SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003, or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from NA to NA. Commission File Number 0-16106 APA OPTICS, INC. (Exact name of Registrant as specified in its charter) MINNESOTA 41-1347235 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 2950 N.E. 84TH LANE, BLAINE, MINNESOTA 55449 (Address of principal executive offices and zip code) (763) 784-4995 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirement for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class: Outstanding at June 30, 2003 Common stock, par value $.01 11,872,331 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
APA OPTICS, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited) June 30, March 31, 2003 2003 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 18,309,434 $ 22,235,686 Accounts receivable, net of allowance of uncollectible accounts of $20,644 at June 30, 2003 and March 31, 2003 1,237,484 468,576 Inventories, net 2,062,061 1,398,203 Prepaid expenses 166,882 134,045 Bond reserve funds - 75,000 ------------- ------------- Total current assets 21,775,861 24,311,510 Property, plant and equipment, net 4,333,534 3,989,344 Bond reserve funds 342,557 340,629 Bond placement costs 13,771 20,013 Patents, net of accumulated amortization 92,737 85,362 Goodwill 2,778,296 2,500,296 Other 592,660 586,542 ------------- ------------- 3,820,021 3,532,842 ------------- ------------- Total assets $ 29,929,416 $ 31,833,696 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,714,305 $ 1,846,922 Accounts payable 317,132 454,804 Accrued expenses 377,769 286,267 ------------- ------------- Total current liabilities 2,409,206 2,587,993 Long-term debt 146,416 326,760 Shareholders' equity: Common stock 118,723 118,723 Additional paid-in capital 52,001,681 52,001,681 Accumulated deficit (24,746,610) (23,201,461) ------------- ------------- Total shareholders' equity 27,373,794 28,918,943 ------------- ------------- Total liabilities and shareholders' equity $ 29,929,416 $ 31,833,696 ============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 2
APA OPTICS, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended June 30, -------------------------- 2003 2002 ------------ ------------ Revenues $ 1,566,992 $ 72,451 Costs and expenses: Cost of sales 1,867,881 753,720 Research and development 144,189 355,712 Selling, general and administrative 1,070,952 321,579 ------------ ------------ 3,083,022 1,431,011 ------------ ------------ Loss from operations (1,516,030) (1,358,560) 25,451 Other income 133,092 Other expense (54,570) (27,276) ------------ ------------ (29,119) 105,816 ------------ ------------ Loss before income taxes (1,545,149) (1,252,744) Income taxes 250 250 ------------ ------------ Net loss $(1,545,399) $(1,252,994) ============ ============ Net loss per share: Basic and diluted ($0.13) ($0.11) ============ ============ Weighted average shares outstanding: Basic and diluted 11,872,331 11,875,840 ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 3
APA OPTICS, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended June 30, -------------------------- 2003 2002 ------------ ------------ OPERATING ACTIVITIES Net loss $(1,545,149) $(1,252,994) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 182,176 156,551 Deferred compensation expense 30,919 13,402 Changes in operating assets and liabilities: Accounts receivable (768,908) (27,707) Inventories (663,858) 25,143 Prepaid expenses (69,871) 38,321 Accounts payable and accrued expenses (46,170) (51,841) Other - 42,927 ------------ ------------ Net cash used in operating activities (2,880,864) (1,056,198) INVESTING ACTIVITIES Purchases of property and equipment (526,366) (56,360) Purchase price paid in excess of market value (278,000) - Investment in patents (7,375) - ------------ ------------ Net cash used in investing activities (811,741) (56,360) FINANCING ACTIVITIES Bond reserve funds 79,314 51,250 Repurchase of common stock - (1,287) Repayment of long-term debt (312,961) (422,651) ------------ ------------ Net cash provided by (used in) financing activities (233,647) (372,688) ------------ ------------ Increase (decrease) in cash and cash equivalents (3,926,252) (1,485,246) Cash and cash equivalents at beginning of period 22,235,686 31,606,403 ------------ ------------ Cash and cash equivalents at end of period $18,309,434 $30,121,157 ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 4 NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The accompanying condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended March 31, 2003. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications of previously reported amounts have been made to conform to the current period presentation. NOTE 2. NET LOSS PER SHARE Basic and diluted net loss per share has been computed by dividing the net loss by the weighted average number of shares outstanding during the period. Common stock options and warrants to purchase 991,197 and 775,872 shares of common stock with a weighted average exercise price of $9.91and $9.01 were outstanding at June 30, 2003 and 2002, respectively, but were excluded from calculating the three months diluted net loss per share because they were antidilutive. NOTE 3. LAND The Company acquired land in Aberdeen, SD as part of a financing package provided by the Aberdeen Development Corporation to locate a manufacturing facility in that city. Ownership of the land was contingent upon the Company remaining in the facility through June 23, 2002. After satisfying the contingent requirement, the Company