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NEOPHOTONICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[April 09, 2014]

NEOPHOTONICS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the period ended September 30, 2013 and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2012 included in our Annual Report on Form 10-K. References to "NeoPhotonics" "we," "our" and "us" are to NeoPhotonics Corporation unless otherwise specified or the context otherwise requires.



This Quarterly Report on Form 10-Q for the period ended September 30, 2013 contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q for the period ended September 30, 2013 that are not purely historical are 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, as amended. Terminology such as "believe," "may," "might," "objective," "estimate," "continue," "anticipate," "intend," "should," "plan," "expect," "predict," "potential," or the negative of these terms or other similar expressions is intended to identify forward-looking statements.

We have based these forward-looking statements largely on our current expectations and projections about future events and industry and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in "Part II -Item 1A. Risk Factors" below, and those discussed in the sections titled "Special Note Regarding Forward-Looking Statements" and "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the SEC on March 15, 2013.


Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Business overview We are a leading designer and manufacturer of photonic integrated circuit, or PIC-based optoelectronic modules and subsystems for bandwidth-intensive, high-speed communications networks.

Our products are designed to enable high-speed transmission rates and efficient allocation of bandwidth over optical networks with high quality and low costs.

Our PIC technology utilizes proprietary design elements that provide optical functionality on a silicon or indium phosphide or hybrid chip. PIC devices can integrate many more functional elements than discretely packaged components, enabling increased functionality in a small form factor while reducing packaging and interconnection costs. In addition, the cost advantages of PIC-based components are similar to the economics of semiconductor wafer mass manufacturing, where the marginal cost of producing an incremental chip is much less than that of a discrete component. We further design and produce certain high speed integrated circuits, or ICs, including gallium arsenide or GaAs ICs, that facilitate the high performance operation of optical components and related products.

We have research and development and wafer fabrication facilities in San Jose and Fremont, California which coordinate with our research and development and manufacturing facilities in Shenzhen and Wuhan, China, Tokyo, Japan, and Ottawa, Canada. We utilize proprietary design tools and design-for-manufacturing techniques to align our design process with our precision nanoscale, vertically integrated manufacturing and testing capabilities. We sell our products to the leading network equipment vendors globally, including ADVA AG Optical Networking Ltd., Alcatel-Lucent SA, Ciena Corporation, Cisco Systems, Inc., Coriant (formerly Nokia Siemens Networks B.V.), ECI Telecom Ltd., FiberHome Technologies Group, Fujitsu Limited, Huawei Technologies Co, Ltd., or Huawei Technologies, Juniper Networks, Inc., Mitsubishi Electric Corporation, NEC Corporation, Telefonaktiebolaget LM Ericsson and ZTE Corporation. We refer to these companies as our Tier 1 customers.

22 -------------------------------------------------------------------------------- On April 27, 2012, we issued and sold approximately 4.97 million shares of our common stock in a private placement transaction at a price of $8.00 per share for a gross amount of approximately $39.8 million. We intend to use the amount received for general corporate purposes. The shares of common stock are restricted from transfer pursuant to a lockup agreement for up to two years, at the end of which we are obligated to file one or more registration statements covering the potential resale of the shares of common stock. Because we did not timely file our Quarterly Report on Form 10-Q for the period ended September 30, 2013 and our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, we are currently ineligible to file the required registration statement on Form S-3 within the original time frame and we have requested an extension from the purchaser. In connection with this private placement transaction, we agreed to certain performance obligations, including establishing a wholly-owned subsidiary in the Russian Federation and making a $30.0 million investment commitment towards the Company's Russian operations. See-Liquidity and Capital Resources, Contractual Obligations and Commitments and Note 9 to the Condensed Consolidated Financial Statements.

On March 29, 2013, we acquired the optical semiconductor business unit of LAPIS Semiconductor Co., Ltd. ("OCU"). OCU is a leading provider of lasers, drivers, and detectors for high speed 100G applications located in Japan. This acquired business is now known as NeoPhotonics Semiconductor. We believe the acquisition of NeoPhotonics Semiconductor enhances our competitive position in 100G products.

In 2012, our revenue growth of 22% over the prior-year was driven primarily by increasing demand for our 40Gbps and 100Gbps speed products, which grew by over 300% over the prior year, as carriers continued to accelerate deployment of high capacity optical transport networks. We operated a sales model that focused on direct alignment with our customers through coordination of our sales, product engineering and manufacturing teams. Our sales and marketing organizations supported our strategy of increasing product penetration with our Tier 1 customers while also serving our broader customer base. We use a direct sales force in the U.S., China, Canada, Israel, Japan, the Russian Federation and the European Union. These individuals worked with our product engineers, and product marketing and sales operations teams, in an integrated approach to address our customers' current and future needs. We also engaged independent commissioned representatives worldwide to extend our global reach.

