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

[November 09, 2012]

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, 2012 and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2011 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, 2012 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, 2012 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 fiscal year ended December 31, 2011, as filed with the SEC on March 30, 2012. 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 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 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., ECI Telecom Ltd., Telefonaktiebolaget LM Ericsson, FiberHome Technologies Group, Fujitsu Limited, Huawei Technologies Co., Ltd., Juniper Networks, Inc., Mitsubishi Electric Corporation, NEC Corporation, Nokia Siemens Networks B.V. and ZTE Corporation. We refer to these companies as our Tier 1 customers.

22-------------------------------------------------------------------------------- Table of Contents We operate a sales model that focuses on direct alignment with our customers through coordination of our sales, product engineering and manufacturing teams.

Our sales and marketing organizations support 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 work 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 engage independent commissioned representatives worldwide to extend our global reach.

In February 2011, we completed our initial public offering of 8,625,000 shares of common stock, including the full underwriters' over-allotment option, at a public offering price of $11.00 per share. Our initial public offering generated net proceeds of $88.2 million before offering expenses. In connection with the closing of the initial public offering, all of the shares of our Series 1, Series 2 and Series 3 preferred stock then outstanding automatically converted into 6,639,513 shares of common stock on a 1-for-1 basis and all of the shares of our Series X preferred stock then outstanding automatically converted into 7,398,976 shares of common stock on a 400-for-1 basis.

In October 2011, we acquired Santur Corporation, a designer and manufacturer of Indium Phosphide (InP) based PIC products. The acquisition of Santur enhances the Company's position in PIC-based modules and subsystems for high speed networks.

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 gross proceeds of approximately $39.8 million. 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. We intend to use a portion of the net proceeds from the sale of the shares of common stock for general corporate purposes and to establish a presence in the Russian Federation. In addition, we intend to establish a production facility in the Russian Federation, in accordance with the terms of a rights agreement entered into in connection with the private placement, for the benefit of the global organization. The expansion into the Russian Federation is targeted for completion by July 31, 2014.

For the nine months of fiscal 2012 compared to the same period in fiscal 2011, we experienced an increase in demand for our 40Gbps and 100Gbps speed products as carriers continued to accelerate deployment of high capacity optical transport networks. Additionally, we experienced an increase in demand for our products as ROADM deployments continued. In the first nine months of fiscal 2012, demand for our access products also increased as fiber-to-the-home deployments continued around the world, particularly in China. 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 macroeconomic conditions, including the slow recovery in the U.S., European sovereign debt issues, and concerns relating to inflation in China, could impact our Company's results.

Critical accounting policies and estimates There have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2012 from those disclosed in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Form 10-K.

Results of operations Revenue We sell substantially all of our products to original equipment manufacturers, or OEMs. Revenue is recognized upon delivery of our product 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 Renminbi ("RMB") or U.S. dollars. For the three and nine months ended September 30, 2012, 42% and 46% of our sales were derived from our China-based subsidiaries, respectively, the majority of which were denominated in RMB. 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 91% of our revenue in both of the three months ended September 30, 2012 and 2011, and 90% and 91% of our revenue in the nine months ended September 30, 2012 and 2011, respectively.

23 -------------------------------------------------------------------------------- Table of Contents Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2012 2011 2012 2011 Total revenue $ 66,152 $ 42,848 $ 183,400 $ 143,845 Revenue increased by $23.3 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, representing a 54% increase. Total revenue increased by $39.6 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, representing a 27% increase. The increase was primarily attributable to growth in our speed and agility products as carriers increased deployments of 40Gbps and 100Gbps telecommunications networks. The increase included NeoPhotonics developed products, as well as those derived from Santur, which was acquired by us in October of 2011. The increase was partially offset by decrease in revenue from our access products and other telecom products primarily as a result of decrease in demand relating to applications below 10Gbps.

Typically, revenue from our top 5 customers comprises more than 50% of our total revenue. In addition, our largest customer, Huawei Technologies, represented 29% and 35% of our total revenue for the three and nine month periods ended September 30, 2012, respectively, and 43% and 52% of our total revenue for the three and nine month periods ended September 30, 2011, respectively.

Alcatel-Lucent SA and Ciena Corporation represented 20% and 18% of our total revenue for the three months ended September 30, 2012, respectively, and 16% and 15% of our total revenue for the nine months ended September 30, 2012, respectively. 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.

In addition, 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 manufacture and test our products. We have a global set of suppliers to help balance considerations related to product availability, quality and cost.

Components of our cost of goods sold are 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 on new 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, as well as yield improvements and assembly and test enhancements. Additionally, our cost of goods sold includes stock-based compensation, reserves for 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 volume, 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 reserves for excess and obsolete inventories. Our newer and more advanced products typically have higher average selling prices and 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.