added $67,760 (the assessed value of the land for tax purposes) to its balance sheet and increased additional-paid-in capital by a like amount. NOTE 4. STOCK OPTION GRANT On August 22, 2002 the Company granted 2,500 options to every current employee with the exception of Anil Jain, the Chief Executive Officer and Ken Olsen, Vice President and Secretary. A total of 122,500 options were granted at the fair market value of the stock on the day of grant. The options are 60% exercisable when the Company achieves certain financial objectives and 40% exercisable when the Company achieves certain operational objectives set forth in the Company's Short-Term Incentive Plan. Accordingly, these options are treated as variable awards, and changes in their value will be reflected in sales, general and administrative expense until the options are exercised or expire. NOTE 5. ACQUISITION The Company acquired the assets of Americable, Inc. on June 27, 2003. The purchase price and assets acquired are as follows: Accounts receivable $ 594,000 Inventory 638,000 Property, plant and equipment 450,000 -------------- Assets purchased 1,682,000 Goodwill 278,000 -------------- Purchase price $ 1,960,000 ============== 5 NOTE 6. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS In September 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement supercedes SFAS 121 and was effective April 1, 2002 for the Company. This statement did not have a material effect on the financial statements of the Company, but could have a future effect in the event that asset impairment occurs. In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The Company believes the adoption of SFAS No. 145 will not have a material effect on the Company's financial position or results of operations. In June 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires the recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred versus the date the Company commits to an exit plan. In addition, SFAS No. 146 states the liability should be initially measured at fair value. The requirements of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company believes the adoption of SFAS No. 146 will not have a material effect on the Company's financial position or results or operations. In December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This statement amends FASB Statement No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation. The transition provisions of this statement are effective for fiscal years ending after December 15, 2002 and the disclosure provisions are effective for annual financial statements for fiscal years ending after December 15, 2002 and the first interim period beginning after December 15, 2002. The Company believes the adoption of SFAS No. 148 will not have a material effect on the Company's financial position or results of operations. In November 2002, FASB issued Interpretation 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." This statement clarifies the initial accounting and disclosure requirements of SFAS 5 for certain guarantees. The initial recognition and measurement provisions are effective for guarantees issued or modified after December 31, 2002 and the disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company believes the adoption of FIN 45 will not have a material effect on the Company's financial position or results of operations. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements in this Report about future sales prospects and other matters to occur in the future are forward looking statements and are subject to uncertainties due to many factors, many of which are beyond our control. These factors include, but are not limited to, the continued development of our products, acceptance of those products by potential customers, our ability to sell such products at a profitable price, and our ability to fund our operations. For further discussion regarding these factors, see "Factors That Influence Future Results." 6 OVERVIEW We design, manufacture, source from third parties, and market a variety of fiber optic and copper components to the data communication and telecommunication industries. We are also active in the design, manufacture and marketing of ultraviolet (UV) detection and measurement devices, optical components and in research and development in the area of Gallium Nitride (GaN) based transistors. Our primary internally manufactured products include standard and custom fiber optic assemblies, copper cable assemblies, value added fiber optics frames, panels and modules. These products are manufactured by our wholly owned subsidiary APA Cables & Networks, Inc. (APACN) who acquired certain assets of Computer System Products, Inc. ("CSP") on March 14, 2003 and certain assets of Americable, Inc. ("Americable") on June 27, 2003. Several of the items discussed under "Results of Operations" show significant changes from the comparable period in the preceding fiscal year as a result of the acquisition of CSP. We expect to see similar changes in the second quarter of fiscal 2004 as a result of our acquisition of Americable. We outsource from third parties passive optical splitters, arrayed waveguides (AWGs) and wavelength division multiplexers (WDMs) based on Thin Film Filter (TFF) technology, which we combine with our internally manufactured products to create value added components for our customers. The majority of our outsourced product providers are located offshore. Most companies in the communications industry have been affected by the slowdown in telecommunications equipment spending. Decreased demand