For the three and nine months ended September 30, 2013 compared to the same periods in 2012, we continued to experience an increase in demand for our 100Gbps products as carriers continued to accelerate deployment of high capacity optical transport networks. This trend helped revenue from our Speed and Agility products to grow on a year over year basis. We expect continued volume growth for our 100Gbps products; however, at declining prices due to the results of our annual customer negotiation and new entrants into the market. In the third quarter of 2013, demand for our Access products declined relative to the same period in 2012 due to lower fiber-to-the-home deployments in China and North America. The market for optical communications products remains highly competitive. We expect to continue to experience competition from companies that range from large international companies offering a wide range of products to smaller companies specializing in narrow markets. We anticipate that macroeconomic conditions, including the slow recovery in the U.S., European sovereign debt issues, and a potential slowdown in the economic growth rate in China, could impact our results.

Critical accounting policies and estimates Other than the item, "Business Combinations" below, there have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2013 from those disclosed in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2012 Form 10-K.

Business Combinations We allocate the fair value of purchase consideration to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill.

When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets.

Fair value estimates are based on the assumptions management believes a market participant would use in pricing the asset or liability. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from customer relationships and acquired patents and developed technology; and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

Amounts recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisition, as additional information about conditions existing at the acquisition date becomes available.

23-------------------------------------------------------------------------------- Results of operations Revenue We sell substantially all of our products to original equipment manufacturers, or OEMs. Revenue is recognized when title of our products passes to the OEM. We price our products based on market and competitive conditions and may periodically reduce the price of our products as market and competitive conditions change and as manufacturing costs are reduced. Our sales transactions to customers are denominated primarily in Chinese Renminbi ("RMB"), Japanese Yen ("JPY") or U.S. dollars. For the three and nine months ended September 30, 2013, 31% and 32% of our sales were derived from our China-based subsidiaries, respectively. For the three and nine months ended September 30, 2012, 42% and 46% of our sales were derived from our China-based subsidiaries, respectively.

Revenue is driven by the volume of shipments and may be impacted by pricing pressures. We have generated most of our revenue from a limited number of customers. Given the high concentration of network equipment vendors in our industry, our top ten customers represented approximately 85% and 91% of our revenue in the three months ended September 30, 2013 and 2012, respectively, and 85% and 90% of our revenue in the nine months ended September 30, 2013 and 2012, respectively.

Three Months Ended Nine Months Ended September 30, September 30, $ % $ % (in thousands) 2013 2012 Change Change 2013 2012 Change Change Total revenue $ 76,814 $ 66,152 $ 10,662 16 % $ 207,867 $ 183,400 $ 24,467 13 % Total revenue increased by $10.7 million in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, representing a 16% increase. Total revenue increased by $24.5 million in the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, representing a 13% increase. The increase in revenue was primarily attributable to revenue from NeoPhotonics Semiconductor, which we acquired at the end of the first quarter of 2013 and which contributed to growth in our Speed and Agility products as carriers increased deployment of 40 Gbps and 100 Gbps telecommunications networks. Revenue from our high speed products, which is primarily 100Gbps was $28.4 million or 37% of total revenue in the third quarter of 2013, an increase of 31% over the third quarter of 2012. This increase was partially offset by a decrease in demand for our access products and other telecom products primarily as a result of decrease in demand relating to applications of below10 Gbps.

For the three months ended September 30, 2013, Huawei Technologies (23%), Alcatel-Lucent SA (17%) and Ciena Corporation (13%), each accounted for 10% or more of our total revenue. For the nine months ended September 30, 2013, Huawei Technologies (26%), Ciena Corporation (16%), and Alcatel-Lucent SA (14%) each accounted for 10% or more of our total revenue. For the three months ended September 30, 2012, Huawei Technologies (29%), Alcatel-Lucent SA (20%), and Ciena Corporation (18%) each accounted for 10% or more of our total revenue. For the nine months ended September 30, 2012, Huawei Technologies (35%), Alcatel-Lucent SA (16%) and Ciena Corporation (15%) each accounted for 10% or more of our total revenue. No other customers accounted for 10% or more of total revenue. We expect that a significant portion of our revenue will continue to be derived from a limited number of customers. As a result, the loss of, or a significant reduction in, orders from Huawei Technologies or any of our other key customers would materially and adversely affect our revenue and results of operations. We expect a significant portion of our sales to be denominated in foreign currencies in the future, and therefore may continue to be affected by changes in foreign exchange rates.

Cost of goods sold and gross margin Our cost of goods sold consists primarily of the cost to produce wafers and to assemble and test our products. We have a global supplier network that we believe enables us to balance product availability, quality and cost considerations. Some of our cost of goods sold is denominated primarily in RMB.

Our manufacturing process extends from wafer fabrication through final module and subsystem assembly and test. The cost of our manufacturing, assembly and test processes includes the cost of personnel and the cost of our manufacturing equipment and facilities. Our cost of goods sold is impacted by manufacturing variances such as assembly and test yields and production volume. We typically experience lower yields and higher associated costs with newer products. In general, our cost of goods sold associated with a particular product declines over time as a result of decreases in wafer costs associated with the increase in the volume of wafers produced, decreases in the costs of purchased materials associated with increases in volumes as well as yield improvements and assembly and test enhancements. Additionally, our cost of goods sold includes stock-based compensation, write off of excess and obsolete inventory, royalty payments, amortization of certain purchased intangible assets and acquisition-related fair value adjustments, warranty, shipping and allocated facilities costs.