24 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 % of % of % of % of (in thousands, except percentages) Amount Revenue Amount Revenue Amount Revenue Amount Revenue Cost of goods sold $ 45,536 69 % $ 30,827 72 % $ 135,773 74 % $ 106,034 74 % Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 Gross margin 31 % 28 % 26 % 26 % Cost of goods sold increased by $14.7 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, representing a 48% increase. Cost of goods sold increased primarily from higher sales volumes, additional direct labor and overhead costs, as a result of increased salary and employee benefit costs, and the amortization of intangible assets. The acquisition of Santur significantly increased our cost of goods sold. Gross margin was 31% for the three months ended September 30, 2012, compared to 28% for the three months ended September 30, 2011. The increase in gross margin was primarily due to higher revenue during the quarter as a result of higher demand of our speed and agility products for 40Gbps and 100Gbps telecommunications networks.

Cost of goods sold increased by $29.7 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, representing a 28% increase. $28.0 million of the increase was due primarily to the acquisition of Santur. Gross margin was 26% for the nine months ended September 30, 2012 and 2011, which remained relatively constant notwithstanding a change in product and customer mix.

We expect to experience increased demand for certain of our products that can have lower than average margins, which can cause our gross margin to be lower than the comparable year-ago periods. In addition, we may experience higher China manufacturing labor cost due to future laws and regulations in China, and our gross margins and results of operations may be adversely affected.

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. Although our operating expenses are denominated primarily in RMB and U.S. dollars, most are denominated in U.S.

dollars.

Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 % of % of % of % of (in thousands, except percentages) Amount Revenue Amount Revenue Amount Revenue Amount Revenue Research and development $ 9,893 15 % $ 7,059 16 % $ 29,753 16 % $ 19,816 14 % Sales and marketing 3,354 5 % 3,103 7 % 9,783 5 % 8,318 6 % General and administrative 6,770 10 % 5,877 14 % 20,616 11 % 14,613 10 % Amortization of purchased intangible assets 321 0 % 104 0 % 996 1 % 668 0 % Adjustment to fair value of contingent consideration (850 ) (1 )% 0 0 % (246 ) 0 % 0 0 % Total operating expenses $ 19,488 29 % $ 16,143 38 % $ 60,902 33 % $ 43,415 30 % 25 -------------------------------------------------------------------------------- Table of Contents 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 $2.8 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011, representing a 40% increase. This increase was primarily due to a $3.0 million increase in additional payroll and employee-related costs mainly due to our acquisition of Santur.

Research and development expense increased by $9.9 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, representing a 50% increase. This increase was primarily due to a $9.7 million increase in additional payroll and employee-related costs mainly due to the result of our 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 $0.3 million in the three months ended September 30, 2012 compared to the three months ended September 30, 2011, representing an 8% increase. This increase was primarily due to a $0.2 million increase in additional payroll and employee-related costs mainly as the result of our acquisition of Santur.

Sales and marketing expense increased by $1.5 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, representing an 18% increase. This increase was primarily due to a $1.5 million increase in additional payroll and employee-related costs.

We expect our sales and marketing expense to increase as a result of the acquisition of Santur and as we grow our business, expand our marketing activities, increase the number of sales and marketing professionals and incur higher stock-based compensation expense and 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, 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 of capital equipment, facility costs and restructuring charges.

General and administrative expense increased by $0.9 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011, representing a 15% increase. This increase was primarily due to a $1.0 million increase in payroll and employee-related costs.

General and administrative expense increased by $6.0 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, representing a 41% increase. This increase was primarily due to a $3.5 million increase in payroll and employee-related costs, $1.2 million increase in overall expense as a result of our acquisition of Santur, a $0.6 million increase in integration expenses as a result of acquisition activities, a $0.3 million increase in professional services expense related to public company compliance expenses and legal fees, and a $0.2 million increase in depreciation expense.

We expect our general and administrative expense to increase as we incur costs associated with being a public company and as we expand and grow our operations and business. As a percentage of total revenue, our general and administrative expense may vary as our revenue changes over time.

26-------------------------------------------------------------------------------- Table of Contents 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, 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 includes within cost of goods sold, while customer relationships and noncompete agreements are recorded within operating expenses.

Amortization of purchased intangible assets increased by $0.2 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011, representing a 209% increase. Amortization of purchased intangible assets increased by $0.3 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, representing a 49% increase. The increases were primarily due to amortization of purchased intangible related to our acquisition of Santur.

