Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 30, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 000-30684
 
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12035102&doc=12 
OCLARO, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
20-1303994
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
225 Charcot Avenue, San Jose, California 95131
(Address of principal executive offices, zip code)
(408) 383-1400
(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 such filing requirements for the past 90 days:    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer
 
x

Accelerated filer
¨

Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
Emerging growth company
¨



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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

169,432,841 shares of common stock outstanding as of February 5, 2018
 


Table of Contents


OCLARO, INC.
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 


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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

OCLARO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
December 30, 2017
 
July 1, 2017
 
(Thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
157,153

 
$
219,270

Restricted cash

 
716

Short-term investments
132,955

 
37,559

Accounts receivable, net of allowances for doubtful accounts of $1,318 and $1,533 as of December 30, 2017 and July 1, 2017, respectively
122,880

 
122,287

Inventories
103,549

 
101,068

Prepaid expenses and other current assets
34,669

 
40,870

Total current assets
551,206

 
521,770

Property and equipment, net
135,746

 
114,333

Other intangible assets, net
393

 
699

Deferred tax assets, non-current
19,158

 
25,774

Other non-current assets
1,168

 
2,573

Total assets
$
707,671

 
$
665,149

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
78,363

 
$
88,316

Accrued expenses and other liabilities
42,561

 
42,499

Capital lease obligations, current
2,166

 
2,368

Total current liabilities
123,090

 
133,183

Deferred gain on sale-leaseback
5,722

 
5,895

Capital lease obligations, non-current
1,234

 
1,379

Other non-current liabilities
11,474

 
11,019

Total liabilities
141,520

 
151,476

Commitments and contingencies (Note 7)

 

Stockholders’ equity:
 
 
 
Preferred stock: 1,000 shares authorized; none issued and outstanding

 

Common stock: $0.01 par value per share; 275,000 shares authorized; 169,431 shares issued and outstanding at December 30, 2017 and 167,639 shares issued and outstanding at July 1, 2017
1,694

 
1,676

Additional paid-in capital
1,694,824

 
1,688,777

Accumulated other comprehensive income
42,428

 
40,973

Accumulated deficit
(1,172,795
)
 
(1,217,753
)
Total stockholders’ equity
566,151

 
513,673

Total liabilities and stockholders’ equity
$
707,671

 
$
665,149


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

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OCLARO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands, except per share amounts)
Revenues
$
139,335

 
$
153,914

 
$
294,933

 
$
289,406

Cost of revenues
87,507

 
93,150

 
180,401

 
182,286

Gross profit
51,828

 
60,764

 
114,532

 
107,120

Operating expenses:
 
 
 
 
 
 
 
     Research and development
15,358

 
13,758

 
31,793

 
26,865

     Selling, general and administrative
16,892

 
13,355

 
31,758

 
28,147

     Amortization of other intangible assets
154

 
241

 
306

 
485

     Restructuring, acquisition and related (income) expense, net

 
82

 

 
393

     (Gain) loss on sale of property and equipment
169

 
(74
)
 
191

 
(111
)
Total operating expenses
32,573

 
27,362

 
64,048

 
55,779

Operating income
19,255

 
33,402

 
50,484

 
51,341

Other income (expense):
 
 
 
 
 
 
 
     Interest income (expense), net
123

 
70

 
557

 
(13,788
)
     Gain (loss) on foreign currency transactions, net
1,599

 
(3,324
)
 
2,088

 
(3,842
)
     Other income (expense), net
936

 
156

 
1,510

 
350

Total other income (expense)
2,658

 
(3,098
)
 
4,155

 
(17,280
)
Income before income taxes
21,913

 
30,304

 
54,639

 
34,061

Income tax provision
3,176

 
37

 
9,413

 
443

Net income
$
18,737

 
$
30,267

 
$
45,226

 
$
33,618

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.11

 
$
0.18

 
$
0.27

 
$
0.23

Diluted
$
0.11

 
$
0.18

 
$
0.26

 
$
0.21

Shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
168,990

 
165,822

 
168,564

 
149,151

Diluted
170,692

 
168,856

 
171,079

 
159,801

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


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OCLARO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Net income
$
18,737

 
$
30,267

 
$
45,226

 
$
33,618

Other comprehensive income:
 
 
 
 
 
 
 
Unrealized gain (loss) on marketable securities
(47
)
 
5

 
(40
)
 
5

Currency translation adjustments

 
(3,799
)
 
1,495

 
(3,245
)
Total comprehensive income
$
18,690

 
$
26,473

 
$
46,681

 
$
30,378

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


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OCLARO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Cash flows from operating activities:
 
 
 
Net income
$
45,226

 
$
33,618

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of deferred gain on sale-leaseback
(391
)
 
(370
)
Amortization (accretion) of premiums and discounts on short-term investments
(403
)
 

Amortization of debt discount and issuance costs in connection with convertible notes payable

 
102

Depreciation and amortization
13,845

 
10,168

Adjustment in deferred tax assets
6,712

 

Interest make-whole charge and induced conversion expense related to convertible notes

 
8,463

Stock-based compensation expense
7,138

 
5,032

Other non-cash adjustments
191

 
(112
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
1,548

 
(17,067
)
Inventories
(813
)
 
(11,517
)
Prepaid expenses and other current assets
7,072

 
(12,042
)
Other non-current assets
646

 
(207
)
Accounts payable
(9,450
)
 
16,665

Accrued expenses and other liabilities
124

 
8,585

Net cash provided by operating activities
71,445

 
41,318

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(36,240
)
 
(31,206
)
Purchases of short-term investments
(140,493
)
 
(19,953
)
Maturities of short-term investments
45,500

 

Transfer from restricted cash
716

 

Net cash used in investing activities
(130,517
)
 
(51,159
)
Cash flows from financing activities:
 
 
 
Proceeds from the exercise of stock options
632

 
2,587

Shares repurchased for tax withholdings on vesting of restricted stock units
(2,427
)
 
(2,518
)
Proceeds from the sale of common stock in connection with the public offering, net of expenses

 
135,153

Payments on capital lease obligations
(590
)
 
(1,493
)
Net cash provided by (used in) financing activities
(2,385
)
 
133,729

Effect of exchange rate on cash and cash equivalents
(660
)
 
2,979

Net increase (decrease) in cash and cash equivalents
(62,117
)
 
126,867

Cash and cash equivalents at beginning of period
219,270

 
95,929

Cash and cash equivalents at end of period
$
157,153

 
$
222,796

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest make-whole and induced conversion charges related to the exercise of convertible notes
$

 
$
4,700

 
 
 
 
Supplemental disclosures of non-cash transactions:
 
 
 
Issuance of common stock in exchange for the net carrying value of the liability component of the convertible notes
$

 
$
62,125

Purchases of property and equipment funded by accounts payable
8,713

 
9,359

Capital lease obligations incurred for purchases of property and equipment
77

 

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

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OCLARO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PREPARATION
Basis of Presentation
Oclaro, Inc., a Delaware corporation, is sometimes referred to in this Quarterly Report on Form 10-Q as “Oclaro,” “we,” “us” or “our.”
The accompanying unaudited condensed consolidated financial statements of Oclaro as of December 30, 2017 and for the three and six months ended December 30, 2017 and December 31, 2016 have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Article 10 of Securities and Exchange Commission ("SEC") Regulation S-X, and include the accounts of Oclaro and all of our subsidiaries. Accordingly, they do not include all of the information and footnotes required by such accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of our consolidated financial position and results of operations have been included. The condensed consolidated results of operations for the three and six months ended December 30, 2017 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2018.
The condensed consolidated balance sheet as of July 1, 2017 has been derived from our audited financial statements as of such date, but does not include all disclosures required by U.S. GAAP. These unaudited condensed consolidated financial statements should be read in conjunction with our audited financial statements included in our Annual Report on Form 10-K for the year ended July 1, 2017 ("2017 Form 10-K").
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reported periods. Examples of significant estimates and assumptions made by management involve the fair value of other intangible assets and long-lived assets, valuation allowances for deferred tax assets, the fair value of stock-based compensation, the fair value of pension liabilities, estimates for allowances for doubtful accounts and valuation of excess and obsolete inventories. These judgments can be subjective and complex and consequently actual results could differ materially from those estimates and assumptions. Descriptions of the key estimates and assumptions are included in our 2017 Form 10-K.
Fiscal Years
We operate on a 52/53 week year ending on the Saturday closest to June 30. Our fiscal year ending June 30, 2018 will be a 52 week year, with the quarter ended December 30, 2017 being a 13 week quarterly period. Our fiscal year ended July 1, 2017 was a 52 week year, with the quarter ended December 31, 2016 being a 13 week quarterly period.
Reclassifications
For presentation purposes, we have reclassified certain prior period amounts to conform to the current period financial statement presentation, including an adjustment relating to an immaterial error of approximately $8.2 million, increasing cash flows from operations associated with changes in accounts payable and increasing cash flows used in investing activities associated with purchases of property and equipment, in our condensed consolidated statement of cash flows for the six months ended December 31, 2016. We determined that the adjustments did not have a material impact to our prior period consolidated financial statements.
Functional Currency
Effective October 1, 2017, the functional currency for our worldwide operations is the U.S. dollar. Prior to October 1, 2017, the functional currency for each of our foreign subsidiaries was the respective local currency for that subsidiary. The change in our functional currency is a result of significant changes in economic facts and circumstances, including (i) a re-organization of our operating environment, which includes consolidating and integrating our sales, supply chain and manufacturing organizations; (ii) a transition to centrally negotiating worldwide supplier contracts and capital expenditures in U.S. dollars; and (iii) a shift to recording all intercompany transactions in U.S. dollars.
Translation adjustments reported prior to October 1, 2017, will remain as a component of accumulated other comprehensive income in our condensed consolidated balance sheet. The translated values for any non-monetary assets and liabilities as of October 1, 2017 become the new accounting basis for those assets.

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Effective October 1, 2017, monetary assets and liabilities denominated in currencies other than the U.S. dollar functional currency are re-measured each reporting period into U.S. dollars, with the resulting exchange gains and losses reported in gain (loss) on foreign currency transactions, net within the condensed consolidated statement of operations.
U.S. Tax Reform
On December 22, 2017, H.R.1, commonly referred to as the Tax Cuts and Jobs Act ("TCJA"), was signed into law. Among other things, the TCJA permanently lowers the corporate federal income tax rate to 21 percent from the existing maximum rate of 35 percent, effective for tax years including or commencing January 1, 2018. Since we operate on a 52/53 week year ending on the Saturday closest to June 30, the lower corporate income tax rate will be phased in, resulting in a U.S. statutory federal rate of approximately 28 percent for our fiscal year ending June 30, 2018, and 21 percent for subsequent fiscal years. As a result of the reduction of the corporate federal income tax rate to 21 percent, U.S. GAAP requires companies to re-value their deferred tax assets and deferred tax liabilities as of the date of enactment, with the resulting tax effects accounted for in the reporting period of enactment. As a result, we have concluded this will cause our net deferred taxes to be re-measured at the new lower tax rate. The estimated rate change impact to our net deferred tax assets is a reduction of $32.4 million. We maintain a full valuation allowance on our U.S. net deferred tax assets. Deferred tax asset re-measurement (tax expense) will be offset by a net decrease in valuation allowance, resulting in no impact on our income tax for the period ending December 30, 2017. We have not completed the revaluation calculation and will disclose any adjustments in our fiscal year end financial statements.
Additionally, TCJA introduces new international tax provisions that will be effective for our fiscal year 2019, including (i) a new provision designed to currently tax the global low-taxed income of our foreign subsidiaries, together with a deduction of up to 50 percent and a partial credit for foreign taxes incurred by the foreign subsidiaries; (ii) limitations on the deductibility of certain base eroding payments to foreign entities; and (iii) limitations on the use of foreign tax credits to reduce U.S. income tax liability. While each of these provisions may have an impact on our tax expense for fiscal year 2019 and future periods, we expect the tax on low-taxed income of foreign subsidiaries to have the most significant impact.
Because of the complexity of the new tax on low-taxed income of foreign subsidiaries and uncertainties regarding its application in certain circumstances, we are continuing to evaluate this provision of the TCJA and its impact on our determination of the realizability of our deferred tax assets. We elected to utilize the reporting provisions of the SEC's Staff Accounting Bulletin 118 ("SAB 118"), as we did not have the necessary information available, prepared or analyzed for certain future taxable income tax effects of the TCJA in order to determine a reasonable estimate to be included as provisional amounts. We will not adjust our current or deferred taxes for those tax effects of the TCJA, for which we are unable to reasonably estimate, until a reasonable estimate can be determined.

