dropped from a long-term supply program and result in significant lost revenue opportunity over the term of that program |
| Our fiber optic components are deployed in large and complex communications networks and may contain defects that are not detected until after our products have been installed, which could damage our reputation and cause us to lose customers |
| Our products are designed for deployment in large and complex optical networks |
| Because of the nature of these products, they can only be fully tested for reliability when deployed in networks for long periods of time |
| Our fiber optic products may contain undetected defects when first introduced or as new versions are released, and our customers may discover defects in our products only after they have been fully deployed and operated under peak stress conditions |
| In addition, our products are combined with products from other vendors |
| As a result, should problems occur, it may be difficult to identify the source of the problem |
| If we are unable to fix defects or other problems, we could experience, among other things: o loss of customers; o damage to our reputation; o failure to attract new customers or achieve market acceptance; o diversion of development and engineering resources; and o legal actions by our customers |
| The occurrence of any one or more of the foregoing factors could cause our net loss to increase |
| The market for fiber optic components is new and unpredictable, characterized by rapid technological changes, evolving industry standards, and significant changes in customer demand, which could result in decreased demand for our products, erosion of average selling prices, and could negatively impact our revenues |
| The market for fiber optic components is new and characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards |
| Because this market is new, it is difficult to predict its potential size or future growth rate |
| Widespread adoption of optical networks, especially in the metropolitan, last mile, and enterprise access segments of the networks, is critical to our future success |
| Potential end-user customers who have invested substantial resources in their existing copper lines or other systems may be reluctant or slow to adopt a new approach, such as optical networks |
| Our success in generating revenues in this emerging market will depend on: o the education of potential end-user customers and network service providers about the benefits of optical networks; and o the continued growth of the metropolitan, last mile, and enterprise access segments of the communications network |
| 14 _________________________________________________________________ If we fail to address changing market conditions, sales of our products may decline, which would adversely impact our revenues |
| We may be unable to successfully integrate acquired businesses or assets, including our acquisition of the photonics division of Ritek Corporation, with our business, which may disrupt our business, divert management’s attention and slow our ability to expand the range of our proprietary technologies and products |
| To expand the range of our proprietary technologies and products, we may acquire complementary businesses, technologies or products, if appropriate opportunities arise |
| For example, in 2004 we acquired the photonics division of Ritek Corporation |
| We may be unable to identify other suitable acquisitions at reasonable prices or on reasonable terms, or consummate future acquisitions or other investments, any of which could slow our growth strategy |
| We may have difficulty integrating the acquired products, personnel or technologies of the photonics division of Ritek Corporation or of any other company or acquisition that we may make |
| Similarly, we may not be able to attract or retain key management, technical or sales personnel of any other companies that we acquire or from which we acquire assets |
| These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses |
| If our common stock is not relisted on the Nasdaq National Market, we will be subject to certain provisions of the California General Corporation Law that may affect our charter documents and result in additional expenses |
| Beginning at the commencement of trading on November 8, 2002, the listing of our common stock was transferred from the Nasdaq National Market to the Nasdaq Capital Market |
| As a result, we may become subject to certain sections of the California General Corporation Law that will affect our charter documents if our common stock is not returned to being listed on the Nasdaq National Market |
| A recent Delaware decision has called into question the applicability of the California General Corporation Law to Delaware corporations |
| However, if the California General Corporation Law applies to our company, we will not be able to continue to have a classified board or continue to eliminate cumulative voting by our stockholders |
| In addition, certain provisions of our Certificate of Incorporation that call for supermajority voting may need to be approved by stockholders every two years or be eliminated |
| Also, in the event of a reorganization, stockholders will have dissenting stockholder rights under both California and Delaware law |
| Any of these changes will result in additional expense as we will have to comply with certain provisions of the California General Corporation Law as well as the Delaware General Corporation Law |
| We included these provisions in our charter documents in order to delay or discourage a change of control or changes in our management |
| Because of the California General Corporation Law, we may not be able to avail ourselves of these provisions |
| If we are unable to maintain our listing on the Nasdaq Capital Market, the price and liquidity of our common stock may decline |
| There can be no assurance that we will be able to satisfy all of the quantitative maintenance criteria for continued listing on the Nasdaq Capital Market, including a continued minimum bid price of dlra1dtta00 per share |
| If the closing bid price of our common stock falls and remains below dlra1dtta00 for 30 consecutive days as it has for significant periods of time in the past, our common stock may not remain listed on the Nasdaq Capital Market |
| If we fail to maintain continued listing on the Nasdaq Capital Market and must move to a market with less liquidity, our financial condition could be harmed and our stock price would likely decline |
| If we are delisted, it could have a material adverse effect on the market price of, and the liquidity of the trading market for our common stock |
| Many companies that face delisting as a result of closing bid prices that are below the Nasdaq SmallCap Market’s continued listing standards seek to maintain the listing of their securities by effecting reverse stock splits |
| However, reverse stock splits do not always result in a sustained closing bid price per share |
| We continue to consider the merits of implementing a reverse split and to evaluate other courses of action |
| If we fail to protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenues or increase our costs |
| The fiber optic component market is a highly competitive industry in which we, and most other participants, rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect proprietary rights |