Gross profit as a percentage of total revenue, or gross margin, has been and is expected to continue to be affected by a variety of factors, including the introduction of new products, production volumes, production volume compared to sales over time, the mix of products sold, inventory changes, changes in the average selling prices of our products, changes in the cost and volumes of materials purchased from our suppliers, changes in labor costs, changes in overhead costs or requirements, revaluation of stock appreciation unit awards that are impacted by our stock price, and any write off of for excess and obsolete inventories. Our newer and more advanced 24 -------------------------------------------------------------------------------- products typically have higher average selling prices and often have higher gross margins. Average selling prices by product typically decline as a result of periodic negotiations with our customers and competitive pressures. We strive to increase our gross margin as we seek to manage the costs of our supply chain and increase productivity in our manufacturing processes.

Three Months Ended September 30, 2013 2012 % of % of $ %(in thousands, except percentages) Amount Revenue Amount Revenue Change Change Cost of goods sold $ 58,635 76 % $ 45,536 69 % $ 13,099 29 % Nine Months Ended September 30, 2013 2012 % of % of $ %(in thousands, except percentages) Amount Revenue Amount Revenue Change Change Cost of goods sold $ 162,330 78 % $ 136,190 74 % $ 26,140 19 % Three Months Ended Nine Months Ended September 30, September 30, 2013 2012 2013 2012 Gross margin 24 % 31 % 22 % 26 % Cost of goods sold increased by $13.1 million and $26.1 million in the three and nine months ended September 30, 2013, respectively, compared to the corresponding 2012 periods. Gross margin for the three and nine months ended September 30, 2013 was 24% and 22%, respectively, compared to 31% and 26% for the corresponding 2012 periods. The decrease in gross margin partially resulted from costs associated with our NeoPhotonics Semiconductor acquisition. In connection with this acquisition, we recorded $3.1 million of inventory step up equal to the excess of the fair value of the inventory over its cost at the acquisition date, all of which was amortized into cost of goods sold during the nine months ended September 30, 2013. Our gross margin for the three and nine months ended September 30, 2013 was also impacted by restructuring charges of $0.6 million and lower average selling prices resulting from increased competition and pricing pressure from our major customers. These factors were partially offset by a $1.8 million decrease in the write-down of inventory in the nine months ended September 30, 2013 compared to the same period in 2012.

We may experience higher China manufacturing labor cost due to laws or policies that affect future labor rates or other laws and regulations in China, and our gross margins and results of operations may be adversely affected.

25-------------------------------------------------------------------------------- Operating expenses Our operating expenses consist of research and development, sales and marketing, general and administrative, amortization of purchased intangible assets, and adjustment to the fair value of contingent consideration. Personnel costs are the most significant component of operating expenses and consist of costs such as salaries, benefits, bonuses, stock-based compensation and, with regard to sales and marketing expense, sales commissions. Our operating expenses are denominated primarily in RMB and U.S. dollars.

Three Months Ended September 30, 2013 2012 % of % of $ % (in thousands, except percentages) Amount Revenue Amount Revenue Change Change Research and development $ 12,227 16 % $ 9,893 15 % $ 2,334 24 % Sales and marketing 3,580 5 % 3,354 5 % 226 7 % General and administrative 8,905 12 % 6,530 10 % 2,375 36 % Adjustment to fair value of contingent consideration 1,026 1 % (850 ) -1 % 1,876 221 % Amortization of purchased intangible assets 381 - % 321 - % 60 19 % Restructuring charges 450 1 % - - % 450 100 % Acquisition-related transaction costs 126 - % 240 - % (114 ) -48 % Total operating expenses $ 26,695 35 % $ 19,488 29 % $ 7,207 37 % Nine Months Ended September 30, 2013 2012 % of % of $ % (in thousands, except percentages) Amount Revenue Amount Revenue Change Change Research and development $ 33,021 16 % $ 29,753 16 % $ 3,268 11 % Sales and marketing 10,515 5 % 9,783 5 % 732 7 % General and administrative 21,853 10 % 19,704 11 % 2,149 11 % Adjustment to fair value of contingent consideration 1,026 - % (246 ) - % 1,272 517 % Amortization of purchased intangible assets 1,128 1 % 996 1 % 132 13 % Restructuring charges 775 - % - - % 775 100 % Acquisition-related transaction costs 5,317 3 % 912 - % 4,405 483 % Total operating expenses $ 73,635 35 % $ 60,902 33 % $ 12,733 21 % Research and development Research and development expense consists of personnel costs, including stock-based compensation, for our research and development personnel, and product development costs, including engineering services, development software and hardware tools, depreciation of capital equipment and facility costs. We record all research and development expense as incurred.