NOTE 2. RECENT ACCOUNTING STANDARDS
In May 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2017-09, Compensation - Stock Compensation, to provide clarity and reduce both (i) diversity in practice and (ii) cost and complexity associated with changes to the terms or conditions of a share-based payment award. The guidance will be effective for us in the first quarter of fiscal 2019, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, changing the presentation of net periodic benefit cost in the income statement. The guidance will be effective for us in the first quarter of fiscal 2019, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations: Clarifying the Definition of a Business, providing guidance for evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. The guidance will be effective for us in the first quarter of fiscal 2019. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows: Restricted Cash to standardize the presentation of transfers between cash and restricted cash in the cash flow statement. Amounts described as restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The guidance will be effective for us in the first quarter of fiscal 2019, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory, to reduce the complexity related to the accounting for the income tax consequences of intra-entity transfers of assets other than

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inventory. This guidance will be effective for us in the first quarter of fiscal 2019, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments to reduce the diversity in practice related to the presentation and classification of various cash flow scenarios. This guidance will be effective for us in the first quarter of fiscal 2019, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In May 2014 and May 2016, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients, respectively. These updates clarify the principles for recognizing revenue and develop a common revenue standard for GAAP and International Financial Reporting Standards. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. The guidance permits two methods of adoption, the full retrospective method applying the standard to each prior reporting period presented, or the modified retrospective method with a cumulative effect of initially applying the guidance recognized at the date of initial application. We currently plan on adopting this guidance on July 1, 2018, the start to our first quarter of fiscal 2019, using the modified retrospective method with a cumulative catch up adjustment and providing additional disclosures comparing results to previous rules. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This guidance will be effective for us in the first quarter of fiscal 2020, with early adoption permitted. We are currently evaluating the likely impact the implementation of this standard will have on our financial statements and footnote disclosures.

NOTE 3. BALANCE SHEET DETAILS
Cash and Cash Equivalents
The following table provides details regarding our cash and cash equivalents at the dates indicated:
 
December 30, 2017
 
July 1, 2017
 
(Thousands)
Cash and cash equivalents:
 
     Cash-in-bank
$
85,938

 
$
79,259

     Money market funds
63,202

 
99,037

     Corporate bonds
4,017

 
2,012

     Commercial paper
3,996

 
22,981

     U.S. agency securities

 
15,981

 
$
157,153

 
$
219,270


Short-Term Investments
The following table provides details regarding our short-term investments at the dates indicated:
 
December 30, 2017
 
July 1, 2017
Short-term investments
(Thousands)
     Commercial paper
$
66,582

 
$
23,459

     U.S. Treasury securities
47,831

 
4,006

     Corporate bonds
18,542

 
10,094

 
$
132,955

 
$
37,559


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Inventories
The following table provides details regarding our inventories at the dates indicated:
 
December 30, 2017
 
July 1, 2017
 
(Thousands)
Inventories:
 
Raw materials
$
20,642

 
$
32,421

Work-in-process
60,981

 
40,171

Finished goods
21,926

 
28,476

 
$
103,549

 
$
101,068

Property and Equipment, Net
The following table provides details regarding our property and equipment, net at the dates indicated:
 
December 30, 2017
 
July 1, 2017
 
(Thousands)
Property and equipment, net:
 
Buildings and improvements
$
10,777

 
$
10,222

Plant and machinery
129,047

 
99,779

Fixtures, fittings and equipment
3,178

 
3,225

Computer equipment
23,477

 
15,901

 
166,479

 
129,127

Less: Accumulated depreciation
(30,733
)
 
(14,794
)
 
$
135,746

 
$
114,333

Property and equipment includes assets under capital leases of $3.4 million and $3.7 million at December 30, 2017 and July 1, 2017, respectively. Amortization associated with assets under capital leases is recorded in depreciation expense.
During fiscal 2017, we began the implementation of a new ERP system. We capitalized certain costs incurred in connection with the development of this internal use software, totaling $14.3 million. During the second quarter of fiscal 2018, we began using the ERP software for its intended use, and began recording depreciation expense.  
Other Intangible Assets, Net
The following table summarizes the activity related to our other intangible assets for the six months ended December 30, 2017:
 
Core and
Current
Technology
 
Development
and Supply
Agreements
 
Customer
Relationships
 
Patent
Portfolio
 
Other
Intangibles
 
Accumulated Amortization
 
Total
 
(Thousands)
Balance at July 1, 2017
$
6,249

 
$
4,496

 
$
2,402

 
$
915

 
$
3,338

 
$
(16,701
)
 
$
699

Amortization

 

 

 

 

 
(306
)
 
(306
)
Balance at December 30, 2017
$
6,249

 
$
4,496

 
$
2,402

 
$
915

 
$
3,338

 
$
(17,007
)
 
$
393

We expect the amortization of intangible assets to be $0.3 million for the remainder of fiscal 2018 and $0.1 million for fiscal 2019, based on the current level of our other intangible assets as of December 30, 2017.

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Accrued Expenses and Other Liabilities
The following table presents details regarding our accrued expenses and other liabilities at the dates indicated:
 
December 30, 2017
 
July 1, 2017
 
(Thousands)
Accrued expenses and other liabilities:
 
Trade payables
$
2,247

 
$
7,805

Compensation and benefits related accruals
13,174

 
13,837

Warranty accrual
4,206

 
4,124

Purchase commitments in excess of future demand, current
6,793

 
4,009

Other accruals
16,141

 
12,724

 
$
42,561

 
$
42,499

Accumulated Other Comprehensive Income
The following table presents the components of accumulated other comprehensive income at the dates indicated:
 
December 30, 2017
 
July 1, 2017
 
(Thousands)
Accumulated other comprehensive income:
 
Currency translation adjustments
$
42,626

 
$
41,131

Unrealized loss on marketable securities
(48
)
 
(8
)
Japan defined benefit plan
(150
)
 
(150
)
 
$
42,428

 
$
40,973


NOTE 4. FAIR VALUE
We define fair value as the estimated price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. We apply the following fair value hierarchy, which ranks the quality and reliability of the information used to determine fair values:
Level 1-
Quoted prices in active markets for identical assets or liabilities.
Level 2-
Inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices of identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets), or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3-
Unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.
Our cash equivalents and short-term investment instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include most money market funds, which are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs include investment-grade corporate bonds, commercial paper, U.S. Treasury and agency securities, which are generally classified within Level 2 of the fair value hierarchy.

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Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are shown in the table below by their corresponding balance sheet caption and consisted of the following types of instruments at December 30, 2017 and July 1, 2017:
 
 
Fair Value Measurement at December 30, 2017 Using
 
 
Quoted Prices
 
Significant
 
 
 
 
 
 
in Active
 
Other
 
Significant
 
 
 
 
Markets for
 
Observable
 
Unobservable
 
 
 
 
Identical Assets
 
Inputs
 
Inputs
 
 
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
 
(Thousands)
Assets:
 
Cash and cash equivalents: (1)
 
 
 
 
 
 
 
Money market funds
$
63,202

 
$

 
$

 
$
63,202

Commercial paper

 
3,996

 

 
3,996

Corporate bonds

 
4,017

 

 
4,017

Short-term investments:
 
 
 
 
 
 
 
Commercial paper

 
66,582

 

 
66,582

U.S. Treasury securities

 
47,831

 

 
47,831

Corporate bonds

 
18,542

 

 
18,542

Total assets measured at fair value
$
63,202

 
$
140,968

 
$

 
$
204,170

(1) 
Excludes $85.9 million in cash held in our bank accounts at December 30, 2017.

 
 
Fair Value Measurement at July 1, 2017 Using
 
 
Quoted Prices
 
Significant
 
 
 
 
 
 
in Active
 
Other
 
Significant
 
 
 
 
Markets for
 
Observable
 
Unobservable
 
 
 
 
Identical Assets
 
Inputs
 
Inputs
 
 
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
 
(Thousands)
Assets:
 
Cash and cash equivalents: (1)
 
 
 
 
 
 
 
Money market funds
$
99,037

 
$

 
$

 
$
99,037

Commercial paper

 
22,981

 

 
22,981

U.S. agency securities

 
15,981

 

 
15,981

Corporate bonds

 
2,012

 

 
2,012

Restricted cash:
 
 
 
 
 
 
 
Money market funds
712

 

 

 
712

Short-term investments:
 
 
 
 
 
 
 
Commercial paper

 
23,459

 

 
23,459

Corporate bonds

 
10,094

 

 
10,094

U.S. Treasury securities

 
4,006

 

 
4,006

Total assets measured at fair value
$
99,749

 
$
78,533

 
$

 
$
178,282

(1) 
Excludes $79.3 million in cash held in our bank accounts at July 1, 2017.


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NOTE 5. CONVERTIBLE NOTES
6.00% Convertible Senior Notes due 2020 ("6.00% Notes")
On February 12, 2015, we entered into a Purchase Agreement (the “Purchase Agreement”), with Jefferies LLC (the “Initial Purchaser”), pursuant to which we agreed to issue and sell to the Initial Purchaser up to $65.0 million in aggregate principal Convertible Senior Notes due 2020 (the “6.00% Notes”). On February 19, 2015, we closed the private placement of $65.0 million aggregate principal amount of the 6.00% Notes. The 6.00% Notes were sold at 100 percent of par, resulting in net proceeds of approximately $61.6 million, after deducting the Initial Purchaser’s discounts of $3.4 million. We also incurred offering expenses of $0.6 million.
The 6.00% Notes were scheduled to mature on February 15, 2020 and bore interest at a fixed rate of 6.00 percent per year, payable semi-annually in arrears on February 15 and August 15 of each year, beginning on August 15, 2015. In August 2016, we entered into multiple privately negotiated agreements, pursuant to which all of our 6.00% Notes were canceled, and the indenture, by and between us and U.S. Bank National Association, pursuant to which the 6.00% Notes were issued, was satisfied and discharged. In connection with these privately negotiated agreements, we issued a total of 34,659,972 shares of our common stock and made total cash payments of $4.7 million.
Pursuant to the terms of the indenture governing the 6.00% Notes, we recorded an interest make-whole charge of $5.9 million in interest (income) expense, net, in the condensed consolidated statements of operations for the six months ended December 31, 2016, which was settled with a combination of common stock issuances and cash payments. We also recorded an induced conversion expense of $7.4 million, which we recorded in interest (income) expense, net, in the condensed consolidated statements of operations for the six months ended December 31, 2016. See Note 6. Credit Line and Notes in our 2017 Form 10-K for further details regarding the 6.00% Notes.

