Item 1B.
Unresolved Staff Comments
None.
Our principal properties as of July 2, 2011 are set forth below:
In addition to the above properties, we also own and/or lease administrative, manufacturing and research and development facilities in Shanghai, China (24,000 square feet); Acton, Massachusetts (23,000 square feet); Paignton, United Kingdom (18,000 square feet); Tucson, Arizona (15,000 square feet); Horseheads, New York (15,000 square feet); Daejeon, South Korea (7,000 square feet); Denville, New Jersey (6,000 square feet); Jerusalem, Israel (5,000 square feet) and Ottawa, Canada (4,000 square feet), with lease expiration dates ranging from September 2012 to December 2017.
As of July 2, 2011, we owned or leased a total of approximately 0.8 million square feet worldwide, including the locations listed above. We believe that our properties are adequate to meet our business needs.
On June 26, 2001, the first of a number of securities class actions was filed in the United States District Court for the Southern District of New York against New Focus, Inc., now known as Oclaro Photonics, Inc. (“New Focus”), certain of our officers and directors, and certain underwriters for New Focus’ initial and secondary public offerings. A consolidated amended class action complaint, captioned In re New Focus, Inc. Initial Public Offering Securities Litigation, No. 01 Civ. 5822, was filed on April 20, 2002. The complaint generally alleges that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in New Focus’ initial public offering and seeks unspecified damages for claims under the Exchange Act on behalf of a purported class of purchasers of common stock from May 17, 2000 to December 6, 2000.
The lawsuit against New Focus is coordinated for pretrial proceedings with a number of other pending litigations challenging underwriter practices in over 300 cases, as In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS), including actions against Bookham Technology plc, now known as Oclaro Technology Ltd (“Bookham Technology”) and Avanex Corporation, now known as Oclaro (North America), Inc. (“Avanex”), and certain of each entity’s respective officers and directors, and certain of the underwriters of their public offerings. In October 2002, the claims against the directors and officers of New Focus, Bookham Technology and Avanex were dismissed, without prejudice, subject to the directors’ and officers’ execution of tolling agreements.
The parties have reached a global settlement of the litigation. On October 5, 2009, the Court entered an order certifying a settlement class and granting final approval of the settlement. Under the settlement, the insurers will pay the full amount of the settlement share allocated to New Focus, Bookham Technology and Avanex, and New Focus, Bookham Technology and Avanex will bear no financial liability. New Focus, Bookham Technology and Avanex, as well as the officer and director defendants who were previously dismissed from the action pursuant to tolling agreements, will receive complete dismissals from the case. Certain objectors have appealed the Court’s October 5, 2009 order to the Second Circuit Court of Appeals. If for any reason the settlement does not become effective, we believe that Bookham Technology, New Focus and Avanex have meritorious defenses to the claims and therefore believe that such claims will not have a material effect on our financial position, results of operations or cash flows.
On December 6, 2010, a bankruptcy preferential transfer avoidance action was filed by Nortel Networks Inc. et al. against Oclaro Technology Ltd. (formerly Bookham Technology Plc.) and Oclaro (North America), Inc. (formerly Avanex Corporation) in the United States Bankruptcy Court for the District of Delaware, Adversary Proceeding No. 10-55919-KG. The complaint alleges, among other things, that Nortel Networks Inc., and/or its affiliated debtors in the Chapter 11 bankruptcy cases also pending before the Delaware Bankruptcy Court (Jointly Administered Case No. 09-10138-KG), made at least $4,593,152 in preferential transfers to the defendants’ predecessors, Bookham Technology Plc. and Avanex Corporation, in the 90 days prior to the commencement of the Nortel Chapter 11 bankruptcy cases on January 14, 2009. We intend to vigorously contest the claims set forth in the complaint.
On May 19, 2011, Curtis and Charlotte Westley filed a purported class action complaint in the United States District Court for the Northern District of California, against us and certain of our officers and directors, allegedly on behalf of persons who purchased or otherwise acquired our common stock between May 6 and October 27, 2010. The complaint, captioned as Westley v. Oclaro, Inc., No. 11 Civ. 2448 EMC (N.D. Cal. filed May 19, 2011), alleges generally that defendants issued materially false and misleading statements during the relevant time period regarding our current business and financial condition, including projections for our revenues, earnings, and gross margins, for the first quarter of fiscal year 2011 as well as the full fiscal year. The complaint alleges violations of section 10(b) of the Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, as well as section 20(a) of the Securities Exchange Act. The complaint seeks damages and costs of an unspecified amount. Discovery has not commenced, and no trial has been scheduled in this action. We intend to defend this litigation vigorously.
On June 10, 2011, a purported shareholder, Stanley Moskal, filed a purported derivative action in the Superior Court for the State of California, County of Santa Clara, against us, as nominal defendant, and certain of our current and former officers and directors, as defendants. The case is styled Moskal v. Couder, No. 1:11 CV 202880 (Santa Clara County Super. Ct. filed June 10, 2011). Four other purported shareholders, Matteo Guindani, Jermaine Coney, Jefferson Braman and Toby Aguilar, separately filed substantially similar lawsuits in the United States District Court for the Northern District of California on June 27, June 28, July 7 and July 26, 2011, respectively. The cases are styled Guindani v. Couder, No. 11 Civ. 3176 PSG (N.D. Cal. filed June 27, 2011), Coney v. Couder, No. 11 Civ. 3214 HRL (N.D. Cal. filed June 28, 2011), and Braman v. Couillaud, No. 11 Civ. 3322 RS (N.D. Cal. filed July 7, 2011), and Aguilar v. Couillaud, No. 11 Civ. 3668 EDL (N.D. Cal. filed July 26, 2011). Each purported derivative complaint alleges that Oclaro has been, or will be, damaged by the actions alleged in the Westley complaint, and the litigation of the Westley action, and any damages or settlement paid in the Westley action. Each purported derivative complaint alleges counts for breaches of fiduciary duty, waste, and unjust enrichment. Additionally, the complaint in Aguilar alleges claims for contribution pursuant to Sections 10(b) and 21D of the Securities and Exchange Act, and Securities and Exchange Commission Rule 10b-5, and Section 20(a) of the Securities Exchange Act. Each purported derivative complaint seeks damages and costs of an unspecified amount, as well as injunctive relief. Discovery has not commenced, and no trial has been scheduled in any of these actions. We intend to defend this litigation vigorously.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders
Our common stock is currently quoted on the NASDAQ Global Select Market under the symbol “OCLR.” The following table shows, for the periods indicated, the high and low sale prices of our common stock as reported on the NASDAQ Global Select Market on and subsequent to January 3, 2011 and the NASDAQ Global Market prior to January 3, 2011.
On September 6, 2011, the closing sale price of our common stock as reported on the NASDAQ Global Select Market was $4.30 per share. According to the records of our transfer agent, there were 9,819 stockholders of record of our common stock on September 6, 2011. A substantially greater number of holders of our common stock are “street name” or beneficial owners, whose shares of record are held by banks, brokers and other financial institutions.
Dividends
We have never paid cash dividends on our common stock or ordinary shares. To the extent we generate earnings, we intend to retain them for use in our business and, therefore, do not anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, our credit facility with Wells Fargo Capital Finance, Inc. contains restrictions on our ability to pay cash dividends on our common stock.
Comparison of Stockholder Return
The following graph compares the cumulative five-year total return provided shareholders on Oclaro, Inc.’s common stock relative to the cumulative total returns of the NASDAQ Composite Index and the NASDAQ Telecommunications Index.
Comparison of Five-Year Cumulative Total Return*
Among Oclaro, Inc., the NASDAQ Composite Index
and the NASDAQ Telecommunications Index
*
Assumes that $100.00 was invested in Oclaro common stock and in each index at market closing prices on July 1, 2006, and that all dividends were reinvested. No cash dividends have been declared on our common stock. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
The selected financial data set forth below should be read in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.
The selected financial data set forth below at July 2, 2011 and July 3, 2010, and for the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, are derived from our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected financial data at June 27, 2009, June 28, 2008 and June 30, 2007, and for the fiscal years ended June 28, 2008 and June 30, 2007 are derived from audited financial statements not included in this Annual Report on Form 10-K, after giving effect to the discontinued operations of our New Focus business. On April 29, 2010, we effected a 1-for-5 reverse split of our common stock. All share and per share amounts presented below are reflected on a post-reverse-split basis.