and competition have put downward pressure on margins. This downward pressure is likely to continue and we will need to reduce operating costs and improve efficiencies to remain competitive in the marketplace. We cannot predict whether we will be able to compete with our existing or new products or with current and future competitors. We believe that technological change, the convergence of Internet, data, video and voice on a single broadband network, the possibility of regulatory changes and industry consolidation or new entrants will continue to cause rapid evolution in the competitive environment. The full scope and nature of changes are difficult to predict at this time. Increased competition could lead to price cuts, reduced profit margins and loss of market share, which may seriously harm our business, operating results and financial condition. Our consumer GaN based product, the SunUVPersonal UV Monitor (SunWatch) is ready for production. As of June 30, 2003, and currently, we are working with our manufacturing facility in China to address yield and production capacity issues. Our goal is to increase production to meet demand for the 2003 holiday season. Our ability to meet this objective is dependent upon depends on our ability to solve production related issues. Our industrial GaN based product, the TrUVMetertm, required additional engineering to meet the accuracy and reliability specifications for key markets in sterilization, curing and scientific measurement. As of June 30, 2003 reliability tests were in progress and field-testing will follow this process prior to introduction. RESULTS OF OPERATIONS - ----------------------- REVENUES Revenues for the quarter ended June 30, 2003, were $1,566,992, reflecting over a twenty-fold increase from the comparable period in the preceding fiscal year. The increase is attributable to revenues generated by our wholly owned subsidiary APACN, which produced $1,512,368 in revenues for the quarter. There are no corresponding revenues from APACN in the comparable period in the preceding fiscal year. We expect revenues to increase again in the second quarter of fiscal 2004 when the results of operations reflect the acquisition of Americable. 7 COST OF SALES Cost of sales increased $1,114,161 to $1,867,881 for the quarter ended June 30, 2003, reflecting a 148% increase from the comparable period in the preceding fiscal year. The increase is due primarily to the volume increase attributable to APACN. Gross margins for APACN for the current quarter were $316,564 or 21%. Overall gross margins were negative in both periods. We expect cost of sales to increase again in the second quarter of fiscal 2004 when the results of operations reflect the acquisition of Americable, Inc. We expect gross margins for APACN to gradually improve over the balance of fiscal 2004 as we consolidate the operations of APACN and Americable, Inc. and eliminate duplicate expenses. We expect overall gross margins to improve as well, but to remain negative through the end of fiscal 2004. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses decreased by $211,523 to $144,189 for the quarter ended June 30, 2003 compared to the same period for the preceding fiscal year. This represents a decrease of 59%. The decrease is the result of decreased research activity related to our fiber optic products. The majority of the decrease is due to a reduction in salaries and other related expenses. We expect research and development expenses to remain stable for the balance of fiscal 2004. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased $699,411 for the quarter ended June 30, 2003, reflecting a 249% increase compared to the same period in the preceding fiscal year. The increase was primarily due to the acquired operations of APACN, which incurred expenses of $519,415 for the quarter. Nearly half the total is employee related. The majority of the increase of $229,958 is related to non-recurring uncapitalized transaction costs for the acquisitions of CSP and Americable. LOSS FROM OPERATIONS The loss from operations was $1,516,030, an increase of $157,470 or 12% for the quarter ended June 30, 2003 over the comparable period in fiscal 2003. The increased loss in the quarter was the result of operating losses at APACN, which totaled $202,851 for the period. We expect the losses to decrease over the balance of fiscal 2004 as we realize cost savings and efficiencies related to the consolidation of the operations of APACN and Americable. OTHER INCOME AND EXPENSE Other income decreased $107,641 or 81% for the quarter ended June 30, 2003, from the comparable period in fiscal 2003. The decrease was primarily due to a decrease in interest income due to a decline in interest rates earned on the investment of company funds. Other expenses increased $27,294 or 100% from the same period in the prior fiscal year. The decreases were due to the combination of a decline in the rate of interest earned on short-term investments and a lower average cash balance, as cash was consumed to fund operations, capital investment, debt service and acquisitions. Unless short-term interest rates increase, we anticipate continuing decreases in interest income as a result of the use of cash in operations, for capital expansion and for debt service. NET LOSS The net loss for the quarter ended June 30, 2003, was $1,545,399 (or $0.13 per basic and diluted share), an increase of $292,405 or 23% from the net loss reported for the same period in fiscal 2003. The increased net loss was primarily attributable to losses at APACN. LIQUIDITY AND CAPITAL