Research and development expense increased by $2.3 million in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, representing a 24% increase. The acquisition of NeoPhotonics Semiconductor increased our research and development expense by $1.3 million. The increase was also due to $1.1 million increase in research and development projects to support our business growth partially offset by a $0.1 million net decrease in compensation-related costs.

Research and development expense increased by $3.3 million in the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012, representing an 11% increase. The acquisition of NeoPhotonics Semiconductor increased our research and development expense by $2.6 million. The increase was also due to $1.3 million increase in research and development projects to support our business growth, partially offset by a net decrease of $0.5 million in compensation-related costs compared to the same period in 2012, which included additional costs related to the acquisition of Santur.

We intend to continue to invest in research and development and expect this expense to increase as we grow our business. As a percentage of total revenue, our research and development expense may vary as our revenue changes over time.

Sales and marketing Sales and marketing expense consists primarily of personnel costs, including stock-based compensation and sales commissions, costs related to sales and marketing programs and services and facility costs.

Sales and marketing expense increased by $0.2 million in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, representing a 7% increase which is primarily due to increases from the acquisition of NeoPhotonics Semiconductor.

26 -------------------------------------------------------------------------------- Sales and marketing expense increased by $0.7 million in the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, representing a 7% increase. The increase is largely due to the acquisition of NeoPhotonics Semiconductor which increased our sales and marketing expense by $0.3 million and expenses incurred as part of our geographic expansion into Russia.

We expect our sales and marketing expense to increase as a result of the acquisition of NeoPhotonics Semiconductor and as we grow our business, expand our marketing activities, increase the number of sales and marketing professionals and incur employee-related costs accordingly. As a percentage of total revenue, our sales and marketing expense may vary as our revenue changes over time.

General and administrative General and administrative expense consists primarily of personnel costs, including stock-based compensation, for our finance, legal, human resources and information technology personnel and certain executive officers, as well as professional services costs related to accounting, tax, banking, legal and information technology services, depreciation, facility costs and restructuring charges.

General and administrative expense increased by $2.4 million in the three months ended September 30, 2013 compared to the three months ended September 30, 2012, representing a 36% increase. Costs in the newly acquired NeoPhotonics Semiconductor increased our general and administrative expenses by $1.0 million.

We incurred $1.6 million in higher consulting and professional services costs, of which approximately $1.0 million was attributable to resources engaged to assist in addressing internal control issues, provide technical accounting support and fill vacant key positions on an interim basis. We expect such costs to continue to be high through the second quarter of 2014. Additional increases included $0.2 million in IT related costs and $0.4 million in other costs to support our continued growth. These increases were partially offset by a net $0.9 million decrease in payroll related costs primarily attributable to a decrease in accrued bonus expense.

General and administrative expense increased by $2.1 million in the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, representing an 11% increase. Increases included $2.2 million in consulting and professional services, $1.0 million in IT related costs, costs in the newly acquired NeoPhotonics Semiconductor of $0.9 million and $0.5 million in other costs to support our continued growth. These increases were partially offset by a net decrease in payroll and related costs of $2.4 million primarily due to a decrease in accrued bonus expense.

We expect our general and administrative expense to increase in absolute terms as a result of the acquisition of NeoPhotonics Semiconductor and as we expand and grow our operations and business.

Adjustment to the fair value of contingent consideration In January 2014, the Company reached a non-binding verbal understanding for the terms of a settlement agreement ("Settlement") covering the outstanding claims in connection with its 2011 acquisition of Santur Corporation ("Santur"). The Settlement is subject to the execution of a definitive written agreement between the Company and the other parties. Under the Settlement, a net amount of $1.9 million will be paid to the Company from the escrow account that was set up under the original merger agreement. This amount comprises $3.9 million related to certain indemnification claims by the Company ("Indemnification Amount") which were partially offset by $2.0 million related to additional consideration for the business acquisition that was contingent upon Santur's gross profit performance during 2012 ("Contingent Consideration Amount"). Prior to this Settlement, the Company had recorded $1.0 million as its estimated fair value of the Contingent Consideration Amount. As a result of this Settlement the Company recorded an additional $1.0 million in its operating expenses for the three and nine months ended September 30, 2013 to adjust the fair value of the Contingent Consideration Amount to the full $2.0 million settlement amount. Because it is considered to be a contingent gain, the $3.9 million Indemnification Amount will not be recognized as other income until paid.

Amortization of purchased intangible assets We completed a series of business acquisitions in 2005 and 2006 and, more recently, in the fourth quarter of 2011 and in the first quarter of 2013, which included the acquisition of intangible assets. These intangible assets are being amortized over their estimated useful lives. Amortization expense relating to technology and patents and leasehold interests are included within cost of goods sold, while customer relationships and noncompete agreements are recorded within operating expenses. See Note 5 "Business Combination" and Note 6 "Balance Sheet Components" in our Notes to Condensed Consolidated Financial Statements for details.