Consolidated Statements of Operations Data
Consolidated Balance Sheet Data
The following items affect the comparability of our financial data for the periods shown in the consolidated statements of operations data above:
Revenues, operating income (loss), income (loss) from continuing operations and net income (loss) in fiscal years 2011, 2010 and 2009 include the revenues, costs of revenues and operating expenses of Avanex from April 27, 2009, the date of the merger. Operating losses for fiscal years ended July 2, 2011 and June 27, 2009 include $20.0 million and $9.1 million in recognition of impairment of goodwill and other intangible assets as more fully discussed in Note 4, Goodwill and Other Intangible Assets, to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Income (loss) from discontinued operations corresponds to the net operating results of our New Focus business, which was sold to Newport in the exchange of assets that closed in July 2009, as more fully discussed in Note 3, Business Combinations, to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Risk Factors” appearing in Item 1A of this Annual Report on Form 10-K, “Selected Financial Data” appearing in Item 6
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Interest rates
We finance our operations through a mixture of issuances of equity securities, finance leases, working capital and by drawing on our Credit Agreement. Our only exposure to interest rate fluctuations is on our cash deposits and for amounts borrowed under our Credit Agreement. At July 2, 2011 there was no amount outstanding under our Credit Agreement. As of July 2, 2011, we had $1.1 million in three outstanding standby letters of credit with vendors secured under our Credit Agreement.
We monitor our interest rate risk on cash balances primarily through cash flow forecasting. Cash that is surplus to immediate requirements is invested in short-term deposits with banks accessible with one day’s notice and invested in overnight money market accounts. We believe our current interest rate risk is immaterial.
Foreign currency
As our business has grown and become multinational in scope, we have become increasingly subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues and pay expenses. Despite our change in domicile from the United Kingdom to the United States in 2004, and our movement of certain functions, including assembly and test operations, from the United Kingdom to China, in the future we expect that a majority of our revenues will continue to be denominated in U.S. dollars, while a significant portion of our expenses will continue to be denominated in U.K. pounds sterling and the Swiss franc. Fluctuations in the exchange rate between the U.S. dollar, the U.K. pound sterling and the Swiss franc and, to a lesser extent, other currencies in which we collect revenues and pay expenses, could affect our operating results. This includes the Chinese yuan, the Korean won, the Israeli shekel and the Euro in which we pay expenses in connection with operating our facilities in Shenzhen and Shanghai, China; Daejeon, South Korea; Jerusalem, Israel and San Donato, Italy. 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.
As of July 2, 2011, our U.K. subsidiary had $45.3 million, net, in U.S. dollar denominated operating intercompany payables and $59.5 million in U.S. dollar denominated accounts receivable related to sales to external customers. It is estimated that a 10 percent fluctuation in the U.S. dollar relative to the U.K. pound sterling would lead to a profit of $1.4 million (U.S. dollar strengthening), or loss of $1.4 million (U.S. dollar weakening) on the translation of these receivables, which would be recorded as gain (loss) on foreign exchange in our consolidated statement of operations.
Hedging Program
We enter into foreign currency forward exchange contracts in an effort to mitigate a portion of our exposure to such fluctuations between the U.S. dollar and the U.K. pound sterling. We do not currently hedge our exposure to the Chinese yuan, Korean won, Israeli shekel, Swiss franc or the Euro, but we may in the future if conditions warrant. We also do not currently hedge our exposure related to our U.S. dollar denominated intercompany payables and receivables. We may be required to convert currencies to meet our obligations. Under certain circumstances, foreign currency forward exchange contracts can have an adverse effect on our financial condition. As of July 2, 2011, we held five foreign currency forward exchange contracts with a notional value of $4.0 million which include put and call options which expire, or expired, at various dates from July 2011 to November 2011 and we have recorded an unrealized gain of $0.1 million to accumulated other comprehensive income in connection with marking these contracts to fair value. It is estimated that a 10 percent fluctuation in the dollar between July 2, 2011 and the maturity dates of the put and call instruments underlying these contracts would lead to a profit of $0.4 million (U.S. dollar weakening) or break-even (U.S. dollar strengthening) on our outstanding foreign currency forward exchange contracts, should they be held to maturity.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The financial statements required by this item may be found on pages through of this Annual Report on Form 10-K.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
(a) Evaluation of Disclosure 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 July 2, 2011. 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 Chief Executive Officer and Chief Financial Officer, as the principal executive and 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 necessarily 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 July 2, 2011, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Management’s report on our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) is included immediately below and is incorporated herein by reference.
(b) Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements, fraud or the results of fraud. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of July 2, 2011. In making its assessment of internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework.
Based on our assessment, management concluded that, as of July 2, 2011, our internal control over financial reporting is effective based on these criteria.
Our independent registered public accounting firm has issued an attestation report on the effectiveness of our internal control over financial reporting. This report appears under Item 8 of this Annual Report on Form 10-K.
(c) Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the most recent fiscal quarter ended July 2, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Information required by this Item is incorporated by reference to the information contained in our definitive Proxy Statement for our 2011 Annual Meeting of Stockholders under the headings “Proposal 1 - Election of Class I Directors,” “Corporate Governance,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Code of Business Conduct and Ethics” and “Non-Director Executive Officers.”
Information required by this Item is incorporated by reference to the information contained in our definitive Proxy Statement for our 2011 Annual Meeting of Stockholders under the headings “Executive Compensation,” “Director Compensation,” “Compensation Committee Interlocks and Insider Participation,” “Compensation Committee Report,” and “Employment, Change of Control and Severance Arrangements.”
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this Item is incorporated by reference to the information contained in our definitive Proxy Statement for our 2011 Annual Meeting of Stockholders under the headings “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information.”
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Information required by this Item is incorporated by reference to the information contained in our definitive Proxy Statement for our 2011 Annual Meeting of Stockholders under the headings “Policies and Procedures for Related Person Transactions,” “Board Determination of Independence,” “Employment, Change of Control and Severance Arrangements,” “Proposal 1 - Election of Class I Directors,” and “Corporate Governance.”
Item 14.
Item 14.
Principal Accounting Fees and Services
Information required by this Item is incorporated by reference to the information contained in our definitive Proxy Statement for our 2011 Annual Meeting of Stockholders under the headings “Principal Accounting Fees and Services” and “Pre-Approval Policies and Procedures.”
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(a) The following documents are filed as part of or are included in this Annual Report on Form 10-K:
1. Financial Statements
See Index to Consolidated Financial Statements on page of this Annual Report on Form 10-K.
2. Financial Statement Schedules
The Financial Statement Schedule II: Valuation and Qualifying Accounts that follows the Notes to Consolidated Financial Statements is filed as part of this Annual Report Form 10-K. Other financial statement schedules have been omitted since they are either not required or the information is otherwise included.
3. List of Exhibits
The Exhibits filed as part of this Annual Report on Form 10-K, or incorporated by reference, are listed on the Exhibit Index immediately preceding such Exhibits, which Exhibit Index is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Oclaro, Inc.
We have audited the accompanying consolidated balance sheets of Oclaro, Inc. (a Delaware corporation) and subsidiaries as of July 2, 2011 and July 3, 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended July 2, 2011. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15 (a) (2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Oclaro, Inc. and subsidiaries as of July 2, 2011 and July 3, 2010, and the results of their operations and their cash flows for each of the three years in the period ended July 2, 2011 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Oclaro, Inc. and subsidiaries’ internal control over financial reporting as of July 2, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated September 9, 2011, expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
San Francisco, California
September 9, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Oclaro, Inc.
We have audited Oclaro, Inc. (a Delaware corporation) and subsidiaries’ internal control over financial reporting as of July 2, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Oclaro, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Oclaro Inc.’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Oclaro, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of July 2, 2011, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Oclaro, Inc. and subsidiaries as of July 2, 2011 and July 3, 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended July 2, 2011. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). Our report dated September 9, 2011 expressed an unqualified opinion thereon.
/s/ GRANT THORNTON LLP
San Francisco, California
September 9, 2011
OCLARO, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes form an integral part of these consolidated financial statements.
OCLARO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes form an integral part of these consolidated financial statements.
OCLARO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes form an integral part of these consolidated financial statements.
OCLARO, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
The accompanying notes form an integral part of these consolidated financial statements.
OCLARO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Business and Summary of Significant Accounting Policies
Business
Oclaro, Inc., a Delaware corporation (“Oclaro,” “we,” or “our”), is a leading provider of high-performance core optical network components, modules and subsystems to global telecommunications (“telecom”) equipment manufacturers. We leverage our proprietary core technologies and vertically integrated product development to provide our customers with cost-effective and innovative optical solutions in metro and long-haul network applications. In addition, we utilize our optical expertise to address new and emerging optical product opportunities in selective non-telecom markets, such as materials processing, consumer, medical, industrial, printing and biotechnology. We offer our customers a differentiated solution that is designed to make it easier for our customers to do business by combining optical technology innovation, photonic integration, and a vertical approach to manufacturing and product development.