RESOURCES - ---------------------------------- APA's cash and cash equivalents consist primarily of money market funds, U.S. Government instruments or other government instruments with original maturities of less than three months. The balance of cash and cash equivalents 8 at June 30, 2003 is $18,309,434 compared to $22,235,686 at March 31, 2003. The decrease in cash was primarily the result of the acquisition of the assets of Americable, Inc. and the use of cash to fund operations. We used net cash of $811,741 in investing activities in the quarter compared to $56,360 used in the same period of the preceding fiscal year. Of this amount, $456,357 was used to purchase assets and $278,000 was paid for goodwill in connection with our acquisition of Americable. We also invested $70,009 during the quarter for computer and production equipment. We anticipate a total of approximately $750,000 in capital expenditures in fiscal 2004, primarily for equipment. We expect to invest in equipment to support the HFET research and development activities over the next several quarters. Net cash used in financing activities in the quarter totaled $233,647. We used $312,961 for the scheduled reduction of debt and a reduction in bond reserve funds generated $79,314. During the same period in fiscal 2003 we used $372,688 in financing activities, of which $422,651 was used for the scheduled reduction of debt, $51,250 was generated from the reduction of bond reserve funds and $1,287 was used to repurchase common stock of the company. We believe we have sufficient funds for operations for at least the next twelve months. Our contractual obligations and commitments are summarized in the table below (in 000's):
Less than After Total 1 Year 1-3 years 4-5 years 5 years ---------------------------------------------------- Long-term debt $1,861 $ 1,615 $ 70 $ 36 $ 140 Operating leases 908 337 571 - - ---------------------------------------------------- Total Contractual Cash Obligations $2,769 $ 1,952 $ 641 $ 36 $ 140 ====================================================
Application of Critical Accounting Policies We have reviewed our use of estimates in applying our accounting policies and determined that significant changes in our various estimates would not have a material impact on the presentation of our financial condition, changes in financial condition or results of operations. Accordingly, we do not consider any of our estimates to be "critical estimates" as defined in the rules of the Securities and Exchange Commission. See Note A of Notes to Financial Statements under Item 8 of our Report on Form 10-K for our fiscal year ended March 31, 2003 for descriptions of the use of estimates in our accounting policies. Our management and the audit committee of our board of directors have discussed our use of estimates and have approved our disclosure relating to it in this report. In Note 7 of this report, the effect of recent promulgations of the Financial Accounting Standards Board (FASB) on the Company is described. We believe the adoption of Statements of Financial Accounting Standards (SFAS) Nos. 144, 145, 146 and 148, and Interpretation 45 (FIN 45) will not have a material effect on the Company's financial position or results of operations. FACTORS THAT MAY INFLUENCE FUTURE RESULTS The statements contained in this report on Form 10-Q that are not purely historical are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitations, statements regarding the Company's expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. 9 Forward-looking statements include, but are not limited to, statements contained in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations." Actual results could differ from those projected in any forward-looking statements for the reasons, among others, detailed below. We believe that many of the risks detailed here are part of doing business in the industry in which we compete and will likely be present in all periods reported. The fact that certain risks are characteristic to the industry does not lessen the significance of the risk. The forward-looking statements are made as of the date of this Form 10-Q and we assume no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. Unless we generate significant revenue growth, our expenses and negative cash flow will significantly harm our financial position. We have not been profitable since fiscal 1990. As of June 30, 2003, we had an accumulated deficit of $24.7 million. We may incur operating losses for the foreseeable future, and these losses may be substantial. Further, we may continue to incur negative operating cash flow in the future. We have funded our operations primarily through the sale of equity securities and borrowings. We have significant fixed expenses and we expect to continue to incur significant and increasing manufacturing, sales and marketing, product development and administrative expenses. As a result, we will need to generate significantly higher revenues while containing costs and operating expenses if we are to achieve profitability. Declining average selling prices for our fiber optic products will require us to reduce production costs to effectively compete and market these products Since the time we first introduced our fiber optic components to the marketplace we have seen the average selling price of fiber optic components decline. We expect this trend to continue. To achieve profitability in this environment we must continually decrease our costs of production. In order to reduce our production costs, we will continue to pursue one or more