NOTE 6. POST-RETIREMENT BENEFITS
We maintain a defined contribution plan and a defined benefit plan that provides retirement benefits to our employees in Japan. We also contribute to a U.K. based defined contribution pension scheme for employees.
Japan Defined Contribution Plan
Under the defined contribution plan in Japan, contributions are provided based on grade level and totaled $0.1 million and $0.3 million for the three and six months ended December 30, 2017, respectively and $0.1 million and $0.3 million for the three and six months ended December 31, 2016, respectively. Employees can elect to receive the benefit as additional salary or contribute the benefit to the plan on a tax-deferred basis.
Japan Defined Benefit Plan
Under the defined benefit plan in Japan (the “Japan Plan”), we calculate benefits based on an employee’s individual grade level and years of service. Employees are entitled to a lump sum benefit upon retirement or upon certain instances of termination.
As of December 30, 2017, there were no plan assets associated with the Japan Plan. As of December 30, 2017, there was $0.2 million in accrued expenses and other liabilities and $6.7 million in other non-current liabilities in our condensed consolidated balance sheet to account for the projected benefit obligations under the Japan Plan. Net periodic pension costs for the Japan Plan included the following:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Service cost
$
157

 
$
152

 
$
314

 
$
324

Interest cost
5

 
1

 
10

 
2

Net periodic pension costs
$
162

 
$
153

 
$
324

 
$
326

We made no benefit payments under the Japan Plan during the three and six months ended December 30, 2017 and made $0.1 million and $0.2 million in benefit payments during the three and six months ended December 31, 2016, respectively.
U.K. Defined Contribution Pension Scheme
Under the defined contribution pension scheme, employer contributions totaled $0.4 million and $0.8 million for the three and six months ended December 30, 2017, respectively, and $0.3 million and $0.5 million for the three and six months ended December 31, 2016, respectively.

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NOTE 7. COMMITMENTS AND CONTINGENCIES
Loss Contingencies
We are involved in various lawsuits, claims, and proceedings that arise in the ordinary course of business. We record a loss provision when we believe it is both probable that a liability has been incurred and the amount can be reasonably estimated.
Guarantees
We indemnify our directors and certain employees as permitted by law, and have entered into indemnification agreements with our directors and executive officers. We have not recorded a liability associated with these indemnification arrangements, as we historically have not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that we maintain, however, such insurance may not cover any, or may cover only a portion of, the amounts we may be required to pay. In addition, we may not be able to maintain such insurance coverage in the future.
We also have indemnification clauses in various contracts that we enter into in the normal course of business, such as indemnifications in favor of customers in respect of liabilities they may incur as a result of purchasing our products should such products infringe the intellectual property rights of a third party. We have not historically paid out any material amounts related to these indemnifications; therefore, no accrual has been made for these indemnifications. See Litigation - Oyster Optics Litigation below for additional details.
Warranty Accrual
We generally provide a warranty for our products for twelve months to thirty-six months from the date of sale, although warranties for certain of our products may be longer. We accrue for the estimated costs to provide warranty services at the time revenue is recognized. Our estimate of costs to service our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty costs would increase, resulting in a decrease in gross profit.
The following table summarizes movements in the warranty accrual for the periods indicated:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Warranty provision—beginning of period
$
4,271

 
$
4,600

 
$
4,124

 
$
3,827

Warranties issued
84

 
437

 
300

 
1,542

Warranties utilized or expired
(153
)
 
(371
)
 
(273
)
 
(655
)
Currency translation and other adjustments
4

 
(106
)
 
55

 
(154
)
Warranty provision—end of period
$
4,206

 
$
4,560

 
$
4,206

 
$
4,560

Capital Leases
In October 2015, we entered into a capital lease agreement for certain capital equipment. The lease term is for 5 years, after which time the ownership of the equipment will transfer from the lessor to us. During the lease term, we will make twenty equal installments of principal and interest, payable quarterly. Interest on the capital lease will accrue at 1.15 percent per annum.

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The following table shows the future minimum lease payments due under non-cancelable capital leases at December 30, 2017:
 
Capital Leases
 
(Thousands)
Fiscal Year Ending:
 
2018 (remaining)
$
1,477

2019
1,158

2020
602

2021
260

Total minimum lease payments
3,497

Less amount representing interest
(97
)
Present value of capitalized payments
3,400

Less: current portion
(2,166
)
Long-term portion
$
1,234

Purchase Commitments
We purchase components from a variety of suppliers and use contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with suppliers and contract manufacturers that either allow them to procure inventory based upon criteria as defined by us or establish the parameters defining our requirements. A significant portion of our reported purchase commitments arising from these agreements consist of firm, non-cancelable and unconditional commitments.
We record a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of December 30, 2017 and July 1, 2017, the liability for these purchase commitments was $6.8 million and $4.0 million, respectively, and was included in accrued expenses and other liabilities in our condensed consolidated balance sheets.
Malaysian Goods and Services Tax (“GST”)
In February 2016, the Malaysian tax authorities preliminarily denied our Malaysia GST refund claims representing approximately $2.5 million. These claims were made in connection with the export of finished goods from our contract manufacturing partner’s Malaysian facilities. We are currently appealing the denial of these claims, and believe that additional options may be available to us if we do not obtain a favorable resolution. Although we have taken action to minimize the impact of the GST with respect to our ongoing operations, we believe it is reasonably possible that, ultimately, we may not be able to recover some of these GST amounts. Of the $2.5 million in GST claims, we recorded $0.7 million in prepaid expenses and other current assets in our condensed consolidated balance sheet at December 30, 2017, net of reserves and certain offsetting payments from our contract manufacturing partner.
Litigation
Overview
In the ordinary course of business, we are involved in various legal proceedings, and we anticipate that additional actions will be brought against us in the future. The most significant of these proceedings are described below. These legal proceedings, as well as other matters, involve various aspects of our business and a variety of claims in various jurisdictions. Complex legal proceedings frequently extend for several years, and a number of the matters pending against us are at very early stages of the legal process. As a result, some pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to determine whether the proceeding is material to us or to estimate a range of possible loss, if any. Unless otherwise disclosed, we are unable to estimate the possible loss or range of loss for the legal proceedings described below. While it is not possible to accurately predict or determine the eventual outcome of these items, an adverse determination in these items currently pending could have a material adverse effect on our results of operations, financial position or cash flows.

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Oyster Optics Litigation
On November 23, 2016, Oyster Optics LLC (“Oyster”) filed a civil suit against Cisco Systems, Inc. (“Cisco”) and British Telecommunications PLC (“BT”), in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01301. In the complaint, Oyster alleges that Cisco and BT infringed seven patents owned by Oyster, which patents allegedly relate to certain Cisco optical platform products, some of which may incorporate Oclaro components. Oyster subsequently dismissed its claim against BT without prejudice. In January 2017, Cisco requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Cisco. In April 2017, Oyster served infringement contentions on Cisco. Those infringement contentions identified certain Cisco products that do implicate Oclaro components that were the subject of those commercial agreements. Accordingly, in May 2017, Oclaro and Cisco preliminarily agreed to an allocation of the responsibilities for the costs of defense associated with Oyster’s claims. However, due to the uncertainty regarding the infringement allegations that Oyster may present at trial and the resultant uncertainty regarding the number of Oclaro components that may be implicated by such infringement allegations, Oclaro and Cisco agreed to defer until the conclusion of the litigation the final determination of whether and to what extent Oclaro will indemnify Cisco for any amounts Cisco may be required to pay Oyster and Cisco’s related defense costs. On May 18, 2017, Oyster’s case against Cisco was consolidated with cases that Oyster brought against other parties. On June 1, 2017, Cisco filed a motion to transfer Oyster’s case against it to the Northern District of California, which was denied on December 8, 2017. A claim construction hearing was held on November 20, 2017, and the court issued its Claim Construction Order on December 5, 2017. The parties have exchanged opening and responsive expert reports regarding infringement, invalidity and damages, and the deadline to file dispositive motions is February 26, 2018. In its expert report regarding infringement, Oyster alleges Cisco infringes only two of the seven previously asserted patents. Trial proceedings are set to begin June 4, 2018 in the consolidated cases. Discovery in the consolidated cases closed on December 22, 2017. Allegedly based on that discovery, Oyster sought to amend its infringement contentions to accuse additional Cisco products. To date, no such amendments have been agreed to by Cisco or ordered by the Court. Oyster nonetheless has included, to some extent, some of its proposed amended contentions in its expert reports. At the close of discovery, Oyster moved to compel Cisco to produce financial information relating to these additional Cisco products. That motion is fully briefed and awaiting decision. If the Court grants Oyster’s motion, or otherwise permits the amendment(s) it previously sought, Oyster could pursue claims accusing Cisco products that implicate certain Oclaro components that are the subject of commercial agreements between Oclaro and Cisco. Cisco and Oclaro filed Petitions for inter partes review of the patents that Oyster is asserting against Cisco with the U.S. Patent Office on June 20, July 27, and September 27, 2017. Oyster has filed its Preliminary Patent Owner's Response to each of the petitions. On January 23, 2018 and January 26, 2018, the Patent Office issued its Institution Decisions for two of the patents, instituting inter partes review on some of the challenged claims for each and denying institution for others. The Patent Office has not yet made any Institution Decisions on the remaining petitions.

On November 24, 2016, Oyster also filed a civil suit against Coriant America Inc. (“Coriant”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-cv-01302. In the complaint against Coriant, Oyster alleges that Coriant has infringed the same seven patents that were asserted against Cisco. On May 18, 2017, Oyster’s case against Coriant was consolidated with cases that Oyster brought against other parties, including Cisco. As a result, the November 20, 2017 consolidated claim construction hearing and order, December 22, 2017 close of fact discovery, February 26, 2018 deadline for dispositive motions, and the June 4, 2018 date for the commencement of trial described above also apply to the litigation against Coriant. On December 21, 2017 Coriant requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Coriant. Oclaro has refused this request for reasons including that Oyster’s claims against Coriant do not clearly implicate Oclaro products and that Coriant’s request was not timely made. Coriant has stated their disagreement with this position. As a result, Oclaro remains in discussions with Coriant regarding Coriant’s request for defense and indemnification.

Oyster also filed a civil suit on November 24, 2016 against Ciena Corporation (“Ciena”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01300. In the complaint against Ciena, Oyster alleges that Ciena has infringed the same seven patents that were asserted against Cisco. On June 15, 2017, Ciena filed a motion to transfer Oyster’s case against it to the Northern District of California. On September 22, 2017, the Court granted Ciena’s motion. On January 4, 2018, Ciena filed a motion to stay pending inter partes review of the Oyster patents. The Court granted Ciena’s motion to stay on January 29, 2018. The case is currently stayed and the parties have been ordered to file a joint status report on June 1, 2018 reporting on the status of the inter partes review proceedings. On October 16, 2017, Ciena requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Ciena. Oclaro refused this request for reasons including that Oyster's claims against Ciena do not clearly implicate Oclaro products and that Ciena's request was not timely made.
Kunst Worker Compensation Matter
On June 18, 2015, Gerald Kunst, or Kunst, filed a civil suit against us and Travelers Property Casualty Company of America, or Travelers, in Massachusetts Superior Court, Civil Action No. SUCV2015-01818F. Travelers is our general liability insurance carrier. The complaint filed by Kunst, an employee of a third party service provider, alleges that he was injured while performing

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air conditioning repair services on the premises of our Acton, Massachusetts facility and seeks judgment in an amount to be determined by the court or jury, together with interest and costs. On July 24, 2015, we filed an answer to the complaint, which included our affirmative defenses. Following a mediation held on October 30, 2017, the parties contingently agreed on terms for a settlement of all claims in the case, subject to final documentation and judicial approval. The terms for settlement and release of all claims were approved by the Administrative Law Judge (Department of Industrial Accidents, Division of Dispute Resolution) on November 20, 2017 and a stipulation of dismissal with prejudice was filed on December 14, 2017 in the Massachusetts Superior Court.  Oclaro was not liable for any payments under the terms of the settlement.