On April 27, 2009, Oclaro, at the time named Bookham, Inc. (“Bookham”), and Avanex Corporation (“Avanex”) completed a merger of Avanex with and into a subsidiary of Bookham with Avanex being the surviving corporation as a wholly-owned subsidiary of Bookham.
In a separate transaction that also occurred on April 27, 2009, following the closing of the merger of Avanex into a subsidiary of Bookham, Bookham changed its name to Oclaro, Inc. This name change was effected pursuant to Section 253 of the General Corporation Law of the State of Delaware by the merger of a wholly-owned subsidiary of Bookham (“the Subsidiary”) into Bookham. Bookham was the surviving corporation in this merger with the Subsidiary and, in connection with the merger, amended its Restated Certificate of Incorporation to change its name to Oclaro, Inc. pursuant to a Certificate of Ownership and Merger filed on April 27, 2009 with the Secretary of State of the State of Delaware. References herein to “Oclaro,” “we” or “our” mean Bookham and its subsidiaries’ consolidated business activities prior to April 27, 2009 and Oclaro and its subsidiaries’ consolidated business activities since April 27, 2009. Subsequent to the merger, Avanex changed its name to Oclaro (North America), Inc. All references to “Avanex” in time periods after the merger refer to Oclaro (North America), Inc.
Basis of Presentation
The consolidated financial statements include the accounts of Oclaro and our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Up to and through the second quarter of fiscal year 2011, we were organized and operated as two operating segments: (i) telecom and (ii) advanced photonics solutions (“APS”). In late calendar 2010, we aligned our APS portfolio to more fully leverage the assets of our telecom business. Our APS products, strategies and infrastructure support are now more closely aligned with the rest of our telecom business, and beginning in the third quarter of fiscal year 2011 we have operated our business accordingly, under the same management. As a result, beginning in the third quarter of fiscal year 2011 we no longer report APS as a separate operating segment.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued guidance now codified as FASB Accounting Standards Codification (“ASC”) Topic 105, Generally Accepted Accounting Principles. ASC Topic 105 establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative accounting principles generally accepted in the United States of America (“U.S. GAAP”). Under the Codification, all existing accounting standards and pronouncements were superseded and reorganized into a consistent structure arranged by topic, subtopic, section and paragraph. Since the Codification did not change or alter existing U.S. GAAP, it did not have any impact on our consolidated financial statements; however, it changed the way references to accounting standards and pronouncements are presented. The provisions of ASC Topic 105 were adopted by us in the first quarter of fiscal year 2010. References made to FASB guidance throughout this Annual Report on Form 10-K refer to the Codification.
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 goodwill and long-lived assets, the fair value of purchase consideration paid, assets acquired and liabilities assumed in business combinations, valuation allowances for deferred tax assets, the fair value of stock-based compensation, 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.
Fiscal Years
We operate on a 52/53 week year ending on the Saturday closest to June 30. Each of the fiscal years ended July 2, 2011 and June 27, 2009 were 52 week years. Our fiscal year ended July 3, 2010 was a 53 week year.
Cash and Cash Equivalents
Cash and cash equivalents are carried at market value. We consider all liquid investment securities with an original maturity date of three months or less to be cash equivalents. Any realized gains and losses on liquid investment securities are included in other income (expense) in our consolidated statements of operations. Restricted cash of $0.6 million as of July 2, 2011 consists of collateral for the performance of our obligations under certain facility lease agreements and bank accounts otherwise restricted.
The following table provides details regarding our cash and cash equivalents at the dates indicated:
Concentration of Credit Risks
We place our cash and cash equivalents with and in the custody of financial institutions which at times, are in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC). Management monitors the ongoing creditworthiness of these institutions. Our investment policy limits the amounts invested with any one institution, type of security and issuer. To date, we have not experienced significant losses on these investments.
Our trade accounts receivable are concentrated with companies in the telecom industry. At July 2, 2011, no customer accounted for 10 percent or more of our gross accounts receivable. At July 3, 2010, two customers accounted for a total of 29 percent of our gross accounts receivable.
Allowance for Doubtful Accounts and Sales Return Allowance
We perform ongoing credit evaluations of our customers and record specific allowances for doubtful accounts when a customer is unable to meet its financial obligations, as in the case of bankruptcy filings or deteriorated financial position. Estimates are used in determining allowances for customers based on factors such as current trends, the length of time the receivables are past due and historical collection experience. We write-off a receivable account when all rights, remedies and recourses against the account and its principals are exhausted and record a benefit when previously reserved accounts are collected. We recorded provisions of $0.6 million, $1.5 million and $0.2 million as allowances for doubtful accounts in fiscal years 2011, 2010 and 2009, respectively.
We record a provision for estimated sales returns, which is netted against revenues, in the same period as the related revenues are recorded. These estimates are based on historical sales returns, other known factors and our return policy. We recorded provisions of $0.6 million, $0.2 million and $0.1 million as sales return allowances in fiscal years 2011, 2010 and 2009, respectively.
Inventories
Inventories, consisting of raw materials, work-in-process and finished goods are stated at the lower of cost (first in, first out basis) or market. We plan production based on orders received and forecasted demand and maintain stock of certain items. These production estimates are dependent on assessment of current and expected orders from our customers, including consideration that orders are subject to cancellation with limited advance notice prior to shipment. We assess the valuation of our inventory, including significant inventories held by contract manufacturers on our behalf, on a quarterly basis. Products may be unsalable because they are technically obsolete due to substitute products, specification changes or excess inventory relative to customer forecasts. We adjust the carrying value of inventory using methods that take these factors into account. If we find that the cost basis of our inventory is greater than the current market value, we write the inventory down to the estimated selling price, less the estimated costs to complete and sell the product.
The following table provides details regarding our inventories at the dates indicated:
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method based upon the estimated useful lives of the assets, which generally range from three to five years, except for buildings which are generally depreciated over twenty years. Leasehold improvements are amortized using the straight-line method over the estimated useful lives or the term of the related lease, whichever is shorter. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are removed from the accounts. Gain or loss resulting from asset dispositions are included in (gain) loss on sale of property and equipment in the accompanying consolidated statements of operations. Repair and maintenance costs are expensed as incurred.
The following table provides details regarding our property and equipment, net at the dates indicated:
Depreciation expense was $15.3 million, $10.9 million and $11.0 million for the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, respectively.
Goodwill and Other Intangible Assets
We review our goodwill and other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable and also review goodwill annually. The values assigned to goodwill and other intangible assets are based on estimates and judgments regarding expectations for the success and life cycle of products and technologies acquired.
Goodwill is tested for impairment using a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the fair value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill is considered not impaired and no further testing is required. If the carrying value of the net assets assigned to a reporting unit exceeds the fair value of a reporting unit, a second step of the impairment test is performed whereby we hypothetically apply purchase accounting to the reporting unit using the fair values from the first step in order to determine the implied fair value of a reporting unit’s goodwill.
Non-Marketable Cost Method Investments
In May 2010, we made a $7.5 million investment in ClariPhy Communications, Inc. (“ClariPhy”), a privately-held company, receiving in exchange a less than 20 percent equity interest in ClariPhy. In addition, ClariPhy and Oclaro executed a co-marketing and development agreement under which we have the opportunity to increase our initial equity interest stake in ClariPhy through achievement of certain milestones related to this agreement. Achievement of the maximum additional equity interest in ClariPhy through the co-marketing and development agreement would still result in a less than 20 percent equity interest in ClariPhy.
As of July 2, 2011 and July 3, 2010, including the investment in ClariPhy, we had $8.7 million and $9.0 million, respectively, of investments in privately-held companies. These investments consist of less than 20 percent equity ownership interests of common stock and/or preferred stock in these companies and are accounted for under the cost method of accounting. These investments are included in other non-current assets in our consolidated balance sheets.
Derivative Financial Instruments
Our operating results are subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues and pay expenses. A majority of our revenues are denominated in U.S. dollars, while a significant portion of our expenses are denominated in United Kingdom (U.K.) pounds sterling, the Chinese yuan, Swiss franc, and the Euro, in which we pay expenses in connection with operating our facilities in the U.K., China, Switzerland and Italy. We currently enter into foreign currency forward exchange contracts in an effort to mitigate a portion of our exposure to fluctuations between the U.S. dollar and the U.K. pound sterling.
We recognize all derivatives, such as foreign currency forward exchange contracts, on our consolidated balance sheets at fair value regardless of the purpose for holding the instrument. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through operating results or recognized in accumulated other comprehensive income until the hedged item is recognized in operating results in our consolidated statements of operations.