Restructuring charges In the first quarter of 2013, we exited and closed one facility at our headquarters location to align our facilities usage with our current size. As a result, we recorded a restructuring charge in operating expenses related to the facility impairment of approximately 27-------------------------------------------------------------------------------- $0.3 million including $0.1 million write-off of deferred rent. As of September 30, 2013, the remaining balance on this restructuring obligation was $0.2 million, which we expect to pay through 2015.

In the third quarter of 2013, we approved and implemented a restructuring plan to reduce our workforce and close a facility in China and to exit our contract manufacturing activities in Malaysia. The workforce reduction affected 67 employees, or approximately 3% of our total workforce, all of which were terminated prior to September 30, 2013. We recorded a restructuring charge of $1.1 million in the quarter ended September 30, 2013 of which $0.5 million was recorded in operating expenses with the remainder recorded in costs of goods sold.

Acquisition-related transaction costs In connection with the NeoPhotonics Semiconductor acquisition we incurred $0.1 million and $5.3 million in acquisition-related transaction costs in the three and nine months ended September 30, 2013, respectively. The costs related to investment banking, legal, accounting and other professional services and fees as well as transfer and acquisition taxes related to real property acquired.

We accounted for our acquisition of the NeoPhotonics Semiconductor assets and assumed liabilities as a business combination. NeoPhotonics Semiconductor's tangible and identifiable intangible assets acquired and liabilities assumed were recorded based upon their estimated fair values as of the closing date of the acquisition. See Note 5 "Business Combination" in our Notes to Condensed Consolidated Financial Statements for details.

Interest and other expense, net Interest income consists of income earned on our cash, cash equivalents and short-term investments. Interest expense consists of amounts paid for interest on our bank and other borrowings. Other income (expense), net is primarily made up of government subsidies, and foreign currency transaction gains and losses.

The functional currency of our subsidiaries in China is the RMB and of our subsidiaries in Japan is the JPY. The foreign currency transaction gains and losses of our subsidiaries in China and Japan primarily result from their transactions in U.S. dollars.

Three Months Ended Nine Months Ended September 30, September 30, $ % $ % (in thousands) 2013 2012 Change Change 2013 2012 Change Change Interest income $ 66 $ 147 $ (81 ) -55 % $ 269 $ 424 $ (155 ) -37 % Interest expense (251 ) (135 ) (116 ) 86 % (756 ) (434 ) (322 ) 74 % Other income (expense), net 115 154 (39 ) -25 % (432 ) (121 ) (311 ) 257 % Total $ (70 ) $ 166 $ (236 ) -142 % $ (919 ) $ (131 ) $ (788 ) 602 % Total interest and other expense, net, increased by $0.2 million in the three months ended September 30, 2013, compared to the three months ended September 30, 2012. Total interest and other expense, net, increased by $0.8 million in the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. The change in both periods was primarily related to higher interest expense due to additional borrowings and foreign exchange changes due to currency fluctuations. We expect our interest income to remain relatively modest given the low yields available in the marketplace and lower investable balances. See Note 7 "Debt" in our Notes to Condensed Consolidated Financial Statements for more information.

Income taxes We conduct our business globally. Therefore, our operating income is subject to varying rates of tax in the United States, China, Japan and other various foreign jurisdictions. Consequently, our effective tax rate is dependent upon the geographic distribution of our earnings or losses and the tax laws and regulations in each geographical region. We expect that our income taxes will vary in relation to our profitability and the geographic distribution of our profits. Historically, we have experienced net losses in the U.S. and in the short term, we expect this trend to continue. In China, one of our subsidiaries has qualified for a preferential 15% tax rate available for high technology enterprises as opposed to the statutory 25% tax rate. The preferential rate applies to 2012-2013, and has been benefited for years 2008-2011 as well and we intend to reapply for the preferential rate for 2014-2016.

Three Months Ended Nine Months Ended September 30, June 30, (in thousands) 2013 2012 2013 2012 Provision for income taxes $ 777 $ 571 $ 870 $ 888 Our income tax expense for the three and nine months ended September 30, 2013 was primarily related to income taxes of our non-U.S. operations.

28-------------------------------------------------------------------------------- Liquidity and capital resources We have financed our operations through issuances of investment securities and from various lending arrangements. At September 30, 2013, our cash and cash equivalents totaled $43.7 million, and our short-term investments totaled $26.9 million. Cash and cash equivalents were held for working capital purposes and were invested primarily in money market funds. We do not enter into investments for trading or speculative purposes.

We believe that our existing cash and cash equivalents, and cash flows from our operating activities, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products, the costs to increase our manufacturing capacity, the continuing market acceptance of our products and acquisitions of businesses and technology. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

A customary business practice in China is for customers to exchange our accounts receivable with notes receivable issued by their bank. From time to time we accept notes receivable from certain of our customers in China. These notes receivable are non-interest bearing and are generally due within six months, and such notes receivable may be redeemed with the issuing bank prior to maturity at a discount. Historically, we have collected on the notes receivable in full at the time of maturity.