NOTE 8. EMPLOYEE STOCK PLANS

Stock Incentive Plans
On November 17, 2017, our stockholders approved an amendment to the Fifth Amended and Restated 2001 Long-Term Stock Incentive Plan (the "Plan"), adding 8.0 million shares of common stock to the share reserve under the Plan. As of December 30, 2017, there were approximately 16.4 million shares of our common stock available for grant under the Plan.
We generally grant stock options that vest over a two to four year service period, and restricted stock awards and restricted stock unit ("RSU") awards that vest over a one to four year service period, and in certain cases each may vest earlier based upon the achievement of specific performance-based objectives as set by our board of directors or the compensation committee of our board of directors.
Performance-Based Restricted Stock Units ("PSUs")
In August 2017, our board of directors approved a grant of 1.1 million PSUs to certain executive officers with an aggregate estimated grant date fair value of $9.5 million. These PSUs have service- and performance-based vesting conditions. One-third of the PSUs will vest subject to the achievement of $700.0 million of revenue over any four consecutive quarters through the end of fiscal 2020, subject to service conditions; one-third of the PSUs will vest upon the achievement of $100.0 million of free cash flow (defined as adjusted EBITDA less capital expenditures) over any four consecutive quarters through the end of fiscal 2020, subject to service conditions; and one-third of the PSUs will vest upon the achievement of $800.0 million of revenue in any one fiscal year from 2018 through 2020 and upon achievement of $100.0 million of free cash flow over any four consecutive quarters through the end of fiscal 2020, subject to service conditions. Upon reaching each performance condition, the service-based vesting condition is satisfied for that tranche as to 1/3 of the PSUs on the first anniversary of the vesting commencement date, and with respect to 1/12 of the underlying shares each subsequent quarter, such that all PSUs for that tranche are fully vested on the third anniversary of the vesting commencement date. As of December 30, 2017, we determined that the achievement of the performance conditions associated with these PSUs was improbable.
In August 2016, our board of directors approved a grant of 0.8 million PSUs to certain executive officers with an aggregate estimated grant date fair value of $4.8 million. Subject to the achievement of an aggregate of $25.0 million or more of free cash flow (defined as adjusted EBITDA less capital expenditures) over any consecutive four fiscal quarters ending on or before June 27, 2020, as determined by our board of directors, these PSUs will vest contingent upon service conditions being met through August 10, 2020. On July 25, 2017, the compensation committee of our board of directors certified that the performance condition for these PSUs was achieved. As a result, these PSUs vested with respect to 25 percent of the shares subject to the PSUs on August 10, 2017, and with respect to 6.25 percent of the underlying shares each subsequent quarter over the following three years, subject to continuous service.
In August 2015, our board of directors approved a grant of 0.9 million PSUs to certain executive officers with an aggregate estimated grant date fair value of $2.5 million. Subject to the achievement of positive free cash flow (defined as adjusted EBITDA less capital expenditures) in any fiscal quarter ending prior to June 30, 2018, vesting of these PSUs is contingent upon service conditions being met through August 10, 2018. On October 29, 2015, the compensation committee of our board of directors certified that this performance condition was achieved during the first quarter of fiscal 2016. As a result, these PSUs vested with respect to 33.4 percent of the underlying shares on August 10, 2016, and will vest with respect to 8.325 percent of the underlying shares each subsequent quarter over the following two years, subject to continuous service.
Restricted Stock Units
In August 2017, our board of directors approved a long term incentive grant of 0.6 million RSUs to certain executive officers and 1.6 million RSUs to other employees, which vest over four years.
In August 2016, our board of directors approved a long term incentive grant of 0.8 million RSUs to certain executive officers and 2.0 million RSUs to other employees, which vest over four years.

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Stock Incentive Plan Activity
The following table summarizes the combined activity under all of our equity incentive plans for the six months ended December 30, 2017:
 
Shares
Available
For Grant
 
Stock
Options /
SARs
Outstanding
 
Weighted-
Average
Exercise Price
 
Time and Performance-based Restricted Stock
Awards / Units
Outstanding
 
Weighted-
Average Grant
Date Fair Value
 
(Thousands)
 
(Thousands)
 
 
 
(Thousands)
 
 
Balance at July 1, 2017
13,581

 
1,858

 
$
7.84

 
5,687

 
$
5.43

Increase in share reserve
8,000

 

 

 

 

Granted
(5,386
)
 

 

 
3,847

 
8.28

Exercised or released
23

 
(187
)
 
3.38

 
(1,890
)
 
5.17

Forfeited or expired
211

 
(78
)
 
25.65

 
(97
)
 
6.41

Balance at December 30, 2017
16,429

 
1,593

 
$
7.49

 
7,547

 
$
6.94


Supplemental disclosure information about our stock options and stock appreciation rights ("SARs") outstanding as of December 30, 2017 is as follows:
 
Shares
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual Life
 
Aggregate
Intrinsic
Value
 
(Thousands)
 
 
 
(Years)
 
(Thousands)
Options and SARs exercisable
1,554

 
$
7.63

 
2.3
 
$
2,173

Options and SARs outstanding
1,593

 
$
7.49

 
2.4
 
$
2,362

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the closing price of our common stock of $6.74 on December 29, 2017, which would have been received by the option holders had all option holders exercised their options as of that date. There were approximately 0.8 million shares of common stock subject to in-the-money options which were exercisable as of December 30, 2017. We settle employee stock option exercises with newly issued shares of common stock.

NOTE 9. STOCK-BASED COMPENSATION
We recognize stock-based compensation expense in our condensed consolidated statement of operations related to all share-based awards, including grants of stock options, based on the grant date fair value of such share-based awards.
In March 2016, the FASB issued ASU No. 2016-09, Compensation: Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards, and classification on the statement of cash flows. This guidance is effective for us in the first quarter of fiscal 2018. Pursuant to the adoption of ASU No. 2016-09, we elected to record forfeitures when they occur. This change in accounting principle with regards to forfeitures was adopted using a modified retrospective approach. With the adoption of this guidance we recorded an adjustment of $0.3 million in our accumulated deficit and additional paid-in capital during the first quarter of fiscal 2018.

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The amounts included in cost of revenues and operating expenses for stock-based compensation were as follows:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Stock-based compensation by category of expense:
Cost of revenues
$
755

 
$
462

 
$
1,193

 
$
751

Research and development
858

 
526

 
1,725

 
983

Selling, general and administrative
2,326

 
1,601

 
4,220

 
3,298

 
$
3,939

 
$
2,589

 
$
7,138

 
$
5,032

Stock-based compensation by type of award:
 
 
 
 
 
 
 
Stock options
$
30

 
$
32

 
$
62

 
$
70

Restricted stock awards
3,966

 
2,612

 
7,430

 
5,203

Inventory adjustment to cost of revenues
(57
)
 
(55
)
 
(354
)
 
(241
)
 
$
3,939

 
$
2,589

 
$
7,138

 
$
5,032

Included in stock-based compensation for three and six months ended December 30, 2017 is approximately $0.5 million and $1.3 million, respectively, in stock-based compensation cost related to the issuance of PSUs. Included in stock-based compensation for three and six months ended December 31, 2016 is approximately $0.6 million and $1.2 million, respectively, in stock-based compensation cost related to the issuance of PSUs. The amount of stock-based compensation expense recognized in any one period related to PSUs can vary based on the achievement or anticipated achievement of the performance conditions. If the performance conditions are not met or not expected to be met, no compensation cost would be recognized on the shares underlying the PSUs, and any previously recognized compensation expense related to those PSUs would be reversed. As of December 30, 2017, we determined that the achievement of the performance conditions associated with the PSUs issued in August 2017 was not probable.
During the three and six months ended December 30, 2017, we capitalized stock-based compensation of $0.1 million and $0.4 million, respectively, into inventory. During the three and six months ended December 31, 2016, we capitalized stock-based compensation of $0.1 million and $0.2 million, respectively, into inventory. As of December 30, 2017 and July 1, 2017, we had capitalized a total of $0.9 million and $0.6 million of stock-based compensation, respectively, into inventory.
As of December 30, 2017, we had less than $0.1 million in unrecognized stock-based compensation expense related to unvested stock options, that will be recognized over a weighted-average period of 0.7 years, and $35.5 million in unrecognized stock-based compensation expense related to unvested time-based restricted stock awards, net of estimated forfeitures, that will be recognized over a weighted-average period of 2.4 years.

NOTE 10. INCOME TAXES
The income tax provision of $3.2 million and $9.4 million for the three and six months ended December 30, 2017, respectively, relates primarily to our foreign operations. The income tax provision of $37,000 and $0.4 million for the three and six months ended December 31, 2016, respectively, relates primarily to our foreign operations, which included a $0.5 million release of a reserve in Italy due to the expiration of the applicable statute of limitations.
The total amount of our unrecognized tax benefits as of December 30, 2017 and July 1, 2017 were approximately $3.5 million and $3.5 million, respectively. As of December 30, 2017, we had $2.9 million of unrecognized tax benefits that, if recognized, would affect our effective tax rate. While it is often difficult to predict the final outcome of any particular uncertain tax position, we believe that unrecognized tax benefits could decrease by approximately $1.3 million in the next twelve months.
On December 22, 2017, the TCJA was signed into law. Among other things, the TCJA permanently lowers the corporate federal income tax rate to 21 percent from the existing maximum rate of 35 percent, effective for tax years including or commencing January 1, 2018. Since we operate on a 52/53 week year ending on the Saturday closest to June 30, the lower corporate income tax rate will be phased in, resulting in a U.S. statutory federal rate of approximately 28 percent for our fiscal year ending June 30, 2018, and 21 percent for subsequent fiscal years. As a result of the reduction of the corporate federal income tax rate to 21 percent, U.S. GAAP requires companies to re-value their deferred tax assets and deferred tax liabilities as of the date of enactment, with the resulting tax effects accounted for in the reporting period of enactment. As a result, we have concluded this will cause our net deferred taxes to be re-measured at the new lower tax rate. The estimated rate change impact to our net deferred tax assets is a reduction of $32.4 million. We maintain a full valuation allowance on our U.S. net deferred tax assets. Deferred tax asset re-measurement (tax expense) will be offset by a net decrease in valuation allowance, resulting in no impact on our income tax for

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the period ending December 30, 2017. We have not completed the revaluation calculation and will disclose any adjustments in our fiscal year end financial statements.
Additionally, the TCJA introduces new international tax provisions that will be effective for our fiscal year 2019, including (i) a new provision designed to currently tax the global low-taxed income of our foreign subsidiaries, together with a deduction of up to 50 percent and a partial credit for foreign taxes incurred by the foreign subsidiaries; (ii) limitations on the deductibility of certain base eroding payments to foreign entities; and (iii) limitations on the use of foreign tax credits to reduce U.S. income tax liability. While each of these provisions may have an impact on our tax expense for fiscal year 2019 and future periods, we expect the tax on low-taxed income of foreign subsidiaries to have the most significant impact.
Because of the complexity of the new tax on low-taxed income of foreign subsidiaries and uncertainties regarding its application in certain circumstances, we are continuing to evaluate this provision of the TCJA and its impact on our determination of the realizability of our deferred tax assets. We elected to utilize the reporting provisions of SAB 118, as we did not have the necessary information available, prepared or analyzed for certain future taxable income tax effects of the TCJA in order to determine a reasonable estimate to be included as provisional amounts. We will not adjust our current or deferred taxes for those tax effects of the TCJA, for which we are unable to reasonably estimate, until a reasonable estimate can be determined.