Accrued Expenses and Other Liabilities
The following table provides details for our accrued expenses and other liabilities at the dates indicated:
(1)
Includes interest expense accrued during fiscal year 2011. In fiscal year 2011, we reclassified this escrow liability from other non-current liabilities to accrued expenses and other liabilities.
(2)
Includes interest expense accrued during fiscal year 2011. In fiscal year 2011, we reclassified the non-current portion of this earnout liability from other non-current liabilities to accrued expenses and other liabilities.
Warranty
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 will increase, resulting in a decrease in gross profit and a decrease in net income.
Revenue Recognition
We recognize product revenue when (i) persuasive evidence of an arrangement exists, (ii) the product has been shipped and title has transferred, (iii) collectability is reasonably assured, (iv) the fees are fixed or determinable and (v) there are no uncertainties with respect to customer acceptance. We record a provision for estimated sales returns in the same period as the related revenues are recorded, which is netted against revenue. These estimates are based on historical sales returns, other known factors and our return policy. We recognize revenues from financially distressed customers when collectability becomes reasonably assured, assuming all other above criteria for revenue recognition have been met.
In the second quarter of fiscal year 2009 we issued billings of $4.1 million for products that were shipped to Nortel Networks Corporation (“Nortel”), but for which payment was not received prior to Nortel’s bankruptcy filing on January 14, 2009. As a result, the corresponding revenue was deferred, and therefore was not recognized as revenues or accounts receivable in our consolidated financial statements at the time of such billings, as we determined that such amounts were not reasonably assured of collectability in accordance with our revenue recognition policy. In fiscal year 2009, we recognized revenues of $0.6 million from Nortel upon receipt of payment for billings which had been previously deferred and Nortel returned $0.8 million in products to us which had been shipped to Nortel prior to the bankruptcy filing and which had not been paid for by Nortel.
As of July 2, 2011, we had remaining contractual receivables from Nortel, associated with product shipments deferred as a result of Nortel’s January 14, 2009 bankruptcy filing, totaling $2.7 million, which are not reflected in the accompanying consolidated balance sheets. To the extent that collectability becomes reasonably assured for these deferred billings in future periods, our future results will benefit from the recognition of these amounts.
Research and Development Costs
Research and development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred. Our advertising costs for the years ended July 2, 2011, July 3, 2010 and June 27, 2009 were not significant.
Restructuring Expenses
We record costs associated with employee terminations and other exit activities when the liability is incurred. Employee termination benefits are recorded when the benefit arrangement is communicated to the employee and no significant future services are required. If employees are required to render service until they are terminated in order to receive the termination benefits, the fair value of the termination date liability is recognized ratably over the future service period. Lease cancellation and commitment costs are recorded when we make a formal decision to exit the facility. Lease cancellation and commitment costs are calculated using estimated future lease commitments less estimated sublease income, based on current market conditions.
Impairment of Long-Lived Assets
We review property and equipment and certain identifiable intangibles, excluding goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable on an annual basis. Recoverability of these assets is measured by comparing their carrying amounts to market prices or the future undiscounted cash flows the assets are expected to generate. If property and equipment or certain identifiable intangibles are considered to be impaired, the impairment to be recognized would equal the amount by which the carrying value of the asset exceeds its fair market value based on market prices or future discounted cash flows.
Our goodwill and intangible assets with indefinite useful lives are tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that they may be impaired.
Intangible assets with definite lives are amortized over their estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate an asset’s carrying value may not be recoverable. We amortize our acquired intangible assets with definite lives over the estimated useful life of the assets, which is generally from 1.5 to 11.5 years and 15 years as to one specific customer contract.
Stock-Based Compensation
We use the Black-Scholes-Merton option pricing model to value the compensation expense associated with our stock-based awards. In addition, we estimate forfeitures when recognizing compensation expense, and we adjust our estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.
Stock options have a term of seven to ten years and generally vest over a two to four year service period, and restricted stock awards generally vest over a one to four year 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.
Foreign Currency Transactions and Translation Gains and Losses
The assets and liabilities of our foreign operations are translated from their respective functional currencies into U.S. dollars at the rates in effect at the consolidated balance sheet dates, and revenue and expense amounts are translated at the average rate during the applicable periods reflected on the consolidated statements of operations. Foreign currency translation adjustments are recorded as accumulated other comprehensive income, except for the translation adjustment of short-term intercompany loans which are recorded as other income or expense. Gains and losses from foreign currency transactions, realized and unrealized in the event of foreign currency transactions not designated as hedges, and those transactions denominated in currencies other than our functional currency, are recorded as gain (loss) on foreign currency translation in our consolidated statements of operations.
Income Taxes
We account for income taxes using an asset and liability based approach. Deferred income tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Valuation allowances are provided against deferred income tax assets which are not likely to be realized.
Net Income (Loss) Per Share
Basic net income (loss) per share is computed using only the weighted-average number of shares of common stock outstanding for the applicable period, while diluted net income (loss) per share is computed assuming conversion of all potentially dilutive securities, such as stock options, unvested restricted stock awards, warrants and obligations under escrow agreements during such period. For the fiscal years ended July 2, 2011 and June 27, 2009, there were no stock options, unvested restricted stock awards, warrants or obligations under escrow agreements factored into the computation of diluted shares outstanding since we incurred a net loss in these periods which would have resulted in their inclusion having an anti-dilutive effect.
Recent Accounting Pronouncements
With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements that are of significance, or of potential significance, to us.
In December 2010, the FASB issued ASU No. 2010-29, which updates accounting guidance to clarify that pro forma disclosures should be presented as if a business combination occurred at the beginning of the prior annual period for purposes of preparing both the current reporting period and the prior reporting period pro forma financial information. These disclosures should be accompanied by a narrative description about the nature and amount of material, nonrecurring pro forma adjustments. ASU No. 2010-29 will be effective from the beginning of our fiscal year 2012. The adoption of this update will not have any effect on our consolidated financial statements as we currently present pro forma financial information in accordance with the disclosure requirements of ASU No. 2010-29.
In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04, an amendment to ASC Topic 820, Fair Value Measurements, providing a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles, clarifies the application of existing fair value measurement and expands the ASC Topic 820 disclosure requirements, particularly for Level 3 fair value measurements. This amendment will be effective for our fiscal quarter beginning January 1, 2012. The adoption of this amendment is not expected to have a material effect on our consolidated financial statements, but may require certain additional disclosures.
In June 2011, the FASB issued ASU No. 2011-05, which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of our statement of stockholders’ equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income that contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU No. 2011-05 will be effective for our fiscal year beginning July 1, 2013. The adoption of this update will not have an impact on our consolidated financial position, results of operations or cash flows as it only requires a change in the format of our current presentation.
Note 2. Fair Value
We define fair value as the 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 non-current marketable securities 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 marketable securities and money market securities. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instrument valued based on other observable inputs are foreign currency forward exchange contracts. Such instruments are generally classified within Level 2 of the fair value hierarchy.
During fiscal year 2011, we classified earnout liabilities arising from our acquisition of Mintera Corporation (“Mintera”) within Level 3 of the fair value hierarchy because their values were primarily derived from management estimates of future operating results. See Note 3, Business Combinations, for additional details regarding these liabilities.
We have a defined benefit pension plan in Switzerland whose assets are classified within Level 1 of the fair value hierarchy for plan assets of cash, equity investments and fixed income investments, and Level 3 of the fair value hierarchy for plan assets of real estate and alternative investments. These pension plan assets are not reflected in the accompanying consolidated balance sheets, and are thus not included in the tables below.
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 July 2, 2011:
The following table provides details regarding the changes in assets and liabilities classified within Level 3 from July 3, 2010 to July 2, 2011:
(1)
In fiscal year 2011, we reclassified the non-current portion of this earnout liability from other non-current liabilities to accrued expenses and other liabilities.
Derivative Financial Instruments
At the end of each accounting period, we mark-to-market all foreign currency forward exchange contracts that have been designated as cash flow hedges and changes in fair value are recorded in accumulated other comprehensive income until the underlying cash flow is settled and the contract is recognized in other income (expense) in our consolidated statements of operations. As of July 2, 2011, we held five outstanding foreign currency forward exchange contracts to sell U.S. dollars and buy U.K. pounds sterling. All of these contracts have been designated as cash flow hedges. These contracts had an aggregate notional value of approximately $4.0 million of put and call options which expire at various dates ranging from July 2011 through November 2011. To date, we have not entered into any such contracts for longer than 12 months and, accordingly, all amounts included in accumulated other comprehensive income as of July 2, 2011 will generally be reclassified into other income (expense) within the next 12 months. As of July 2, 2011, each of the five designated cash flow hedges was determined to be fully effective; therefore, we recorded an unrealized gain of $0.1 million to accumulated other comprehensive income related to recording the fair value of these foreign currency forward exchange contracts.