Frequently, we also direct our banking partners to issue notes payable to our suppliers in China in exchange for accounts payable. Our Chinese subsidiaries' banks issue the notes to vendors and issue payment to the vendors upon redemption. We owe the payable balance to the issuing bank. The notes payable are non-interest bearing and are generally due within six months of issuance. As a condition of the notes payable lending arrangements, we are required to keep a compensating balance at the issuing banks that is a percentage of the total notes payable balance until the notes payable are paid by our subsidiaries in China. These balances are classified as restricted cash and included in prepaid expenses and other current assets on our consolidated balance sheets. As of September 30, 2013, our restricted cash totaled $1.6 million.

Approximately $6.3 million of our accumulated deficit at December 31, 2012 was subject to restriction due to the fact that our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year to fund statutory common reserves as well as allocate a discretional portion of their after-tax profits to their staff welfare and bonus fund.

We assumed two defined benefit plans that provide retirement benefits to our employees in Japan in connection with our acquisition of NeoPhotonics Semiconductor on March 29, 2013. Under these defined benefit plans, we calculate benefits based on an employee's individual grade level, years of service and performance. Employees are entitled to a lump sum benefit upon retirement or upon certain instances of termination. Per the terms of the Demerger Agreement with LAPIS, we have up to one year to establish a new pension plan ("New Pension Plan") for our employees in Japan. Until the New Pension Plan is established, the value of the plan assets will remain in plans administered by LAPIS and LAPIS has an obligation to transfer the value of these assets to the New Pension Plan.

Credit agreements We have lending arrangements with several financial institutions, including a loan and security agreement with Comerica Bank in the U.S., which has been amended several times. As of December 31, 2012, our loan and security agreement in the U.S. included the following components: - As of December 31, 2012, $8.0 million was outstanding under the revolving line of credit agreement and $0.0 million was available for borrowing.

Borrowings under this facility bear interest at a rate of LIBOR plus 2%.

- As of December 31, 2012, no amounts were outstanding under the equipment advance line advance and all $7.0 million was available for borrowing.

Borrowings under this facility would bear interest at a rate of LIBOR plus 2%.

- As of December 31, 2012, $14.2 million was outstanding under the acquisition advance and $5.8 million was available for borrowing. The advances bear interest at a rate of LIBOR plus 2%.

On March 21, 2013, we amended and restated the prior loan and security agreement in its entirety. The components of the available credit facilities as of September 30, 2013 are as follows: - As of September 30, 2013, no amount was outstanding under the revolving line of credit agreement and all $20.0 million was available for borrowing subject to covenant requirements. Amounts are due on or before March 2016 and borrowings under this revolving line of credit include an interest rate option of a base rate as defined in the agreement plus 1.5% or LIBOR plus 2.5%. As of September 30, 2013 the rate on the LIBOR option was 2.68%.

29 -------------------------------------------------------------------------------- - As of September 30, 2013, $26.3 million was outstanding under the term loan of the credit facility and interest is payable quarterly in arrears; the principal is paid in equal quarterly installments over the term of the loan ending in June 2017. Borrowings under the term loan include an interest rate option of a base rate as defined in the agreement plus 1.75% or LIBOR plus 2.75%. As of September 30, 2013 the rate on the LIBOR option was 2.93%.

Our Credit Agreement requires the maintenance of specified financial covenants, including a liquidity ratio, restricts our ability to incur additional debt or to engage in specified transactions, restricts the payment of dividends and is secured by substantially all of the Company's U.S. assets, other than intellectual property assets. Our ability to meet the financial covenants in future periods will depend on events beyond our control, and we cannot be assured that we will meet those requirements. A breach of any of these covenants in the future could have an adverse impact on availability of financial assurances. In addition, the amounts outstanding could also be subject to acceleration of maturity if we breach a covenant. If such acceleration were to occur, we may not have sufficient liquidity available to repay the indebtedness.

As of September 30, 2013 and December 31, 2012, we were in compliance with the covenants contained in this agreement.

Subsequent to December 31, 2013, we executed a series of amendments to the Credit Agreement that modified certain covenants and extended the delivery date of our September 30, 2013 Quarterly Report on Form 10-Q and our amended March 31, 2013 and June 30, 2013 Quarterly Reports on Forms 10-Q/A. The amendments also increased the applicable interest margins by 0.25% per annum. Loans under the term loan facility bear interest equal to either the LIBOR rate, plus an applicable margin equal to 3.00% per annum, or a base rate (as defined) plus an applicable margin equal to 2.00% per annum. Loans under the revolving loan facility bear interest at a rate equal to either the LIBOR rate, plus an applicable margin equal to 2.75% per annum, or a base rate (as defined) plus an applicable margin equal to 1.75% per annum. These new interest rate options will be in effect at least until the lender's review of the Company's June 30, 2014 financial statements.