NOTE 11. NET INCOME PER SHARE
Basic net income per share is computed using only the weighted-average number of shares of common stock outstanding for the applicable period, while diluted net income per share is computed assuming conversion of all potentially dilutive securities, such as stock options and unvested restricted stock units and awards during such period.
The following table presents the calculation of basic and diluted net income per share:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands, except per share amounts)
Net income
$
18,737

 
$
30,267

 
$
45,226

 
$
33,618

 
 
 
 
 
 
 
 
Weighted-average shares - Basic
168,990

 
165,822

 
168,564

 
149,151

Effect of dilutive potential common shares from:
 
 
 
 
 
 
 
Stock options and stock appreciation rights
360

 
752

 
432

 
724

Restricted stock units and awards
1,342

 
2,282

 
2,083

 
2,420

Convertible notes

 

 

 
7,506

Weighted-average shares - Diluted
170,692

 
168,856

 
171,079

 
159,801

 
 
 
 
 
 
 
 
Basic net income per share
$
0.11

 
$
0.18

 
$
0.27

 
$
0.23

Diluted net income per share
$
0.11

 
$
0.18

 
$
0.26

 
$
0.21

For the three and six months ended December 30, 2017, we excluded 3.2 million and 0.8 million shares, respectively, underlying outstanding stock options, stock appreciation rights and unvested restricted stock awards from the calculation of diluted net income per share because their effect would have been anti-dilutive.
For the three and six months ended December 31, 2016, we excluded 0.8 million and 0.8 million shares, respectively, underlying outstanding stock options, stock appreciation rights and unvested restricted stock awards from the calculation of diluted net income per share because their effect would have been anti-dilutive.


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NOTE 12. GEOGRAPHIC INFORMATION, PRODUCT GROUPS AND CUSTOMER CONCENTRATION INFORMATION
Geographic Information
The following table shows revenues by geographic area based on the delivery locations of our products:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
Asia-Pacific:
 
 
 
 
 
 
 
China
$
51,431

 
$
63,927

 
$
92,865

 
$
122,669

Thailand
11,938

 
32,184

 
30,013

 
54,130

Malaysia
1,334

 
5,377

 
3,420

 
11,704

Other Asia-Pacific
5,734

 
3,028

 
9,436

 
6,364

Total Asia-Pacific
$
70,437

 
$
104,516

 
$
135,734

 
$
194,867

 
 
 
 
 
 
 
 
Americas:
 
 
 
 
 
 
 
United States
19,513

 
17,281

 
57,203

 
31,742

Mexico
21,645

 
8,068

 
51,131

 
17,359

Other Americas
3,238

 
6,211

 
8,469

 
8,213

Total Americas
$
44,396

 
$
31,560

 
$
116,803

 
$
57,314

 
 
 
 
 
 
 
 
EMEA:
 
 
 
 
 
 
 
Italy
12,311

 
6,718

 
19,237

 
16,024

Germany
3,336

 
3,088

 
7,391

 
6,377

Other EMEA
7,313

 
6,084

 
12,128

 
11,346

Total EMEA
$
22,960

 
$
15,890

 
$
38,756

 
$
33,747

 
 
 
 
 
 
 
 
Japan
$
1,542

 
$
1,948

 
3,640

 
3,478

 
 
 
 
 
 
 
 
Total revenues
$
139,335

 
$
153,914

 
$
294,933

 
$
289,406

Product Groups
The following table sets forth revenues by product group:
 
Three Months Ended
 
Six Months Ended
 
December 30, 2017
 
December 31, 2016
 
December 30, 2017
 
December 31, 2016
 
(Thousands)
100 Gb/s + transmission modules
$
105,371

 
$
113,835

 
$
231,012

 
$
211,606

40 Gb/s and lower transmission modules
33,964

 
40,079

 
63,921

 
77,800

 
$
139,335

 
$
153,914

 
$
294,933

 
$
289,406




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Significant Customers and Concentration of Credit Risk
For the three months ended December 30, 2017, three customers accounted for 10 percent or more of our revenues, representing approximately 19 percent, 13 percent and 13 percent of our revenues, respectively. For the six months ended December 30, 2017, five customers accounted for 10 percent or more of our revenues, representing approximately 15 percent, 13 percent, 12 percent, 11 percent and 10 percent of our revenues, respectively.
For the three months ended December 31, 2016, four customers accounted for 10 percent or more of our revenues, representing approximately 22 percent, 20 percent, 16 percent and 10 percent of our revenues, respectively. For the six months ended December 31, 2016, four customers accounted for 10 percent of more of our revenues, representing 20 percent, 19 percent, 18 percent and 11 percent of our revenues, respectively.
As of December 30, 2017, four customers accounted for 10 percent or more of our accounts receivable, representing approximately 15 percent, 14 percent, 13 percent and 10 percent of our accounts receivable, respectively. As of July 1, 2017, one customer accounted for 10 percent or more of our accounts receivable, representing approximately 20 percent.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, about our future expectations, plans or prospects and our business. You can identify these statements by the fact that they do not relate strictly to historical or current events, and contain words such as “anticipate,” “estimate,” “expect,” “forecast,” “project,” “intend,” “plan,” “believe,” “will,” “should,” “outlook,” “could,” “target,” “model,” "objective," and other words of similar meaning in connection with discussion of future operating or financial performance. We have based our forward looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. There are a number of important factors that could cause our actual results or events to differ materially from those indicated by such forward-looking statements, including (i) our dependence on a limited number of customers for a significant percentage of our revenues, (ii) competition and pricing pressure, (iii) the absence of long-term purchase commitments from many of our long-term customers, (iv) our ability to effectively manage our inventory, (v) our ability to meet or exceed our gross margin expectations, (vi) our ability to timely develop, commercialize and ramp the production of new products to customer required volumes, (vii) the effects of fluctuations in foreign currency exchange rates, (viii) our ability to respond to evolving technologies, customer requirements and demands, and product design challenges, (ix) potential operating or reporting disruptions that could result from the implementation of our new enterprise resource planning system, (x) our manufacturing yields, (xi) our ability to conclude agreements with our customers on favorable terms, (xii) the risks associated with delays, disruptions or quality control problems in manufacturing, (xiii) fluctuations in our revenues, growth rates and operating results, (xiv) changes in our effective tax rates or outcomes of tax audits or similar proceedings, (xv) our ability to obtain governmental licenses and approvals for international trading activities or technology transfers, including export licenses, (xvi) our dependence on a limited number of suppliers and key contract manufacturers, (xvii) the impact of financial market and general economic conditions in the industries in which we operate and any resulting reduction in demand for our products, (xviii) our ability to protect our intellectual property rights, (xix) the risks associated with our international operations, and (xx) other factors described under the caption "Risk Factors" and elsewhere in the documents we periodically file with the SEC. We cannot guarantee any future results, levels of activity, performance or achievements. You should not place undue reliance on forward-looking statements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements, except as required by law. Several of the important factors that may cause our actual results to differ materially from the expectations we describe in forward-looking statements are identified in the sections captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and "Risk Factors" in this Quarterly Report on Form 10-Q and the documents incorporated herein by reference.
As used herein, “Oclaro,” “we,” “our,” and similar terms include Oclaro, Inc. and its subsidiaries, unless the context indicates otherwise.

OVERVIEW
We are one of the leading providers of optical components and modules for the long-haul, metro and data center markets. Leveraging over three decades of laser technology innovation and photonics integration, we provide differentiated solutions for optical networks and high-speed interconnects driving the next wave of streaming video, cloud computing, application virtualization and other bandwidth-intensive and high-speed applications.

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We have research and development ("R&D") facilities in China, Italy, Japan, United Kingdom and the United States, and fabrication facilities in China, Italy, Japan and the United Kingdom. We also have contract manufacturing sites in Asia, with design, sales and service organizations in most of the major regions around the world.
Our customers include: Amazon.com; Ciena Corporation; Cisco Systems, Inc.; Coriant GmbH; Google Inc.; Huawei Technologies Co. Ltd; InnoLight Technology Corporation; Juniper Networks, Inc.; Nokia and ZTE Corporation.

RESULTS OF OPERATIONS

The following table sets forth our condensed consolidated results of operations for the periods indicated, along with amounts expressed as a percentage of revenues, and comparative information regarding the absolute and percentage changes in these amounts:
 
Three Months Ended
 
 
 
Increase
 
 
December 30, 2017
 
December 31, 2016
 
Change
 
(Decrease)
 
 
(Thousands)
 
%
 
(Thousands)
 
%
 
(Thousands)
 
%
 
Revenues
$
139,335

 
100.0
 
$
153,914

 
100.0

 
$
(14,579
)
 
(9.5
)
 
Cost of revenues
87,507

 
62.8
 
93,150

 
60.5

 
(5,643
)
 
(6.1
)
 
Gross profit
51,828

 
37.2
 
60,764

 
39.5

 
(8,936
)
 
(14.7
)
  
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
15,358

 
11.0
 
13,758

 
8.9

 
1,600

 
11.6

 
Selling, general and administrative
16,892

 
12.1
 
13,355

 
8.7

 
3,537

 
26.5

 
Amortization of other intangible assets
154

 
0.1
 
241

 
0.2

 
(87
)
 
(36.1
)
 
Restructuring, acquisition and related (income) expense, net

 
 
82

 
0.1

 
(82
)
 
(100.0
)
 
(Gain) loss on sale of property and equipment
169

 
0.1
 
(74
)
 
(0.1
)
 
243

 
n/m

(1) 
Total operating expenses
32,573

 
23.4
 
27,362

 
17.8

 
5,211

 
19.0

  
Operating income
19,255

 
13.8
 
33,402

 
21.7

 
(14,147
)
 
(42.4
)
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
Interest income (expense), net
123

 
0.1
 
70

 
0.1

 
53

 
75.7

 
Gain (loss) on foreign currency transactions, net
1,599

 
1.1
 
(3,324
)
 
(2.2
)
 
4,923

 
n/m

(1) 
Other income (expense), net
936

 
0.7
 
156

 
0.1

 
780

 
500.0

 
Total other income (expense)
2,658

 
1.9
 
(3,098
)
 
(2.0
)
 
5,756

 
n/m

(1) 
Income before income taxes
21,913

 
15.7
 
30,304

 
19.7

 
(8,391
)
 
(27.7
)
 
Income tax provision
3,176

 
2.3
 
37

 

 
3,139

 
8,483.8

 
Net income
$
18,737

 
13.4
 
$
30,267

 
19.7

 
$
(11,530
)
 
(38.1
)
 
(1)
Not meaningful.