Note 3. Business Combinations
During the fiscal years ended July 2, 2011 and July 3, 2010, we recorded $0.1 million and $2.5 million in legal and other direct acquisition-related costs in connection with business combinations. These costs are recorded within restructuring, acquisition and related costs in our consolidated statement of operations.
As of June 27, 2009, we had capitalized $0.3 million in legal and other deal-related costs associated with our acquisition of Newport Corporation’s (“Newport”) high-power laser diodes business. Upon adoption of ASC Topic 805, Business Combinations, on June 28, 2009, we wrote-off these deferred assets to retained earnings as a cumulative effect of a change in accounting principle.
Fiscal Year 2009
Merger of Oclaro and Avanex
On January 27, 2009, we entered into a definitive agreement providing for the merger of Oclaro and Avanex. On April 27, 2009, we merged with Avanex through the merger of Avanex with a wholly-owned subsidiary of Oclaro following approval by the stockholders of both companies. We issued approximately 17 million shares of our common stock for all of the outstanding shares of Avanex on April 27, 2009.
We accounted for this acquisition under the purchase method of accounting. For accounting purposes, the fair value of the consideration paid to Avanex stockholders in the merger was $36.2 million; which includes the issuance of $31.8 million in common stock, based on a price of $1.87 per share of Oclaro common stock, which was the weighted-average of the closing market prices of our common stock for a period beginning two days before and ending two days after January 27, 2009, the day the merger was announced; $0.6 million for the assumption of vested stock options and warrants to purchase Oclaro common stock; and $3.9 million in acquisition-related transaction costs.
The following table presents the allocation of the purchase price, including the fair value of common stock options and warrants assumed, professional fees and other related transaction costs, to the assets acquired and liabilities assumed, based on their estimated fair values as of April 27, 2009:
Fiscal Year 2010
Sale of the New Focus Business and Acquisition of Newport’s High-Power Laser Diodes Business
On June 3, 2009, we signed a definitive agreement with Newport under which Newport agreed to acquire the net assets of our New Focus business in exchange for the net assets of Newport’s high power laser diodes business and $3.0 million in cash proceeds. The transaction closed on July 4, 2009. Under the agreement, we transferred to Newport substantially all of the operating assets used or held for use in our New Focus business. In exchange, we received substantially all of the operating assets of Newport’s Tucson, Arizona facility, as well as the intellectual property of the high power laser diodes business.
Our estimate of the fair value of the assets and liabilities of the New Focus business transferred to Newport was $9.9 million. The carrying value of these assets and liabilities on our consolidated balance sheet as of July 4, 2009, the date of the exchange, was $8.5 million. In the year ended July 3, 2010, we recorded a $1.4 million gain in income from discontinued operations from the sale of the New Focus business. The financial results of the New Focus business have been classified as discontinued operations for all periods presented.
The following table presents the statements of operations for the discontinued operations of the New Focus business for the fiscal years ended July 3, 2010 and June 27, 2009. There were no discontinued operations in the fiscal year ended July 2, 2011.
We accounted for the assets acquired and liabilities assumed of Newport’s high-power laser diodes business using the purchase method of accounting. The total consideration given to Newport in connection with the exchange described above has been allocated to the assets acquired and liabilities assumed based on their fair values as of the date of the exchange.
Our purchase price, based on the fair values of the assets acquired and liabilities assumed as of the date of the exchange, is as follows:
Any excess of the fair value of assets acquired and liabilities assumed over the aggregate consideration given for such acquisition results in a gain on bargain purchase. In the year ended July 3, 2010, we recorded a gain on bargain purchase of $5.3 million in connection with the acquisition of Newport’s high-power laser diodes business, which is included in other income (expense) in the accompanying consolidated statements of operations. The gain on bargain purchase reflects the completion of our full valuation of the fair value of assets acquired and liabilities assumed. Adjustments resulting from the completion of the full valuation are presented retrospectively in our consolidated financial statements as though they had been recorded as of the acquisition date.
Acquisition of Xtellus
On December 17, 2009, we acquired Xtellus and accounted for the assets acquired and liabilities assumed from this acquisition using the purchase method of accounting. During fiscal year 2011, we completed our fair value assessment of the Xtellus acquisition, which resulted in no change to the estimated fair values of the assets acquired and liabilities assumed from the amounts we previously reported in our 2010 Form 10-K. Under the terms of this acquisition, we issued approximately 3.7 million unregistered shares of Oclaro common stock with a fair value of $22.2 million as of the acquisition closing date, December 17, 2009. Of these shares issued, approximately 3.5 million shares were issued to former Xtellus stockholders and approximately 0.2 million shares were issued to certain former debt holders of Xtellus in order to extinguish outstanding Xtellus debt. The fair value of these shares was determined using the closing price of $6.70 per share of Oclaro common stock as of December 17, 2009, adjusted by a discount of 10.4 percent to reflect the lack of marketability due to the shares being unregistered and subject to restrictions on transfer under Rule 144 of the Securities and Exchange Commission (“SEC”).
We are also obligated to pay an additional $7.0 million in consideration to the former Xtellus stockholders after an 18 month escrow period established to secure the indemnification obligations of the Xtellus stockholders under the acquisition agreement. We issued approximately 1.0 million shares of Oclaro common stock into a third-party escrow account to secure our obligation under the escrow agreement. We determined the net present fair value of this obligation to be $6.3 million at the acquisition date based on our incremental borrowing cost, initially recording this amount in other non-current liabilities in our consolidated balance sheet at July 3, 2010. During fiscal years 2011 and 2010, we recorded $0.7 million and nil, respectively, in interest expense related to the Xtellus escrow liability. The $7.0 million became payable in June 2011 and remained outstanding as of July 2, 2011. During the first quarter of fiscal year 2012, we intend to settle this obligation through issuance of approximately 0.9 million shares of our common stock.
We also agreed to pay a valuation protection guarantee (“value protection liability”) whereby former stockholders of Xtellus were entitled to receive up to $7.0 million in additional consideration if Oclaro’s common stock traded below certain levels at the end of calendar year 2010 and if revenue from Xtellus products was more than $17.0 million in calendar year 2010. The estimated fair value of this valuation protection liability was $0.9 million at the acquisition date. This estimate was determined using management estimates of future operating results and a Monte Carlo simulation model to determine the likelihood of achieving certain market conditions. During fiscal year 2010, we reassessed the fair value of this liability, determining that its value declined from $0.9 million at January 2, 2010 to nil at July 3, 2010. This $0.9 million change in fair value was recognized as income within restructuring, acquisition and related costs during the year ended July 3, 2010. This guarantee expired in December 2010 with no liability due.
For accounting purposes, the total fair value consideration given in connection with the acquisition of Xtellus was $29.4 million, consisting of the following:
The total consideration given to former stockholders and debtholders of Xtellus has been allocated to the assets acquired and liabilities assumed based on their estimated fair values as of the date of the acquisition. Our purchase price allocation is as follows:
This acquisition also provided for an employee retention program under which certain former Xtellus employees received up to an aggregate of $5.0 million in a combination of cash (up to a maximum of $1.0 million) and restricted stock awards which are generally subject to time-based vesting over two years and were partially subject to the achievement of certain revenue targets during calendar year 2010. The costs of this retention program are considered compensatory and are being recorded in our results of operations. During fiscal year 2010, we recorded $1.0 million in restructuring, acquisition and related costs in our consolidated statements of operations related to cash payments due under the retention program.
Fiscal Year 2011
Acquisition of Mintera
On July 21, 2010, we acquired Mintera, a privately-held company providing high-performance optical transport sub-systems solutions. We accounted for the assets acquired and liabilities assumed from this acquisition using the purchase method of accounting. Under the terms of this agreement, we paid $10.5 million in cash to the former security holders and creditors of Mintera at the time of close and assumed $1.5 million in liabilities due by the security holders of Mintera, which we paid during fiscal year 2011. We also agreed to pay additional revenue-based consideration whereby former security holders of Mintera are entitled to receive up to $20.0 million, determined based on a set of sliding scale formulas, to the extent revenue from Mintera products is more than $29.0 million in the 12 months following the acquisition and/or more than $40.0 million in the 18 months following the acquisition. The earnout consideration, if any, will be payable in cash or, at our option, newly issued shares of our common stock, or a combination of cash and stock, in October 2011 for the 12 month earnout liability and April 2012 for the 18 month earnout liability. Achieving cumulative revenues of $40.0 million over the 12 month period and $70.0 million over the 18 month period would lead to the maximum $20.0 million in additional consideration. The estimated fair value of these obligations were determined using management estimates of the total amounts expected to be paid based on estimated future operating results, discounted to their present value using our incremental borrowing cost. The estimated net present fair value of these obligations was $15.1 million at the acquisition date. As of July 2, 2011, we reassessed the fair value of these obligations, determining that their values should remain at $15.1 million plus accrued interest of approximately $1.0 million from the acquisition date. These amounts are recorded in accrued expenses and other liabilities in our consolidated balance sheet at July 2, 2011.