of the following: - Seek lower cost suppliers of raw materials or components. - Work to further automate our assembly process. - Develop value-added components based on integrated optics. - Seek offshore sources for assembly services. We will also seek to form strategic alliances with companies that can supply these services. Decreases in average selling prices also require that we increase unit sales to maintain or increase our revenue. There can be no guarantee that we will achieve these objectives. Our inability to decrease production costs or increase our unit sales could seriously harm our business, financial condition and results of operations. We believe our success in competing with other manufacturers of fiber optic and copper components and assemblies will depend primarily on our manufacturing and marketing skills, the price, quality and reliability of our products, our delivery capabilities and our control of operating expenses. We have experienced and anticipate experiencing increasing pricing pressures from our current and future competitors as well as general pricing pressure from our customers as part of their cost reduction efforts. Competition may also be affected by consolidation among suppliers in this industry which may increase their resources. As a result, other competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements. We cannot predict whether we will be able to compete with our existing or new products or with current and future competitors. We believe that technological change, the convergence of Internet, data, video and voice on a single broadband network, the possibility of regulatory changes and industry consolidation or new entrants will continue to cause rapid evolution in the competitive environment. The full scope and nature of changes are difficult to predict at this time. Increased competition could lead to price cuts, reduced profit margins and loss of market share, which may seriously harm our business, operating results and financial condition. Demand for our products is subject to significant fluctuation. Market conditions in the telecommunications market in particular may harm our financial condition. 10 Demand for our products is dependent on several factors, including capital expenditures in the communications industry. Capital expenditures can be cyclical in nature and result in protracted periods of reduced demand for component parts. Similarly, periods of slow economic expansion or recession can result in periods of reduced demand for our products. The current economic slowdown has been more profound in the telecommunications market resulting in a significant reduction in capital expenditures for products such as our DWDMs and our fiber optic components. It is impossible to predict how long the slowdown will last. Such periods of reduced demand will harm our business, financial condition and results of operations. Changes to the regulatory requirements of the telecommunications industry could also affect market conditions, which could also reduce demand for our fiber optic components. We may be required to rapidly increase our manufacturing capacity to deliver our products to our customers in a timely manner. Manufacturing of our products is a complex and precision process. We have limited experience in rapidly increasing our manufacturing capacity or in manufacturing products at high volumes. If demand for our products increases, we will be required to hire, train and manage additional manufacturing personnel and improve our production processes in order to increase our production capacity. There are numerous risks associated with rapidly increasing capacity, including: - Difficulties in achieving adequate yields from new manufacturing lines, - Difficulty maintaining the precision manufacturing processes required by our products while increasing capacity, - The inability to timely procure and install the necessary equipment, and - Lack of availability of qualified manufacturing personnel. If we apply our capital resources to expanding our manufacturing capacity in anticipation of increased customer orders, we run the risk that the projected increase in orders will not be realized. If anticipated levels of customer orders are not received, we will not be able to generate positive gross margins and profitability. Our dependence on outside manufacturers may result in product delivery delays. We purchase components that are incorporated into our products from outside vendors. If these vendors fail to supply us with components or completed assemblies on a timely basis, or if the quality of the supplied components or completed assemblies is not acceptable, we could experience significant delays in shipping our products. Any significant interruption in the supply or support of any components or completed assemblies could seriously harm our sales and our relationships with our customers. Our products may have defects that are not detected before delivery to our customers. Some of our products are designed to be deployed in large and complex optical networks and must be compatible with other components of the system, both current and future. In addition, our products may not operate as expected over long periods of time. Our customers may discover errors or defects in our products only after they have been fully deployed. If we are unable to fix errors or other problems, we could lose customers, lose revenues, suffer damage to our brand and reputation, and lose our ability to attract new customers or achieve market acceptance. Each of these factors would negatively impact