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Six Months Ended
 
 
 
Increase
 
 
December 30, 2017
 
December 31, 2016
 
Change
 
(Decrease)
 
 
(Thousands)
 
%
 
(Thousands)
 
%
 
(Thousands)
 
%
 
Revenues
$
294,933

 
100.0
 
$
289,406

 
100.0

 
$
5,527

 
1.9

 
Cost of revenues
180,401

 
61.2
 
182,286

 
63.0

 
(1,885
)
 
(1.0
)
 
Gross profit
114,532

 
38.8
 
107,120

 
37.0

 
7,412

 
6.9

  
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
31,793

 
10.8
 
26,865

 
9.3

 
4,928

 
18.3

 
Selling, general and administrative
31,758

 
10.8
 
28,147

 
9.7

 
3,611

 
12.8

 
Amortization of other intangible assets
306

 
0.1
 
485

 
0.2

 
(179
)
 
(36.9
)
 
Restructuring, acquisition and related (income) expense, net

 
 
393

 
0.1

 
(393
)
 
(100.0
)
 
(Gain) loss on sale of property and equipment
191

 
0.1
 
(111
)
 

 
302

 
n/m

(1) 
Total operating expenses
64,048

 
21.7
 
55,779

 
19.3

 
8,269

 
14.8

  
Operating income
50,484

 
17.1
 
51,341

 
17.7

 
(857
)
 
(1.7
)
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
Interest income (expense), net
557

 
0.2
 
(13,788
)
 
(4.7
)
 
14,345

 
n/m

(1) 
Gain (loss) on foreign currency transactions, net
2,088

 
0.7
 
(3,842
)
 
(1.3
)
 
5,930

 
n/m

(1) 
Other income (expense), net
1,510

 
0.5
 
350

 
0.1

 
1,160

 
331.4

 
Total other income (expense)
4,155

 
1.4
 
(17,280
)
 
(5.9
)
 
21,435

 
n/m

(1) 
Income before income taxes
54,639

 
18.5
 
34,061

 
11.8

 
20,578

 
60.4

 
Income tax provision
9,413

 
3.2
 
443

 
0.2

 
8,970

 
2,024.8

 
Net income
$
45,226

 
15.3
 
$
33,618

 
11.6

 
$
11,608

 
34.5

 
(1)Not meaningful.

Revenues
Revenues for the three months ended December 30, 2017 decreased by $14.6 million, or 9 percent, compared to the three months ended December 31, 2016. Compared to the three months ended December 31, 2016, revenues from sales of our 100 Gb/s + transmission modules decreased by $8.5 million, or 7 percent, primarily due to a decline in our 100 Gb/s and above line side modules and components as well as our 100 Gb/s and above client side transceivers; and revenues from sales of our 40 Gb/s and lower transmission modules decreased by $6.1 million, or 15 percent, primarily due to certain legacy 40 Gb/s and 10 Gb/s products being gradually replaced by our newer higher speed products. We expect revenues for the three months ended March 31, 2018 to decrease by a range of 8 percent to 14 percent as compared to the three months ended December 30, 2017 due primarily to lower sales of 100G client side and data center transceivers, a reduction in average selling prices resulting from the annual price negotiations with our customers, and decreased shipments to our China based customers.  These decreases are expected to be partially offset by an increase in sales from our CFP2-ACO product family.
For the three months ended December 30, 2017, three customers accounted for 10 percent or more of our revenues, representing approximately 19 percent, 13 percent and 13 percent of our revenues, respectively. For the three months ended December 31, 2016, four customers accounted for 10 percent or more of our revenues, representing approximately 22 percent, 20 percent, 16 percent and 10 percent of our revenues, respectively.
Revenues for the six months ended December 30, 2017 increased by $5.5 million, or 2 percent, compared to the six months ended December 31, 2016. Compared to the six months ended December 31, 2016, revenues from sales of our 100 Gb/s + transmission modules increased by $19.4 million, or 9 percent, primarily due to growth in our 100 Gb/s line side modules and components; and revenues from sales of our 40 Gb/s and lower transmission modules decreased by $13.9 million, or 18 percent, primarily due to certain legacy 40 Gb/s and 10 Gb/s products being gradually replaced by our newer higher speed products. This product mix shift reflects our continued focus on the market for higher speed products that are smaller in size and have lower power consumption.
For the six months ended December 30, 2017, five customers accounted for 10 percent or more of our revenues, representing approximately 15 percent, 13 percent, 12 percent, 11 percent and 10 percent of our revenues, respectively. For the six months

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ended December 31, 2016, four customers accounted for 10 percent of more of our revenues, representing 20 percent, 19 percent, 18 percent and 11 percent of our revenues, respectively.

Gross Profit
Gross profit is calculated as revenues less cost of revenues. Gross margin rate is gross profit reflected as a percentage of revenues.
Our gross margin rate decreased to approximately 37 percent for the three months ended December 30, 2017, compared to 39 percent for the three months ended December 31, 2016. This decrease was primarily due to a 3 percentage point impact of our fixed costs on lower revenues, and 2 percentage points driven by higher inventory reserves; partially offset by 3 percentage points related to improved product mix of higher margin 100 Gb/s products.
Our gross margin rate increased to approximately 39 percent for the six months ended December 30, 2017, compared to 37 percent for the six months ended December 31, 2016. This increase was primarily driven by 5 percentage points of improved product mix as a result of increased sales of higher margin 100 Gb/s products; partially offset by a 2 percentage point decrease as a result of higher inventory reserves and 2 percentage point decrease related to higher manufacturing overhead costs.
Our cost of revenues consists of the costs associated with manufacturing our products, and includes the purchase of raw materials, labor costs and related overhead, including stock-based compensation charges and the costs charged by our contract manufacturers for the products they manufacture for us. Charges for excess and obsolete inventory are also included in cost of revenues.

Research and Development Expenses
Research and development expenses increased to $15.4 million for the three months ended December 30, 2017, from $13.8 million for the three months ended December 31, 2016. The increase was primarily related to an increase of $1.0 million in non-recurring engineering and material expenses and an investment of $0.9 million in research and development resources, primarily personnel-related, including $0.3 million in stock-based compensation charges. This was partially offset by a $0.4 million United Kingdom research and development tax credit.
Research and development expenses increased to $31.8 million for the six months ended December 30, 2017, from $26.9 million for the six months ended December 31, 2016. The increase was primarily related to an increase of $2.4 million in non-recurring engineering and material expenses and an investment of $2.2 million in research and development resources, primarily personnel-related, including $0.7 million in stock-based compensation charges.
Research and development expenses consist primarily of salaries and related costs of employees engaged in research and design activities, including stock-based compensation charges related to those employees, costs of design tools and computer hardware, costs related to prototyping and facilities costs for certain research and development focused sites.

Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $16.9 million for the three months ended December 30, 2017, from $13.4 million for the three months ended December 31, 2016. The increase was primarily related to an increase of $1.5 million in professional fees, an increase of $1.7 million related to transition costs and incremental depreciation related to our upgrade of our enterprise resource planning ("ERP") system, and an increase of $0.6 million in stock-based compensation charges.
Selling, general and administrative expenses increased to $31.8 million for the six months ended December 30, 2017, from $28.1 million for the six months ended December 31, 2016. The increase was primarily related to an increase of $1.7 million in professional fees, an increase of $1.8 million related to transition costs and incremental depreciation related to our upgrade of our ERP system, and an increase of $0.8 million in stock-based compensation charges. This was partially offset by a decrease of $0.8 million in selling, general and administrative resources, primarily personnel-related.
Selling, general and administrative expenses consist primarily of personnel-related expenses, including stock-based compensation charges related to employees engaged in sales, general and administrative functions, legal and professional fees, facilities expenses, insurance expenses and certain information technology costs.

Amortization of Other Intangible Assets
Amortization of other intangible assets decreased by $0.1 million and $0.2 million during the three and six months ended December 30, 2017, respectively, as compared to the three and six months ended December 31, 2016. We expect the amortization of other intangible assets to be $0.3 million for the remainder of fiscal 2018 and $0.1 million for fiscal 2019, based on the current level of our other intangible assets as of December 30, 2017.


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Restructuring, Acquisition and Related (Income) Expense, Net
During the six months ended December 30, 2017, we did not incur any restructuring, acquisition and related charges, as compared to $0.4 million in restructuring, acquisition and related charges during the six months ended December 31, 2016, related to the consolidation and closure of a facility.

Other Income (Expense)
Other income (expense) was $2.7 million in income for the three months ended December 30, 2017 as compared to $3.1 million in expense for the three months ended December 31, 2016. This change in other income (expense) primarily related to a $4.9 million increase in foreign currency transaction gains during the three months ended December 30, 2017, as compared to the three months ended December 31, 2016, related to the revaluation of non-functional currency denominated balances in our U.K. and Japan subsidiaries. We also recorded a $0.8 million increase in other income (expense), net, related primarily to the recovery of certain accounts receivable balances previously written-off.
Other income (expense) was $4.2 million in income for the six months ended December 30, 2017 as compared to $17.3 million in expense for the six months ended December 31, 2016. This change in other income (expense) primarily related to the conversion of $65.0 million of our 6.00% Notes during the first quarter of fiscal 2017, resulting in an induced conversion expense of $7.4 million and an interest make-whole charge of $5.9 million, which were both recorded in interest (income) expense, net. We also recorded a $5.9 million increase in foreign currency transaction gains during the six months ended December 30, 2017, as compared to the six months ended December 31, 2016, related to the revaluation of our U.S. dollar denominated balances in our U.K. and Japan subsidiaries; and a $1.2 million increase in other income (expense), net, related primarily to the recovery of certain accounts receivable balances previously written-off.

Income Tax Provision
The income tax provision of $3.2 million and $9.4 million for the three and six months ended December 30, 2017, respectively, and the $37,000 and $0.4 million for the three and six months ended December 31, 2016, respectively, relates primarily to our foreign operations.
The total amount of our unrecognized tax benefits as of December 30, 2017 and July 1, 2017 were approximately $3.5 million in both periods. As of December 30, 2017, we had $2.9 million of unrecognized tax benefits that, if recognized, would affect our effective tax rate. While it is often difficult to predict the final outcome of any particular uncertain tax position, we believe that unrecognized tax benefits could decrease by approximately $1.3 million in the next twelve months.

RECENT ACCOUNTING STANDARDS
See Note 2, Recent Accounting Standards, to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for information regarding the effect of new accounting pronouncements on our condensed consolidated financial statements.

APPLICATION OF CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements contained elsewhere in this Quarterly Report on Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The preparation of our financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses and other financial information. Actual results may differ significantly from those based on our estimates and judgments or could be materially different if we used different assumptions, estimates or conditions. In addition, our financial condition and results of operations could vary due to a change in the application of a particular accounting policy.
We identified our critical accounting policies in our Annual Report on Form 10-K for the year ended July 1, 2017 ("2017 Form 10-K") related to revenue recognition and sales returns, inventory valuation, business combinations, impairment of other intangible assets, accounting for stock-based compensation and income taxes. It is important that the discussion of our operating results be read in conjunction with the critical accounting policies discussed in our 2017 Form 10-K.