For accounting purposes, the total fair value of consideration given in connection with the acquisition of Mintera was $25.6 million, consisting of the following:
Our allocation of the purchase price of Mintera, based on the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date, is as follows:
During fiscal year 2011, we completed our fair value assessment of the Mintera acquisition, which resulted in no change to our original estimated fair values of the assets acquired and liabilities assumed.
Unaudited Pro Forma Financial Information
The following unaudited pro forma consolidated results of operations have been prepared as if the acquisition of Mintera had occurred as of June 28, 2009, the first day of our fiscal year 2010:
This unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the Mintera acquisition been consummated as of that time, nor is it intended to be a projection of future results. In addition, this unaudited pro forma financial information does not include the impact of additional acquisitions completed in fiscal year 2010.
Note 4. Goodwill and Other Intangible Assets
Additions
In connection with our acquisition of the Newport high-power laser diodes business on July 4, 2009, we recorded $1.8 million in other intangible assets. The acquired other intangible assets from Newport consist of core and current technology assets of $1.1 million with a weighted average life of 6 years, customer relationships of $0.6 million with a weighted average life of 6 years, and contract backlog of $0.1 million with a weighted average life of 1.5 years.
In connection with our acquisition of Xtellus on December 17, 2009, we recorded $20.0 million in goodwill and $7.3 million in other intangible assets. The acquired other intangible assets from Xtellus consist of core and current technology assets of $3.1 million with a weighted average life of 8 years, customer relationships of $1.2 million with a weighted average life of 5.5 years, patents of $2.8 million with a weighted average life of 11.5 years and trade names of $0.2 million with a weighted average life of 8 years.
During fiscal year 2010, we also acquired through an asset purchase $0.7 million in core and current technology with a weighted average life of 6 years.
In connection with our acquisition of Mintera on July 21, 2010, we recorded $10.9 million in goodwill and $11.7 million in other intangible assets. The other intangible assets acquired from Mintera consist of core and current technology assets of $6.0 million with a weighted-average life of 6 years, a development agreement of $3.4 million with a weighted-average life of 7 years, customer relationships of $1.4 million with a weighted-average life of 8.5 years, manufacturing software of $0.7 million with a weighted-average life of 6 years, patents of $0.1 million with a weighted-average life of 5.5 years, trade names of $0.1 million with a weighted-average life of 1.5 years and backlog of $30,000 with a weighted-average life of 1.5 years.
Impairment Assessments
During the fourth quarter of fiscal year 2011 we completed our annual first step analysis for potential impairment of our goodwill, which included examining the impact of current general economic conditions on our future prospects and the current level of our market capitalization. Based on this analysis, we concluded that goodwill related to our wavelength selective switches (“WSS”) reporting unit was impaired. Our WSS reporting unit’s goodwill was originally recorded in connection with our acquisition of Xtellus. During the fourth quarter of fiscal year 2011 we also completed our second step analysis of goodwill impairment, determining that the $20.0 million of goodwill related to our WSS reporting unit was fully impaired. Based upon this evaluation, we recorded $20.0 million for the goodwill impairment loss in our consolidated statement of operations for fiscal year 2011. In conjunction with our second step goodwill impairment analysis, we also evaluated the fair value of the intangible assets of this reporting unit and concluded that such assets were not impaired.
During the fiscal year ended June 27, 2009, we observed indicators of potential impairment of our goodwill, including the impact of the current general economic downturn on our future prospects and the continued decline of our market capitalization, which caused us to conduct a goodwill impairment analysis. Specifically, indicators emerged within our New Focus reporting unit, which included the technology acquired in the March 2004 acquisition of Oclaro Photonics, Inc. and one other reporting unit that included the technology acquired in the March 2006 acquisition of Avalon Photonics AG (the Avalon reporting unit). These indicators led us to conclude that an impairment test was required to be performed for goodwill related to these reporting units.
During the fiscal year ended June 27, 2009, we determined, in our first step goodwill impairment analysis, that our goodwill related to the New Focus and Avalon reporting units was in fact impaired. We completed our full evaluation of the second step impairment analysis, which indicated that the goodwill was fully impaired. We recorded $7.9 million in goodwill impairment in our statement of operations for the year ended June 27, 2009.
In conjunction with our full evaluation of the second step goodwill impairment analysis, we also evaluated the fair value of the intangible assets of these two reporting units. Based on this testing, we determined that the intangibles of our New Focus reporting unit and our Avalon reporting units were impaired. We recorded $1.2 million for the impairment loss related to these intangibles, net of $2.8 million associated with the discontinued operations of the New Focus business, in our statements of operations for the year ended June 27, 2009.
These impairments will not result in any current or future cash expenditures.
Amortization
Amortization of other intangible assets for the years ended July 2, 2011, July 3, 2010 and June 27, 2009, was $2.8 million, $1.0 million and $0.5 million, respectively. Amortization is recorded as an operating expense within the consolidated statements of operations. Estimated future amortization expense of other intangible assets is $2.9 million for fiscal year 2012, $3.2 million for fiscal year 2013 through fiscal year 2015 and $2.7 million for fiscal year 2016 based on the current level of our intangible assets.
The following table provides details regarding the changes in our goodwill for each of the three years in the fiscal years ended:
The following table summarizes the activity related to our other intangible assets for fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009:
Note 5. Restructuring Liabilities
Fiscal Year 2009
In connection with earlier plans of restructuring, during fiscal year 2009 we accrued approximately $1.7 million in additional expenses for revised estimates of the cash flows for lease cancellations and commitments, and approximately $0.6 million for additional employee separation charges, and continued to make scheduled payments during fiscal year 2009, reducing the related lease liabilities and employee severance and retention obligations.
In connection with the merger with Avanex, during the fourth quarter of fiscal year 2009, we initiated an overhead cost reduction plan which included workforce reductions as well as facility and site consolidation of our Fremont, California and Villebon, France locations. We also assumed from Avanex facilities-related restructuring accruals of $6.2 million related to four locations in Fremont and Newark, California and one location in Villebon, France. During fiscal year 2009, we accrued restructuring charges of approximately $0.3 million for lease commitments related to vacating the Fremont and Villebon locations, and approximately $5.1 million for employee separation charges, and continued to make scheduled payments, reducing the related lease liabilities and employee severance and retention obligations.
Fiscal Year 2010
In connection with earlier cost reduction and restructuring plans, we accrued $0.4 million in additional expenses, net of adjustments, for revised estimates related to lease cancellations and commitments and $2.2 million in additional employee separation costs.
During fiscal year 2010, we initiated a new restructuring plan resulting from our acquisition of Newport’s high-power laser diodes business. This plan involved the transfer of Newport’s high-power laser diodes manufacturing operations from Tucson, Arizona to our European manufacturing facilities. We incurred $0.5 million in restructuring accruals for employee separation charges under the Newport plan. During fiscal year 2010, we also wrote-down $0.8 million in inventory, which became impaired through the integration of our WSS product lines.
Fiscal Year 2011
We incurred $1.5 million in employee separation costs during fiscal year 2011 in connection with cost reduction and restructuring plans, including $0.6 million related to a restructuring plan specific to our acquisition of Mintera. During fiscal year 2011, we recorded reductions to our restructuring reserve of $0.5 million resulting from revised estimates for lease cancellations and commitments and other charges. We also recorded a reduction to our restructuring reserve of $0.2 million related to employee separation costs during fiscal year 2011. We do not expect to incur significant additional restructuring costs in connection with previously announced restructuring plans.
As of July 2, 2011, our $0.2 million in accrued restructuring liabilities relates to an inventory impairment.
For all periods presented, separation payments under the restructuring and cost reduction efforts were accrued and charged to restructuring in the period that the amounts were both determined and communicated to the affected employees.
The following table summarizes the activity related to our restructuring liability for the years ended July 2, 2011, July 3, 2010 and June 27, 2009. Accrued restructuring costs related to earlier restructuring activities of the New Focus business were not assumed by Newport in the July 4, 2009 exchange of assets, and are therefore included at the corresponding balance sheet dates in the table below. The related amounts charged to restructuring charges are included in income (loss) from discontinued operations in the accompanying consolidated statements of operations.