Adjustment to the fair value of contingent consideration In connection with our acquisition of Santur in October 2011, we may be required to pay the former stockholders of Santur up to an additional $7.5 million in cash, contingent upon Santur's gross profit performance during 2012. The fair value of the contingent consideration was measured at the date of acquisition and is remeasured each reporting period and any changes in the fair value of the contingent consideration are recognized as a gain or loss in the consolidated statements of operations. As of December 31, 2011, the fair value of the contingent consideration was $1.5 million. As of September 30, 2012, the fair value of the contingent consideration was $1.3 million and is included in other current liabilities on our consolidated balance sheet. During the three and nine months ended September 30, 2012, we recorded adjustments to the fair value of the consideration of $(0.9) million and $(0.2) million, respectively. We expect the amount of contingent consideration accrued to fluctuate throughout the remainder of the fiscal year as a result of changes and other economic conditions.

Interest and other income (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 short-term and long-term debt borrowings. Other income (expense), net primarily consists of gains from the sale of equity shares of an unconsolidated investee, government subsidies, and foreign currency transaction gains and losses. The functional currency of our subsidiaries in China is RMB and the foreign currency transaction gains and losses of our subsidiaries in China primarily result from their transactions in U.S. dollars.

Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2012 2011 2012 2011 Interest income $ 147 $ 76 $ 424 $ 155 Interest expense (135 ) (52 ) (434 ) (230 ) Other income (expense), net 154 191 (538 ) 14,299 Total $ 166 $ 215 $ (548 ) $ 14,224 Total interest and other income (expense), net decreased by $0.05 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011. Total interest and other income (expense), net decreased by $14.8 million in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011. The decrease for the nine months ended September 30, 2012 compared to same period in 2011 was primarily related to a gain of $13.8 million from the sale of an unconsolidated investee recorded in the second quarter of 2011.

We expect our interest income to remain relatively modest given the low yields available in the marketplace and lower investable balances.

27-------------------------------------------------------------------------------- Table of Contents Income taxes We conduct our business globally. Therefore, our operating income is subject to varying rates of tax in the U.S., China 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 and 2011, and we have been approved for the rate to remain at 15% for 2013 and 2014.

Three Months Ended Nine Months Ended September 30, September 30, (in thousands, except percentages) 2012 2011 2012 2011 Provision for income taxes $ (571 ) $ (258 ) $ (888 ) $ (1,177 ) Effective tax rate 44 % (7 )% (6 )% 14 % Our income tax expense for the three months ended September 30, 2012 is primarily related to income taxes of our non U.S. operations. We recorded an income tax provision of $0.6 million in the three months ended September 30, 2012, compared with an income tax provision of $0.3 million in the three months ended September 30, 2011. We had an effective tax rate of 44% and negative 6% in the three and nine months ended September 30, 2012, respectively, primarily due to the level of foreign withholding tax and income taxes paid based on earnings generated by our foreign subsidiaries, compared with an effective tax rate of negative 7% and 14% in the three and nine months ended September 30, 2011, primarily due to our operating profit realized in our non-U.S. operations, despite a consolidated loss before income taxes.

Liquidity and capital resources We have financed our operations through issuances of equity securities and cash generated from operations and from various lending arrangements. As of September 30, 2012, our cash and cash equivalents totaled $38.6 million, and our short-term investments totaled $67.3 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.

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 gross proceeds of approximately $39.6 million. 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. We intend to use a portion of the net proceeds from the sale of the shares of common stock for general corporate purposes and to establish a presence in the Russian Federation. In addition, we intend to establish a production facility in the Russian Federation, in accordance with the terms of a rights agreement entered into in connection with the private placement, for the benefit of the global organization. The expansion into the Russian Federation is targeted for completion by July 31, 2014. Of the common stock, $5.0 million is considered redeemable, as we may be required to pay this amount if we are unable to achieve our performance obligations by the date specified.

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 nine 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.

28-------------------------------------------------------------------------------- Table of Contents 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 nine 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 on our consolidated balance sheets. As of September 30, 2012, our restricted cash totaled $2.7 million.

We have lending arrangements with several financial institutions, including a loan and security agreement with Comerica Bank in the U.S. and several line of credit arrangements for our subsidiaries in China.

As of September 30, 2012, our loan and security agreement in the U.S. included the following: • An $8.0 million revolving line of credit available through September 2014 and bearing interest at a rate of LIBOR plus 2%. As of September 30, 2012, $8.0 million was outstanding under the revolving line of credit and $0.0 million was available for borrowing.

• A $20.0 million acquisition advance, expiring in September 2015 and bearing interest at a rate of LIBOR plus 2%. Proceeds of the acquisition advance may be used to make permitted business acquisitions. Advances may be drawn in two tranches and are due and payable in equal monthly installments of principal and interest such that all amounts will be repaid by the acquisition line maturity date. In October 2011, we drew down the full $20.0 million in connection with its acquisition of Santur.

As of September 30, 2012, $15.4 million was outstanding under the acquisition advance and the total available borrowing capacity under this facility was $4.6 million.