LIQUIDITY AND CAPITAL RESOURCES
Cash Flows from Operating Activities
Net cash provided by operating activities for the six months ended December 30, 2017 was $71.4 million, primarily resulting from net income adjusted for non-cash items of $72.3 million, partially offset by a $0.9 million decrease in cash due to changes in operating assets and liabilities. The adjustment to net income for non-cash items consisted of $13.8 million in depreciation and

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amortization, $7.1 million of expense related to stock-based compensation, a $6.7 million adjustment to the deferred tax asset as a result of our utilization of net operating losses in Japan, partially offset by $0.4 million in accretion on our marketable securities and $0.4 million from the amortization of a deferred gain from a sales-leaseback transaction in Caswell, U.K. The $0.9 million decrease in cash due to changes in operating assets and liabilities was comprised of a $9.5 million decrease in accounts payable largely attributable to the timing of purchases and payments to vendors, and a $0.8 million increase in inventories resulting from the receipt of inventory intended for sale in future quarters, partially offset by an $7.1 million decrease in prepaid expenses and other current assets primarily due to a decrease in our non-trade receivables related to our business going through our contract manufacturers commensurate with our lower revenues in the second quarter of fiscal 2018, a $1.5 million decrease in accounts receivable attributable to timing of collections, a $0.6 million decrease in other non-current assets, and a $0.1 million increase in accrued expenses and other liabilities.
Net cash provided by operating activities for the six months ended December 31, 2016 was $41.3 million, primarily resulting from net income adjusted for non-cash items of $56.9 million, partially offset by $15.6 million decrease in cash due to changes in operating assets and liabilities. The adjustment to net income for non-cash items consisted of $10.2 million in depreciation and amortization, an $8.5 million charge related to the issuance of common stock to settle a portion of the interest make-whole and induced conversion liabilities in connection with the 6.00% Notes, $5.0 million of expense related to stock-based compensation and $0.1 million from the amortization of the debt discount and issuance costs in connection with the convertible notes, partially offset by $0.4 million from the amortization of a deferred gain from a sales-leaseback transaction in Caswell, U.K. The $15.6 million decrease in cash due to changes in operating assets and liabilities was comprised of a $17.1 million increase in accounts receivable attributable to timing of collections, a $12.0 million increase in prepaid expenses and other current assets primarily due to an increase in our non-trade receivables related to the increased volume of business going through our contract manufacturers, a $11.5 million increase in inventories resulting from the receipt of inventory intended for sale in future quarters, partially offset by a $16.7 million increase in accounts payable largely attributable to the timing of purchases and payments to vendors, and an $8.6 million increase in accrued expenses and other liabilities.
Cash Flows from Investing Activities
Net cash used in investing activities for the six months ended December 30, 2017 was $130.5 million, primarily consisting of $140.5 million of purchases of available-for-sale short-term investments and $36.2 million used in capital expenditures, partially offset by $45.5 million of maturities of available-for-sale short-term investments and $0.7 million transfer from restricted cash related to the release of collateral used to secure credit card accounts and deposits for value-added taxes in foreign jurisdictions.
Net cash used in investing activities for the six months ended December 31, 2016 was $51.2 million, consisting of $31.2 million of capital expenditures and $20.0 million of purchases of available-for-sale short-term investments.
Cash Flows from Financing Activities
Net cash used in financing activities for the six months ended December 30, 2017 was $2.4 million, primarily consisting of $2.4 million related to shares repurchased for tax withholdings on vesting of restricted stock units and $0.6 million in payments on capital lease obligations, partially offset by $0.6 million in proceeds from the exercise of stock options.
Net cash provided by financing activities for the six months ended December 31, 2016 was $133.7 million, primarily consisting of $135.2 million in proceeds relating to the offering, issuance and sale of 17,250,000 shares of our common stock and $2.6 million in proceeds from the exercise of stock options, partially offset by $2.5 million related to shares repurchased for tax withholdings on vesting of restricted stock units and $1.5 million in payments on capital lease obligations.
Convertible Notes
On February 19, 2015, we closed the private placement of our 6.00% Notes, representing $65.0 million in aggregate principal. The sale of the 6.00% Notes resulted in proceeds of approximately $61.6 million, after deducting the initial purchaser's discount of $3.4 million. We also incurred offering costs of $0.6 million in connection with the 6.00% Notes. In August 2016, we entered into multiple privately negotiated agreements, pursuant to which all of our 6.00% Notes were canceled, and the indenture, dated as of February 19, 2015, by and between us and U.S. Bank National Association, pursuant to which the 6.00% Notes were issued, was satisfied and discharged. We issued in aggregate 34,659,972 shares of our common stock and made cash payments totaling $4.7 million in exchange for $65.0 million aggregate principal amount of our 6.00% Notes. These agreements are more fully discussed in Note 5, Convertible Notes to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Future Cash Requirements
As of December 30, 2017, we held $290.1 million in cash, cash equivalents and short-term investments, comprised of $157.2 million in cash and cash equivalents, and $133.0 million of short-term investments; and we had working capital of $428.1 million.

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Based on our current cash and cash equivalent balances, we believe that we have sufficient funds to support our operations through the next 12 months, including approximately $22 million to $32 million of capital expenditures that we expect to incur through the remainder of the current fiscal year.
In the event we need additional liquidity beyond our current expectations, such as to fund future growth or strengthen our balance sheet, we will explore additional sources of liquidity. These additional sources of liquidity could include one, or a combination, of the following: (i) issuing equity securities, (ii) incurring indebtedness secured by our assets, (iii) issuing debt and/or convertible debt securities, or (iv) selling product lines, other assets and/or portions of our business. Issuance of additional equity securities would dilute our existing investors and could contain terms that are senior to or that adversely impact our common stock. Incurring additional indebtedness or issuing debt and/or convertible debt securities would subject us to debt service expenses, and could subject us to restrictive covenants, potential events of default and other terms that could harm our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all.
For additional information on the risks we face related to future cash requirements, see Part II, Item 1A. Risk Factors under "We have a history of large operating losses. We may not be able to sustain profitability in the future and as a result we may not be able to maintain sufficient levels of liquidity," included elsewhere in this Quarterly Report on Form 10-Q.
As of December 30, 2017, $79.9 million of the $157.2 million of our cash, cash equivalents and restricted cash was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we could be required to accrue and pay additional taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S., except for specific entities in China and Germany where we decided to exit certain businesses.
Off-Balance Sheet Arrangements
We indemnify our directors and certain employees as permitted by law, and have entered into indemnification agreements with our directors and executive officers. We have not recorded a liability associated with these indemnification arrangements, as we historically have not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that we maintain, however, such insurance may not cover any, or may cover only a portion of, the amounts we may be required to pay. In addition, we may not be able to maintain such insurance coverage, in whole or in part, in the future.
We also have indemnification clauses in various contracts that we enter into in the normal course of business, such as indemnification in favor of customers in respect of liabilities they may incur as a result of purchasing our products should such products infringe the intellectual property rights of a third party. We have not historically paid out any material amounts related to these indemnifications; therefore, no accrual has been made for these indemnifications. See Note 7, Commitments and Contingencies for additional details.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our principal market risks are our exposure to changes in interest rates and certain exchange rates. We do not use risk sensitive instruments for trading purposes.
INTEREST RATES
We have financed our operations through a mixture of issuances of equity and debt securities, capital leases, working capital and by drawing on credit agreements. We have exposure to interest rate fluctuations on our money market funds, certain of our short-term investments and for amounts borrowed under our capital leases.
At December 30, 2017, we had $3.4 million due under our capital leases. An increase in our average interest rate by 1.0 percent would increase our annual interest expense in connection with our capital leases by less than $0.1 million.
We monitor our interest rate risk on our cash equivalents and short-term investment balances. At December 30, 2017, a 100 basis point increase in interest rates would reduce the market value of our cash equivalents and short-term investments by $0.4 million, while a 100 basis point decrease in interest rates would increase the market value of our cash equivalents and short-term investments by $0.4 million.
FOREIGN CURRENCY
As our business is multinational in scope, we are subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues and pay expenses. We expect that a majority of our revenues will be denominated in U.S. dollars, while a majority of our expenses will be denominated in the U.S. dollar, and to a lesser extent, the U.K. pound sterling and the Japanese yen. Fluctuations in the exchange rate between the U.S. dollar, the U.K. pound sterling, the Japanese yen and other currencies utilized by us to pay expenses, could affect our operating results. This includes the Chinese yuan and the Euro, which we utilize to pay factory expenses in connection with operating our facilities in Shenzhen and Shanghai, China; and San Donato, Italy, respectively. To the extent the exchange rate between the U.S. dollar and these currencies were to fluctuate more significantly than experienced to date, our exposure would increase.
Effective October 1, 2017, the functional currency for our worldwide operations is the U.S. dollar. Prior to October 1, 2017, the functional currency for each of our foreign subsidiaries was the respective local currency for that subsidiary. The change in our functional currency is a result of significant changes in economic facts and circumstances, including (i) a re-organization of our operating environment, which includes consolidating and integrating our sales, supply chain and manufacturing organizations; (ii) a transition to centrally negotiating worldwide supplier contracts and capital expenditures in U.S. dollars; and (iii) a shift to recording all intercompany transactions in U.S. dollars.
Translation adjustments reported prior to October 1, 2017, will remain as a component of accumulated other comprehensive income in our condensed consolidated balance sheet. The translated values for any non-monetary assets and liabilities as of October 1, 2017 become the new accounting basis for those assets.
Effective October 1, 2017, monetary assets and liabilities denominated in currencies other than the U.S. dollar functional currency are re-measured each reporting period into U.S. dollars, with the resulting exchange gains and losses reported in (gain) loss on foreign currency transactions, net within the condensed consolidated statement of operations.
As of December 30, 2017, certain of our foreign subsidiaries had $21.1 million in non-U.S. dollar denominated accounts payable, net of accounts receivable, related to sales to external customers and purchases from suppliers, and $18.6 million in non-U.S. dollar denominated cash accounts. It is estimated that a 10 percent fluctuation in the U.S. dollar relative to these other foreign currencies would lead to a profit of $0.3 million (U.S. dollar strengthening), or loss of $0.3 million (U.S. dollar weakening) on the translation of these balances, which would be recorded as gain (loss) on foreign currency transactions, net, in our condensed consolidated statement of operations.
HEDGING PROGRAM
From time to time, we enter into foreign currency forward contracts in an effort to mitigate a portion of our exposure to fluctuations between the U.S. dollar and the Japanese yen and between the U.S. dollar and the U.K. pound sterling. We do not currently hedge our exposure to the Chinese yuan or the Euro, but we may in the future if conditions warrant. We may be required to convert currencies to meet our obligations. Under certain circumstances, foreign currency forward contracts can have an adverse effect on our financial condition.
During the three and six months ended December 30, 2017, we entered into foreign currency forward exchange contracts, which expired in the same fiscal quarter in which they were established. In connection with these hedges, during the three and six months ended December 30, 2017, we recorded a $0.1 million gain and a $0.2 million gain, respectively, in gain (loss) on foreign currency

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transactions, net within our condensed consolidated statement of operations. As of December 30, 2017, we did not have any outstanding foreign currency forward contracts.
BANK LIQUIDITY RISK
As of December 30, 2017, we have approximately $85.9 million of unrestricted cash (excluding money market funds) in operating accounts that are held with domestic and international financial institutions. These cash balances could be lost or become inaccessible if the underlying financial institutions fail or if they are unable to meet the liquidity requirements of their depositors and they are not supported by the national government of the country in which such financial institution is located. Notwithstanding, to date, we have not incurred any losses and have had full access to our operating accounts. See Note 3, Balance Sheet Details. We believe any failures of domestic and international financial institutions could impact our ability to fund our operations in the short term.
As of December 30, 2017, $79.9 million of the $157.2 million of our cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we could be required to accrue and pay additional taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S., except for specific entities in China and Germany where we decided to exit certain businesses.

ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 30, 2017. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 30, 2017, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
There was no change in our internal control over financial reporting during the three months ended December 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Overview
In the ordinary course of business, we are involved in various legal proceedings, and we anticipate that additional actions will be brought against us in the future. The most significant of these proceedings are described below. These legal proceedings, as well as other matters, involve various aspects of our business and a variety of claims in various jurisdictions. Complex legal proceedings frequently extend for several years, and a number of the matters pending against us are at very early stages of the legal process. As a result, some pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to determine whether the proceeding is material to us or to estimate a range of possible loss, if any. Unless otherwise disclosed, we are unable to estimate the possible loss or range of loss for the legal proceedings described below. While it is not possible to accurately predict or determine the eventual outcome of these items, an adverse determination in these items currently pending could have a material adverse effect on our results of operations, financial position or cash flows.
Oyster Optics Litigation
On November 23, 2016, Oyster Optics LLC (“Oyster”) filed a civil suit against Cisco Systems, Inc. (“Cisco”) and British Telecommunications PLC (“BT”), in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01301. In the complaint, Oyster alleges that Cisco and BT infringed seven patents owned by Oyster, which patents allegedly relate to certain Cisco optical platform products, some of which may incorporate Oclaro components. Oyster subsequently dismissed its claim against BT without prejudice. In January 2017, Cisco requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Cisco. In April 2017, Oyster served infringement contentions on Cisco. Those infringement contentions identified certain Cisco products that do implicate Oclaro components that were the subject of those commercial agreements. Accordingly, in May 2017, Oclaro and Cisco preliminarily agreed to an allocation of the responsibilities for the costs of defense associated with Oyster’s claims. However, due to the uncertainty regarding the infringement allegations that Oyster may present at trial and the resultant uncertainty regarding the number of Oclaro components that may be implicated by such infringement allegations, Oclaro and Cisco agreed to defer until the conclusion of the litigation the final determination of whether and to what extent Oclaro will indemnify Cisco for any amounts Cisco may be required to pay Oyster and Cisco’s related defense costs. On May 18, 2017, Oyster’s case against Cisco was consolidated with cases that Oyster brought against other parties. On June 1, 2017, Cisco filed a motion to transfer Oyster’s case against it to the Northern District of California, which was denied on December 8, 2017. A claim construction hearing was held on November 20, 2017, and the court issued its Claim Construction Order on December 5, 2017. The parties have exchanged opening and responsive expert reports regarding infringement, invalidity and damages, and the deadline to file dispositive motions is February 26, 2018. In its expert report regarding infringement, Oyster alleges Cisco infringes only two of the seven previously asserted patents. Trial proceedings are set to begin June 4, 2018 in the consolidated cases. Discovery in the consolidated cases closed on December 22, 2017. Allegedly based on that discovery, Oyster sought to amend its infringement contentions to accuse additional Cisco products. To date, no such amendments have been agreed to by Cisco or ordered by the Court. Oyster nonetheless has included, to some extent, some of its proposed amended contentions in its expert reports. At the close of discovery, Oyster moved to compel Cisco to produce financial information relating to these additional Cisco products. That motion is fully briefed and awaiting decision. If the Court grants Oyster’s motion, or otherwise permits the amendment(s) it previously sought, Oyster could pursue claims accusing Cisco products that implicate certain Oclaro components that are the subject of commercial agreements between Oclaro and Cisco. Cisco and Oclaro filed Petitions for inter partes review of the patents that Oyster is asserting against Cisco with the U.S. Patent Office on June 20, July 27, and September 27, 2017. Oyster has filed its Preliminary Patent Owner's Response to each of the petitions. On January 23, 2018 and January 26, 2018, the Patent Office issued its Institution Decisions for two of the patents, instituting inter partes review on some of the challenged claims for each and denying institution for others. The Patent Office has not yet made any Institution Decisions on the remaining petitions.

On November 24, 2016, Oyster also filed a civil suit against Coriant America Inc. (“Coriant”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-cv-01302. In the complaint against Coriant, Oyster alleges that Coriant has infringed the same seven patents that were asserted against Cisco. On May 18, 2017, Oyster’s case against Coriant was consolidated with cases that Oyster brought against other parties, including Cisco. As a result, the November 20, 2017 consolidated claim construction hearing and order, December 22, 2017 close of fact discovery, February 26, 2018 deadline for dispositive motions, and the June 4, 2018 date for the commencement of trial described above also apply to the litigation against Coriant. On December 21, 2017 Coriant requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Coriant. Oclaro has refused this request for reasons including that Oyster’s claims against Coriant do not clearly implicate Oclaro products and that Coriant’s request was not timely made. Coriant has stated their disagreement with this position. As a result, Oclaro remains in discussions with Coriant regarding Coriant’s request for defense and indemnification.

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Oyster also filed a civil suit on November 24, 2016 against Ciena Corporation (“Ciena”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01300. In the complaint against Ciena, Oyster alleges that Ciena has infringed the same seven patents that were asserted against Cisco. On June 15, 2017, Ciena filed a motion to transfer Oyster’s case against it to the Northern District of California. On September 22, 2017, the Court granted Ciena’s motion. On January 4, 2018, Ciena filed a motion to stay pending inter partes review of the Oyster patents. The Court granted Ciena’s motion to stay on January 29, 2018. The case is currently stayed and the parties have been ordered to file a joint status report on June 1, 2018 reporting on the status of the inter partes review proceedings. On October 16, 2017, Ciena requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Ciena. Oclaro refused this request for reasons including that Oyster's claims against Ciena do not clearly implicate Oclaro products and that Ciena's request was not timely made.
Kunst Worker Compensation Matter
On June 18, 2015, Gerald Kunst, or Kunst, filed a civil suit against us and Travelers Property Casualty Company of America, or Travelers, in Massachusetts Superior Court, Civil Action No. SUCV2015-01818F. Travelers is our general liability insurance carrier. The complaint filed by Kunst, an employee of a third party service provider, alleges that he was injured while performing air conditioning repair services on the premises of our Acton, Massachusetts facility and seeks judgment in an amount to be determined by the court or jury, together with interest and costs. On July 24, 2015, we filed an answer to the complaint, which included our affirmative defenses. Following a mediation held on October 30, 2017, the parties contingently agreed on terms for a settlement of all claims in the case, subject to final documentation and judicial approval. The terms for settlement and release of all claims were approved by the Administrative Law Judge (Department of Industrial Accidents, Division of Dispute Resolution) on November 20, 2017 and a stipulation of dismissal with prejudice was filed on December 14, 2017 in the Massachusetts Superior Court.  Oclaro was not liable for any payments under the terms of the settlement.

ITEM 1A. RISK FACTORS
Investing in our securities involves a high degree of risk. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity and stock price materially and adversely. You should carefully consider the risks and uncertainties described below in addition to the other information included or incorporated by reference in this Quarterly Report on Form 10-Q. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall and you could lose all or part of your investment.
We depend on a limited number of customers for a significant percentage of our revenues and the loss of a major customer could have a materially adverse impact on our financial condition.
Historically, we have generated most of our revenues from a limited number of customers. Our dependence on a limited number of customers is due to the fact that the optical telecommunications and data communications systems industries are dominated by a small number of large companies. These companies in turn depend primarily on a limited number of major telecommunications carrier and data center customers to purchase their products that incorporate our optical components. The industry in which our customers operate is subject to a trend of consolidation. To the extent this trend continues, we may become dependent on even fewer customers to maintain and grow our revenues.
During the first half of fiscal 2018 and for fiscal years ended July 1, 2017 and July 2, 2016, our three largest customers accounted for 40 percent, 50 percent and 44 percent of our revenues, respectively. Because we rely on a limited number of customers for a significant percentage of our revenues, a decrease in demand for our products from any of our major customers for any reason (including due to datacenter and telecom market conditions, customer inventory buildup, catastrophic events, changes in network architecture, government action or otherwise) could have a material adverse impact on our financial condition and results of operations. For example, as discussed below, in early March 2016, we temporarily ceased shipment of products to Zhongxing Telecommunications Equipment Corporation and its subsidiary, ZTE Kangxun Telecommunications Ltd. (collectively, "ZTE"), one of our significant customers, because the U.S. Department of Commerce (the "DOC") imposed additional licensing restrictions.
The markets in which we operate are highly competitive, which could result in lost sales and lower revenues.
The market for optical components and modules is highly competitive and this competition could result in our existing customers moving their orders to our competitors. We are aware of a number of companies that have developed or are developing optical component products, including tunable lasers, pluggable components, modulators and subsystems, among others, that compete directly with our current and proposed product offerings.
Certain of our competitors may be able to more quickly and effectively: 
develop or respond to new technologies or technical standards;

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react to changing customer requirements and expectations;
devote needed resources to the development, production, promotion and sale of products;
attain high manufacturing yields on new product designs; and
deliver competitive products at lower prices.
Some of our current competitors, as well as some of our potential competitors in adjacent industries such as semiconductors and data communications, have longer operating histories, greater name recognition, broader customer relationships, product offerings and industry alliances and substantially greater financial, technical and marketing resources than we do. Our competitors and new Chinese companies are establishing manufacturing operations in China and other Asian countries to take advantage of comparatively low manufacturing costs, which could enable them to reduce their costs and lower their prices, making their products more competitive than ours.
In addition, network equipment manufacturers and service providers may decide to design and manufacture the optical module and subsystems portions of their products in-house, rather than outsourcing to companies like us. This type of product disaggregation could result in lower revenues and materially and adversely affect our business.
All of these risks may be increased if the market were to further consolidate through mergers or other business combinations between our competitors. We may not be able to compete successfully with our competitors and aggressive competition in the market may result in lower prices for our products, fewer design wins and/or decreased gross margins. Any such development could have a material adverse effect on our business, financial condition and results of operations.
Many of our long-term customer contracts do not commit customers to specified buying levels, and our customers may decrease, cancel or delay their buying levels at any time with little or no advance notice to us.
Many of our customers typically purchase our products pursuant to individual purchase orders or contracts that do not contain purchase commitments. Some customers provide us with their expected forecasts for our products several months in advance, but these customers may decrease, cancel or delay purchase orders already in place, including on short notice, and the impact of any such actions may be intensified given our dependence on a small number of large customers. If any of our major customers decrease, stop or delay purchasing our products for any reason, our business and results of operations would be harmed. Cancellation or delays of such orders may result in excess and obsolete inventory and charges therefor and cause us to fail to achieve our short-term and long-term financial and operating goals.
Our results of operations may suffer if we do not effectively manage our inventory, and we may continue to incur inventory-related charges.
We need to manage our inventory of component parts and finished goods effectively to meet changing customer requirements and demand. Some of our products and supplies have in the past, and may in the future, become obsolete or be deemed excess while in inventory due to rapidly changing customer specifications or a decrease in customer demand. We also have exposure to contractual liabilities to our contract manufacturers for inventories purchased by them on our behalf, based on our forecasted requirements, which may become excess or obsolete. Our inventory balances also represent an investment of cash. To the extent our inventory turns are slower than we anticipate based