Note 6. Credit Agreement
Information presented in this footnote reflects the terms and conditions of our senior secured credit facility as of July 2, 2011. See Note 16, Subsequent Event, for a description of a further amendment and restatement of this credit facility made on July 26, 2011.
On August 2, 2006, we entered into a $25.0 million senior secured revolving credit facility with Wells Fargo Capital Finance, Inc. and other lenders. On April 27, 2009, we, with our wholly-owned subsidiaries Oclaro Technology Ltd, Oclaro Photonics, Inc. and Oclaro Technology, Inc., collectively the Borrowers, entered into an amendment to the existing credit agreement (the “Amended Credit Agreement”) with Wells Fargo Capital Finance, Inc. and other lenders regarding the $25.0 million senior secured revolving credit facility, extending the term to August 1, 2012. We further amended the Amended Credit Agreement from time to time, most recently on May 13, 2011. Under the Amended Credit Agreement, advances are available based on 80 percent of “qualified accounts receivable,” as defined in the Amended Credit Agreement.
The obligations of the Borrowers under the Amended Credit Agreement are guaranteed by Oclaro, Oclaro (North America), Inc., Oclaro (Canada) Inc., Bookham Nominees Limited and Bookham International Ltd., each also a wholly-owned subsidiary, (which are referred to collectively as the Guarantors and together with the Borrowers, as the Obligors), and are secured pursuant to a security agreement, or the Security Agreement, by the assets of the Obligors, including a pledge of the capital stock holdings of the Obligors in some of their direct subsidiaries.
Pursuant to the terms of the Amended Credit Agreement, borrowings made under the facility bear interest at a rate based on either the London Interbank Offered Rate (LIBOR) plus 2.75 percentage points or the bank’s prime rate plus 1.75 percentage points. In the absence of an event of default, any amounts outstanding under the Amended Credit Agreement may be repaid and re-borrowed anytime until maturity, which is August 1, 2012.
The obligations of the Borrowers under the Amended Credit Agreement may be accelerated upon the occurrence of an event of default under the Amended Credit Agreement, which includes customary events of default, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, a cross-default related to indebtedness in an aggregate amount of $1.0 million or more, bankruptcy and insolvency related defaults, defaults relating to such matters as ERISA and certain judgments in excess of $1.0 million, and a change of control default. The Amended Credit Agreement contains negative covenants applicable to the Borrowers and their subsidiaries, including a financial covenant that the Borrowers maintain a minimum fixed charge coverage ratio (defined as the ratio of EBITDA minus capital expenditures made or incurred during such period, to fixed charges for such period), of no less than 1.10 to 1.00, if the Borrowers have not maintained “minimum liquidity” (defined as $30.0 million of qualified cash and excess availability, each as also defined in the Amended Credit Agreement), and to also include restrictions on liens, investments, indebtedness, fundamental changes to the Borrower’s business, dispositions of property, making certain restricted payments (including restrictions on dividends and stock repurchases), entering into new lines of business and transactions with affiliates.
In connection with the Amended Credit Agreement, we paid a closing fee of $250,000 and agreed to pay a monthly servicing fee of $3,000 and an unused line fee equal to 0.50 percentage points per annum, payable monthly on the unused amount of revolving credit commitments. To the extent there are letters of credit outstanding under the Amended Credit Agreement, the Borrowers are obligated to pay the administrative agent a letter of credit fee at a rate equal to 3.50 percentage points per annum.
As of July 2, 2011 and July 3, 2010, there were no amounts outstanding under the Amended Credit Agreement. At July 2, 2011 and July 3, 2010, there were $1.1 million and $2.0 million, respectively, in outstanding standby letters of credit with vendors secured under the Amended Credit Agreement. The outstanding standby letters of credit for $1.1 million expire at various intervals through April 2014.
Note 7. Post-Retirement Benefits
401(k) Plan
In the U.S., we sponsor a 401(k) plan that allows voluntary contributions by eligible employees, who may elect to contribute up to the maximum allowed under the U.S. Internal Revenue Service regulations. We generally make 50 percent matching contributions (up to a maximum of $9,800 per eligible employee per year) and we recorded related expenses of $0.9 million, $0.7 million and $0.4 million in the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, respectively.
Defined Contribution Plan
We contribute to a U.K. based defined contribution pension scheme for employees. Contributions under this plan and the related expenses were $1.3 million, $1.1 million and $1.1 million in the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, respectively.
Switzerland Defined Benefit Plan
We have a pension plan covering employees of our Swiss subsidiary (the “Swiss plan”) which has historically not been recorded in the financial statements because the amounts were immaterial. Due to the increased significance of our Swiss pension plan in fiscal year 2010, we concluded that as of July 3, 2010 our Swiss pension plan should be recorded as a defined benefit plan. As a result, we increased other non-current liabilities by $1.5 million and other non-current assets by $0.3 million, and decreased accumulated other comprehensive income by $1.2 million, net of tax, to reflect the under-funded pension liability.
Employer and employee contributions are made to the Swiss plan based on various percentages of salary and wages that vary according to employee age and other factors. Employer contributions to the Swiss plan for years ended July 2, 2011 and July 3, 2010 were $2.4 million and $1.6 million, respectively. Employer contributions to the Swiss plan in fiscal year 2012 are estimated to be approximately $2.6 million.
The funded status of the Swiss plan at July 2, 2011 and July 3, 2010 was as follows:
Net periodic pension cost associated with the Swiss plan in the years ended July 2, 2011 and July 3, 2010 include the following components:
The projected and accumulated benefit obligations for the Swiss plan were calculated as of July 2, 2011 and July 3, 2010 using the following assumptions:
The discount rate is based on assumed pension benefit maturity and estimates developed using the rate of return and yield curves for high quality Swiss corporate and government bonds. The 2.0 percent salary increase rate is based on our best assessment for on-going increases over time. The 4.0 percent expected long-term rate of return on plan assets is based on the expected asset allocation and taking into consideration historical long-term rates of return for the relevant asset categories.
The Swiss plan is legally separate from Oclaro, as are the assets of the plan. As of July 2, 2011 and July 3, 2010, the Swiss plan’s asset allocation was as follows:
The Swiss plan assets are measured at fair value and are classified into two distinct levels of the fair value hierarchy, as defined in Note 2, Fair Value. The Swiss plan assets are comprised of Level 1 assets, which include cash, equity investments and fixed income investments, and Level 3 assets, which include real estate and alternative investments. The investment strategy of the Swiss plan’s pension committee is to achieve a consistent long-term return which will provide sufficient funding for future pension obligations while limiting risk. The investment strategy is reviewed regularly.
None of the $2.7 million balance in accumulated other comprehensive income at July 2, 2011 is expected to be amortized into net periodic benefit income in fiscal year 2012. Estimated future benefit payments from the Swiss plan are $0.9 million in fiscal year 2012, $1.2 million in fiscal year 2013, $0.8 million in fiscal year 2014, $1.4 million in fiscal year 2015, $1.4 million in fiscal year 2016 and $12.1 million in the following five years.
Note 8. Commitments and Contingencies
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.
Warranty accrual
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 and a decrease in our net income, or an increase in our net loss.
The following table summarizes movements in the warranty accrual for the periods indicated:
Litigation
On June 26, 2001, the first of a number of securities class actions was filed in the United States District Court for the Southern District of New York against New Focus, Inc., now known as Oclaro Photonics, Inc. (“New Focus”), certain of our officers and directors, and certain underwriters for New Focus’ initial and secondary public offerings. A consolidated amended class action complaint, captioned In re New Focus, Inc. Initial Public Offering Securities Litigation, No. 01 Civ. 5822, was filed on April 20, 2002. The complaint generally alleges that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in New Focus’ initial public offering and seeks unspecified damages for claims under the Exchange Act on behalf of a purported class of purchasers of common stock from May 17, 2000 to December 6, 2000.
The lawsuit against New Focus is coordinated for pretrial proceedings with a number of other pending litigations challenging underwriter practices in over 300 cases, as In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS), including actions against Bookham Technology plc, now known as Oclaro Technology Ltd (“Bookham Technology”) and Avanex Corporation, now known as Oclaro (North America), Inc. (“Avanex”), and certain of each entity’s respective officers and directors, and certain of the underwriters of their public offerings. In October 2002, the claims against the directors and officers of New Focus, Bookham Technology and Avanex were dismissed, without prejudice, subject to the directors’ and officers’ execution of tolling agreements.