• A $7.0 million equipment line advance for capital expenditures in the U.S.

Advances may be drawn in four tranches and are due and payable in equal monthly installments of principal and interest such that all amounts will be repaid by September 2015. Borrowings under this facility bear interest at a rate of LIBOR plus 2%. As of September 30, 2012, no amount was outstanding under the acquisition advance and the total available borrowing capacity under this facility was $7.0 million.

Our U.S. loan and security agreement requires us to maintain specified financial covenants, including a liquidity ratio, and restricts our ability to incur additional debt or to engage in specified transactions and is secured by substantially all of our U.S. assets, other than intellectual property assets.

As of September 30, 2012, we were in compliance with all covenants contained in this agreement.

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, 2012. 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 and one such loan agreement is secured by our main manufacturing facility in China. As of September 30, 2012, we had no short-term loans outstanding.

The table below sets forth selected cash flow data for the periods presented: Nine Months Ended September 30, (in thousands) 2012 2011 Net cash used in operating activities $ (7,377 ) $ (9,910 ) Net cash used in investing activities (20,115 ) (59,479 ) Net cash provided by financing activities 33,590 75,192 Effect of exchange rates on cash and cash equivalents (4 ) 234 Net increase in cash and cash equivalents $ 6,094 $ 6,037 29 -------------------------------------------------------------------------------- Table of Contents Operating activities During the nine months ended September 30, 2012, net cash used in operating activities was $7.4 million. Cash used in operating activities was primarily related to cash payments to our employees and suppliers in excess of cash receipts from customers. During the nine months ended September 30, 2012, we recognized a net loss of $14.5 million. However, that net loss incorporated non-cash charges, including depreciation and amortization of $14.3 million, stock-based compensation expenses of $3.4 million, and non-cash increases to our asset reserve accounts of $3.6 million, partially offset by $0.8 million gain on sale of Shenzhen Photon Broadband Technology Co., Ltd. ("Broadband"), a China subsidiary. During the nine months ended September 30, 2012, there was an increase of $1.2 million in accounts payable, accrued and other liabilities.

These amounts were partially offset by an increase of $12.7 million in the purchase of inventory to replenish our inventories in preparation for expected higher potential customer demands in future periods.

During the nine months ended September 30, 2011, net cash used in operating activities was $9.9 million. Cash used in operating activities was primarily related to cash payments to our employees and suppliers in excess of cash receipts from customers. During the nine months ended September 30, 2011, we recognized net income of $7.6 million, which incorporated gain on sale of an unconsolidated investee, net of direct cost, of $13.9 million, and non-cash charges, including depreciation and amortization of $8.2 million and stock-based compensation expenses of $2.4 million. These amounts were partially offset by the purchase of inventory of $15.7 million to replenish our inventories in preparation for higher customer demands in future periods and extended payment terms with certain suppliers, as evidenced by the net increase in accounts payable and accrued liabilities of $0.7 million during the period.

Investing activities Our investing activities consisted primarily of purchases and sales of investments and capital expenditures and in the nine months ended September 30, 2011, and included purchases and sales of debt securities and the sale of equity shares of Ignis ASA ("Ignis").

During the nine months ended September 30, 2012, net cash used in investing activities was $20.1 million, mainly due to the purchase of available-for-sale securities of $151.9 million and the purchase of capital equipment of $9.0 million, partially offset by proceeds from the sale and maturity of equity securities of $138.4 million and proceeds from the sale of Broadband of $1.8 million.

During the nine months ended September 30, 2011, net cash used in investing activities was $59.5 million, mainly due to the purchase of available-for-sale securities of $148.9 million and the purchase of capital equipment of $8.6 million, partially offset by proceeds from sale and maturity of securities of $76.4 million and proceeds from the sale of our equity investment in Ignis of $21.4 million.

We expect our purchases of capital equipment to increase over the remainder of 2012 as we invest in manufacturing capacity to help meet anticipated demand for certain of our products.

Financing activities Our financing activities consisted primarily of proceeds from the issuance of stock and activity associated with our various lending arrangements.

During the nine months ended September 30, 2012, net cash provided by financing activities was $33.6 million. Our private placement transaction generated proceeds of $39.6 million, net of offering expenses, which was partially offset by $3.4 million for the repayment of notes payable, net of proceeds, and $3.8 million for the repayment of debt.

During the nine months ended September 30, 2011, net cash provided by financing activities was $75.2 million. Our initial public offering generated proceeds of $86.5 million, net of offering expenses paid during the nine months ended September 30, 2011, partially offset by $11.9 million of net payments on our outstanding bank loans.

30 -------------------------------------------------------------------------------- Table of Contents Contractual obligations and commitments The following summarizes our contractual obligations as of September 30, 2012:

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