Our subsidiaries in China have short-term line of credit facilities with several banking institutions. These short-term loans have an original maturity date of one year or less as of September 30, 2013. Amounts requested by us are not guaranteed and are subject to the banks' funds and currency availability. The short-term loan agreements do not contain financial covenants. As of September 30, 2013, we had no short-term loans outstanding.

Private placement transaction In connection with the 2012 private placement transaction (see-Business Overview), we agreed to certain performance obligations including establishing a wholly-owned subsidiary in the Russian Federation and making a $30.0 million investment commitment (the 'Investment Obligation') towards the Company's Russian operations. The Investment Obligation can be partially satisfied by cash and/or stock investment inside or outside of the Russian Federation and/or by way of non-cash asset transfers, including but not limited to capital equipment, small tools, intellectual property, and other intangibles. A minimum of $15.0 million of the Investment Obligation is required to be satisfied by making capital expenditure investments and we expect that the remaining $15.0 million will be satisfied through cash and non-cash general working capital and research and development expenditures and commitments. All of the amount for general working capital can be spent either inside or outside of Russia. However, at least 80% of the amount expended for research and development must be spent inside Russia. General working capital can include cash or stock acquisition of technology and other businesses or portions thereof to be owned by the Russian subsidiary. Our current plan is to substantially meet the $15.0 million capital expenditure portion of the Investment Obligation by transferring non-cash assets from other entities within the consolidated Company to the Russian subsidiary, subject to the purchaser's approval as required in the rights agreement. We expect that the remaining $15.0 million will be satisfied through some combination of working capital and research and development spending, which may include technology or other acquisitions acquired by cash or stock through March 2015. The exact timing and composition of those expenditures has not yet been determined.

The purchaser of the common stock has nontransferable veto rights over our Russian subsidiary's annual budget during the investment period, and non-cash asset transfers to be made in satisfaction of the Investment Obligation requires approval by the purchaser. Spending and/or commitments to spend for general working capital and research and development do not require approval by the purchaser. There are no legal restrictions on the specific usage of amounts received in the private placement transaction or on withdrawal from our bank accounts for use in general corporate purposes.

We are required to satisfy the Investment Obligation by July 31, 2014, or, in the event we have not recorded aggregate revenue from sales of our products in the Russian Federation of at least $26.8 million during the period beginning July 1, 2012 and ending June 30, 2014, then by March 31, 2015. We expect the date for achievement of the Investment Obligation will be extended to March 31, 2015. Therefore, we intend to meet the Investment Obligation by March 31, 2015. If we fail to meet the Investment Obligation by the deadline, including failure to meet the Investment Obligation because the purchaser of the common stock does not approve the transfer of non-cash assets, we will be required to pay a $5.0 million penalty as the sole and exclusive remedy for damages and monetary relief available to the purchaser for failure to meet the Investment Obligation.

30 -------------------------------------------------------------------------------- The table below sets forth selected cash flow data for the periods presented: Nine months ended September 30, (in thousands) 2013 2012Net cash used in operating activities $ (5,007 ) $ (7,377 ) Net cash provided by (used in) investing activities 10,164 (20,115 ) Net cash provided by financing activities 1,495 33,590 Effect of exchange rates on cash and cash equivalents 64 (4 ) Net increase in cash and cash equivalents $ 6,716 $ 6,094 Operating activities Cash used in operating activities consists of our net loss adjusted for certain non-cash items, including depreciation and amortization, stock-based compensation expense, write-down of inventory and the effect of changes in working capital and other activities.

During the nine months ended September 30, 2013, net cash used in operating activities was $5.0 million which was a $2.4 million decrease from the $7.4 million used in the nine months ended September 30, 2012. Contributing to the decrease was an increase in accounts payable due to higher inventory purchases and payment timing differences during the latter part of the 2013 period and higher accrued and other current liabilities, mainly from the newly acquired NeoPhotonics Semiconductor business. Operating cash flows also benefited from lower growth in inventory over the nine months ended September 30, 2013 compared to the same period in 2012. These factors were partially offset by a higher net loss and an increase in accounts receivable due to higher revenue in the 2013 quarter.

Investing activities During the nine months ended September 30, 2013, net cash provided by investing activities was $10.2 million, which was a $30.3 million change from the $20.1 million used in investing activities during the nine months ended September 30, 2012. The change was primarily due to net sales and maturities of marketable securities, partially offset by higher purchases of property and equipment and cash used to purchase NeoPhotonics Semiconductor in the 2013 period.

Financing activities During the nine months ended September 30, 2013, net cash provided by financing activities was $1.5 million, which was a $32.1 million decrease from the $33.6 million provided by financing activities during the nine months ended September 30, 2012. The 2012 period benefitted from $39.6 million generated from the private placement transaction. Also contributing to the change was $4.1 million in net proceeds from our amended Credit Agreement in the 2013 period.