| The competitive nature of our industry, rapidly changing technology, frequent new product introductions, changes in customer requirements and evolving industry standards heighten the importance of protecting proprietary technology rights |
| Since the United States Patent and Trademark Office keeps patent applications confidential until a patent is issued, our pending patent applications may attempt to protect proprietary technology claimed in a third party patent application |
| Our existing and future patents may not be sufficiently broad to protect our proprietary technologies as policing unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully as United States laws |
| Our competitors and suppliers may independently develop similar technology, duplicate our products, or design around any of our patents or other intellectual property |
| If we are unable to adequately protect our proprietary technology rights, others may be able to use our proprietary technology without having to compensate us, which could reduce our revenues and negatively impact our ability to compete effectively |
| 15 _________________________________________________________________ Litigation may be necessary to enforce our intellectual property rights or to determine the validity or scope of the proprietary rights of others |
| As a result of any such litigation, we could lose our proprietary rights and incur substantial unexpected operating costs |
| Any action we take to protect our intellectual property rights could be costly and could absorb significant management time and attention |
| In addition, failure to adequately protect our trademark rights could impair our brand identity and our ability to compete effectively |
| We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use some technologies in the future |
| Our industry is very competitive and is characterized by frequent intellectual property litigation based on allegations of infringement of intellectual property rights |
| Numerous patents in our industry have already been issued, and as the market further develops and participants in our industry obtain additional intellectual property protection, litigation is likely to become more frequent |
| From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business |
| In addition, we have and we may continue to enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties |
| Any litigation arising from claims asserting that our products infringe or may infringe the proprietary rights of third parties, whether the litigation is with or without merit, could be time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel |
| We do not have insurance against our alleged or actual infringement of intellectual property of others |
| These claims could cause us to stop selling our products, which incorporate the challenged intellectual property, and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements |
| These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all |
| Although we are not aware of any intellectual property lawsuits filed against us, we may be a party to litigation regarding intellectual property in the future |
| We may not prevail in any such actions, given their complex technical issues and inherent uncertainties |
| Insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed |
| If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely basis, our business could be harmed |
| If we fail to increase sales of our products to optical communications equipment manufacturers outside of North America, growth of our business may be harmed |
| For the years ended December 31, 2005, 2004 and 2003, sales to customers located outside of North America were 25dtta2prca, 13dtta0prca, and 10dtta0prca of our revenues, respectively |
| In order to expand our business, we must increase our sales to customers located outside of North America |
| We have limited experience in marketing and distributing our products internationally and in developing versions of our products that comply with local standards |
| Our international sales will be limited if we cannot establish relationships with international distributors, establish additional foreign operations, expand international sales channels, hire additional personnel and develop relationships with international communications equipment manufacturers |
| Even if we are able to successfully continue international operations, we may not be able to maintain or increase international market demand for our products |
| Outbreaks of diseases pose a risk to the Company’s business |
| In the past, outbreaks of Severe Acute Respiratory Syndrome, or SARS, and of the bird flu have developed into an international health concern, especially in Asia |
| We have manufacturing facilities located in Taiwan and China |
| A new outbreak of disease such as SARS or the bird flu among our employees in Asia could disrupt our Asian manufacturing operations for an extended period of time, which could limit our ability to supply our products to our customers in sufficient quantities on a timely basis |
| A shutdown of our Asian facilities due to fear of spread of infection or because of a quarantine could result in our inability to supply our customers |
| If we are unable to fulfill demand for our products, our relationships with our customers would be harmed and our revenues could be impacted |
| We also rely on companies in Asia for many of the components necessary to manufacture our products |
| If our suppliers experience a significant disruption in their businesses as a result of outbreaks, we may not be able to obtain the parts necessary to make our products which could negatively impact our revenues |
| In addition, if any of our customers experiences a significant disruption in their business as a result of outbreaks, they may delay or cancel purchases of our products which could harm our business |
| Also, certain of our key employees travel to Asia to oversee our Asian operations and to meet with our suppliers and customers |
| If any of our key employees are infected with diseases such as SARS or the bird flu on such a trip or if these employees are quarantined when they return to the United States, our business could be negatively impacted |
| These conditions and uncertainties make it difficult for us, our suppliers and our customers to accurately forecast and plan future business activities |
| 16 _________________________________________________________________ Because our manufacturing operations are located in active earthquake fault zones in California and Taiwan, and our Taiwan location is susceptible to the effects of a typhoon, we face the risk that a natural disaster could limit our ability to supply products |
| Three of our primary manufacturing operations are located in Sunnyvale, California, Tu-Cheng City, Taiwan, and Hu-Kou, Taiwan, all active earthquake fault zones |
| These regions have experienced large earthquakes in the past and may likely experience them in the future |
| In September 2001, a typhoon hit Taiwan causing businesses, including our manufacturing facility, and the financial markets to close for two days |
| Because the majority of our manufacturing operations are located in Taiwan, a large earthquake or typhoon in Taiwan could disrupt our manufacturing operations for an extended period of time, which would limit our ability to supply our products to our customers in sufficient quantities on a timely basis, harming our customer relationships |