cash flow and would seriously harm our business, financial condition and results of operations. We must introduce new products and product enhancements to increase revenue. The successful operation of our business depends on our ability to anticipate market needs and develop and introduce new products and product enhancements that respond to technological changes or evolving industry standards on a timely and cost-effective basis. Our products are complex, and new products may take longer to develop than originally anticipated. These products may contain defects or have unacceptable manufacturing yields when 11 first introduced or as new versions are released. Our products could quickly become obsolete as new technologies are introduced or as other firms introduce lower cost alternatives. We must continue to develop leading-edge products and introduce them to the commercial market quickly in order to be successful. Our failure to produce technologically competitive products in a cost-effective manner and on a timely basis will seriously harm our business, financial condition and results of operations. Our markets are characterized by rapid technological changes and evolving standards. The markets we serve are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. In developing our products, we have made, and will continue to make, assumptions with respect to which standards will be adopted within our industry. If the standards that are actually adopted are different from those that we have chosen to support, our products may not achieve significant market acceptance. Our products may infringe on the intellectual property rights of others Our products are sophisticated and rely on complicated manufacturing processes. We have received multiple patents on aspects of our design and manufacturing processes and we have applied for several more. Third parties may still assert claims that our products or processes infringe upon their intellectual property. Defending our interests against these claims, even if they lack merit, may be time consuming, result in expensive litigation and divert management attention from operational matters. If such a claim were successful, we could be prevented from manufacturing or selling our current products, be forced to redesign our products, or be forced to license the relevant intellectual property at a significant cost. Any of these actions could harm our business, financial condition or results of operations. Acquisitions or investments could have an adverse affect on our business We completed acquisitions of the assets of Computer System Products, Inc. and Americable, Inc. in March 2003 and June 2003 respectively, as part of our strategy to expand our product offerings, develop internal sources of components and materials, and acquire new technologies. We intend to continue reviewing acquisition and investment prospects. There are inherent risks associated with making acquisitions and investments including but not limited to: - Challenges associated with integrating the operations, personnel, etc., of an acquired company; - Potentially dilutive issuances of equity securities; - Reduced cash balances and or increased debt and debt service costs; - Large one-time write-offs of intangible assets; - Risks associated with geographic or business markets different than those we are familiar with; and - Diversion of management attention from current responsibilities. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We invest in short-term securities of high credit issuers with maturities ranging from overnight up to 24 months. The average maturity of the portfolio does not exceed 12 months. The portfolio includes only marketable securities with active secondary or resale markets to ensure liquidity. We have no investments denominated in foreign country currencies and, therefore, our investments are not subject to foreign exchange risk. ITEM 4. CONTROLS AND PROCEDURES. a. Evaluation of disclosure controls and procedures. The Company's chief executive officer and chief financial officer have concluded that the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)) are sufficiently effective to ensure that the information required to be disclosed by the Company in the reports it files under the Exchange Act is gathered, analyzed and disclosed with 12 adequate timeliness, accuracy and completeness, based on an evaluation of such controls and procedures conducted within 90 days prior to the date hereof. b. Changes in internal controls. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above. PART II ITEMS 1 THROUGH 5. NOT APPLICABLE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. Exhibit 10.8 - Sublease with Newport Corporation Exhibit 31.1 - Chief Executive Officer's Certification Exhibit 32.2 - Chief Financial Officer's Certification Exhibit 32.1 - Chief Executive Officer's certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 - Chief Financial Officer's certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K. A report on Form 8-K dated May 23, 2003, reported the acquisition of the assets of Computer System Products, Inc. A report on Form 8-K dated June 30, 2003, reported the acquisition of the assets of Americable, Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. APA OPTICS, INC. 8/8/03 /s/ Anil K. Jain - ---------- ------------------- Date Anil K. Jain President and Chief Executive Officer (Principal executive officer) 13 8/8/03 /s/ David R. Peters - ---------- ---------------------- Date David R. Peters Chief Financial Officer (Principal financial and accounting officer) 14