Contractual obligations and commitments The following summarizes our contractual obligations as of September 30, 2013: Payments due by period Less than 1-3 3-5 More than (in thousands) Total 1 Year Years Years 5 Years Notes payable (1) $ 7,954 $ 7,954 $ - $ - $ - Short-term and long-term loan (2) 10,710 3,570 7,140 - - Debt obligations (3) 26,250 7,000 14,000 5,250 - Retirement obligations (4) 6,102 46 595 1,470 3,991 Operating leases (5) 5,747 1,851 2,305 1,010 581 Purchase commitments (6) 31,780 31,780 - - - Penalty payment derivative (7) 238 - 238 - - Asset retirement obligations (8) 832 - - - 832 89,613 52,201 24,278 7,730 5,404 Expected interest payments (9) 1,651 792 808 51 - Total commitments $ 91,264 $ 52,993 $ 25,086 $ 7,781 $ 5,404 (1) In China, we issue notes payable to our suppliers frequently. The notes payable are generally due within six months of issuance and are non-interest bearing. The amount presented in the table represents the principal portion of the obligations.

31 -------------------------------------------------------------------------------- (2) In connection with acquisition of NeoPhotonics Semiconductor on March 29, 2013, we have 1,050 million Yen to be paid in three equal installments on the first, second and third anniversaries of the closing date for the purchase of the real estate used by the NeoPhotonics Semiconductor. The amount in the table is presented in USD.

(3) We have lending arrangements with several financial institutions, including a loan and security agreement with Comerica Bank in the U.S., which has been amended several times. On March 21, 2013, we amended and restated in its entirety Loan and Security Agreement with the same bank and added East-West Bank as a lender. The amount presented in the table represents the principal portion of the obligations. All of the outstanding debt was subject to fluctuations in interest rates. Interest is paid monthly over the term of the debt arrangement.

(4) In connection with our acquisition of NeoPhotonics Semiconductor on March 29, 2013, we assumed two defined benefit plans that provide retirement benefits to the NeoPhotonics Semiconductor employees in Japan. The net pension liability was $6.1 million as of September 30, 2013.

(5) We have entered into various non-cancelable operating lease agreements for our offices in China, U.S. and Japan.

(6) We are obligated to make payments under various arrangements with suppliers for the procurement of goods and services.

(7) See "Private placement transaction" below and Note 9 to the condensed consolidated financial statements.

(8) We have an asset retirement obligation of $0.7 million associated with our facility lease in California, which expires in October 2019. This obligation is included in other noncurrent liabilities in the condensed consolidated balance sheet as of September 30, 2013. We also have a $0.1 million asset retirement obligation in Japan.

(9) We calculate the expected interest payments based on our outstanding notes payable, loan and debt obligations at prevailing interest rates as of September 30, 2013.

Private placement transaction In connection with our April 2012 common stock private placement transaction, we agreed to certain performance obligations including establishing a wholly-owned subsidiary in the Russian Federation and making a $30.0 million investment (the "Investment Obligation") towards our Russian operations. The Investment Obligation can be partially satisfied by cash and/or stock investment inside or outside of the Russian Federation and/or by way of non-cash asset transfers, including but not limited to capital equipment, small tools, intellectual property, and other intangibles. A minimum of $15.0 million of the Investment Obligation is required to be satisfied by making capital expenditure investments and we expect that the remaining $15.0 million will be satisfied through cash and non-cash general working capital and research and development expenditures and commitments. All of the amount for general working capital can be spent either inside or outside of Russia. However, at least 80% of the amount expended for research and development must be spent inside Russia. General working capital can include cash or stock acquisition of other businesses or portions thereof to be owned by the Russian subsidiary.

Our current plan is to substantially meet the $15.0 million capital expenditure portion of the Investment Obligation by transferring non-cash assets from other entities within the consolidated Company to the Russian subsidiary, subject to the purchaser's approval as required in the rights agreement. We expect that the remaining $15.0 million will be satisfied through some combination of working capital and research and development spending, which may include technology or other acquisitions acquired by cash or stock through March 2015. The exact timing and composition of those expenditures has not yet been determined. There are no legal restrictions on the specific usage of amounts received in the private placement transaction or on withdrawal from our bank accounts for use in general corporate purposes.

We are required to satisfy the Investment Obligation by July 31, 2014, or, in the event we have not recorded aggregate revenue from sales of our products in the Russian Federation of at least $26.8 million during the period beginning July 1, 2012 and ending June 30, 2014, then by March 31, 2015. We expect the date for achievement of the Investment Obligation will be extended to March 31, 2015. Therefore, we intend to meet the Investment Obligation by March 31, 2015. If we fail to meet the Investment Obligation by the deadline, including failure to meet the Investment Obligation because the purchaser of the common stock does not approve the transfer of non-cash assets, we will be required to pay a $5.0 million penalty as the sole and exclusive remedy for damages and monetary relief available to the purchaser for failure to meet the Investment Obligation.

Off-balance sheet arrangements During the three and nine months ended September 30, 2013, we did not have any significant off-balance sheet arrangements.

Recent accounting pronouncements See Note 1 "Basis of presentation and significant accounting policies" in the Notes to Condensed Consolidated Financial Statements on this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements and accounting changes.

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