The parties have reached a global settlement of the litigation. On October 5, 2009, the Court entered an order certifying a settlement class and granting final approval of the settlement. Under the settlement, the insurers will pay the full amount of the settlement share allocated to New Focus, Bookham Technology and Avanex, and New Focus, Bookham Technology and Avanex will bear no financial liability. New Focus, Bookham Technology and Avanex, as well as the officer and director defendants who were previously dismissed from the action pursuant to tolling agreements, will receive complete dismissals from the case. Certain objectors have appealed the Court’s October 5, 2009 order to the Second Circuit Court of Appeals. If for any reason the settlement does not become effective, we believe that Bookham Technology, New Focus and Avanex have meritorious defenses to the claims and therefore believe that such claims will not have a material effect on our financial position, results of operations or cash flows.
On December 6, 2010, a bankruptcy preferential transfer avoidance action was filed by Nortel Networks Inc. et al. against Oclaro Technology Ltd. (formerly Bookham Technology Plc.) and Oclaro (North America), Inc. (formerly Avanex Corporation) in the United States Bankruptcy Court for the District of Delaware, Adversary Proceeding No. 10-55919-KG. The complaint alleges, among other things, that Nortel Networks Inc., and/or its affiliated debtors in the Chapter 11 bankruptcy cases also pending before the Delaware Bankruptcy Court (Jointly Administered Case No. 09-10138-KG), made at least approximately $4.6 million in preferential transfers to the defendants’ predecessors, Bookham Technology Plc. and Avanex Corporation, in the 90 days prior to the commencement of the Nortel Chapter 11 bankruptcy cases on January 14, 2009. We intend to vigorously contest the claims set forth in the complaint.
On May 19, 2011, Curtis and Charlotte Westley filed a purported class action complaint in the United States District Court for the Northern District of California, against us and certain of our officers and directors, allegedly on behalf of persons who purchased or otherwise acquired our common stock between May 6 and October 27, 2010. The complaint, captioned as Westley v. Oclaro, Inc., No. 11 Civ. 2448 EMC (N.D. Cal. filed May 19, 2011), alleges generally that defendants issued materially false and misleading statements during the relevant time period regarding our current business and financial condition, including projections for our revenues, earnings, and gross margins, for the first quarter of fiscal year 2011 as well as the full fiscal year. The complaint alleges violations of section 10(b) of the Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, as well as section 20(a) of the Securities Exchange Act. The complaint seeks damages and costs of an unspecified amount. Discovery has not commenced, and no trial has been scheduled in this action. We intend to defend this litigation vigorously.
On June 10, 2011, a purported shareholder, Stanley Moskal, filed a purported derivative action in the Superior Court for the State of California, County of Santa Clara, against us, as nominal defendant, and certain of our current and former officers and directors, as defendants. The case is styled Moskal v. Couder, No. 1:11 CV 202880 (Santa Clara County Super. Ct. filed June 10, 2011). Four other purported shareholders, Matteo Guindani, Jermaine Coney, Jefferson Braman and Toby Aguilar, separately filed substantially similar lawsuits in the United States District Court for the Northern District of California on June 27, June 28, July 7 and July 26, 2011, respectively. The cases are styled Guindani v. Couder, No. 11 Civ. 3176 PSG (N.D. Cal. filed June 27, 2011), Coney v. Couder, No. 11 Civ. 3214 HRL (N.D. Cal. filed June 28, 2011), and Braman v. Couillaud, No. 11 Civ. 3322 RS (N.D. Cal. filed July 7, 2011), and Aguilar v. Couillaud, No. 11 CV 3668 EDL (N.D. Cal. filed July 26, 2011). Each purported derivative complaint alleges that Oclaro has been, or will be, damaged by the actions alleged in the Westley complaint, and the litigation of the Westley action, and any damages or settlement paid in the Westley action. Each purported derivative complaint alleges counts for breaches of fiduciary duty, waste, and unjust enrichment. Additionally, the complaint in Aguilar alleges claims for contribution pursuant to Sections 10(b) and 21D of the Securities Exchange Act, and Securities and Exchange Commission Rule 10b-5, and Section 20(a) of the Securities Exchange Act. Each purported derivative complaint seeks damages and costs of an unspecified amount, as well as injunctive relief. Discovery has not commenced, and no trial has been scheduled in any of these actions. We intend to defend this litigation vigorously.
Sale-Leaseback
On March 10, 2006, our Oclaro Technology Ltd subsidiary entered into multiple agreements with a subsidiary of Scarborough Development (Scarborough) for the sale and leaseback of the land and buildings located at our Caswell, U.K., manufacturing site. The sale transaction, which closed on March 30, 2006, resulted in immediate proceeds to Oclaro Technology Ltd of £13.75 million (approximately U.S. $24 million on the date of the transaction). Under these agreements, Oclaro Technology Ltd leases back the Caswell site for an initial term of 20 years, with options to renew the lease term for 5 years following the initial term and for rolling 2-year terms thereafter. Based on the exchange rate of $1.61 as of July 1, 2011, annual rent for the next 5 years of the lease is approximately £1.2 million, or $2.0 million per year; annual rent for the subsequent 5 years of the lease is approximately £1.4 million, or $2.3 million per year; and annual rent for the last 5 years of the lease is approximately £1.6 million, or $2.6 million per year. Rent during the optional renewal terms will be determined according to the then market rent for the site. The obligations of Oclaro Technology Ltd under these agreements are guaranteed by us. In addition, Scarborough and Oclaro entered into a pre-emption agreement with the buyer under which Oclaro Technology Ltd, within the initial 20-year term, has a right to purchase the Caswell site in whole or in part on terms acceptable to Scarborough if Scarborough agrees to terms with or receives an offer from a third party to purchase the Caswell facility. As a result of these agreements, we deferred a related gain of $20.4 million, which is being amortized ratably against rent expense over the initial 20-year term of the lease. As of July 2, 2011, the unamortized balance of this deferred gain was $13.9 million.
At the inception of the Caswell lease, we determined the total minimum lease payments which were to be paid over the lease term, and we are recognizing the effects of scheduled rent increases, which are included in the total minimum lease payments, on a straight-line basis over the lease term.
Operating Leases
We lease certain facilities under non-cancelable operating lease agreements that expire at various dates through 2026. Our future fiscal year minimum lease payments under non-cancelable operating leases and related sublease income, including the sale-leaseback of our Caswell facility, are as follows:
Rent expense for these leases was $8.6 million, $9.1 million and $6.8 million during the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, respectively.
Note 9. Stockholders’ Equity
Common Stock
On May 12, 2010, we completed a public offering of 6.9 million shares of our common stock pursuant to a shelf registration statement that was previously filed and declared effective by the Securities and Exchange Commission. We received net proceeds of approximately $77.1 million from the offering after deducting underwriting discounts and commissions and estimated offering expenses.
On April 14, 2010, we announced that our board of directors had approved a 1-for-5 reverse split of our common stock, pursuant to previously obtained stockholder authorization. This reverse stock split, which became effective at 6:00 p.m., Eastern Time, on April 29, 2010, reduced the number of shares of our common stock issued and outstanding from approximately 212 million to approximately 42 million and reduced the number of authorized shares of our common stock from 450 million to 90 million.
On December 17, 2009, in connection with our acquisition of Xtellus, we issued approximately 3.7 million shares of our common stock to the former shareholders and debt holders of Xtellus, and issued approximately 1.0 million shares of our common stock into a third-party escrow account to secure our obligations under an 18 month escrow agreement entered into in connection with this acquisition. This obligation remained outstanding as of July 2, 2011. During the first quarter of fiscal year 2012, we intend to settle this obligation through the issuance of approximately 0.9 million shares of our common stock.
On April 27, 2009, in connection with the merger of Avanex and Oclaro, we issued approximately 17.0 million shares of our common stock for all of the outstanding shares of common stock of Avanex.
Warrants
The following table summarizes activity relating to warrants to purchase our common stock:
On March 22, 2007, we entered into a private placement agreement which included warrants to purchase up to 818,417 shares of common stock with certain institutional accredited investors. The warrants are exercisable during the period from September 23, 2007 through September 22, 2012. As of July 2, 2011, the exercise price was $13.48 per share, which is subject to adjustment based on a weighted average anti-dilution formula if we effect certain equity issuances in the future for consideration per share that is less than the then current exercise price per share of such warrants.
On August 31, 2006, we entered into a private placement agreement which included issuance of warrants to purchase up to 434,804 shares of common stock. On September 19, 2006, through a second closing of this private placement, we issued additional warrants to purchase up to 144,935 shares of common stock. The warrants are exercisable during the period beginning on March 2, 2007 through September 1, 2011, at an exercise price of $20.00 per share.
Preferred Stock
Our restated certificate of incorporation authorizes us to issue up to 1.0 million shares of preferred stock with designations, rights and preferences determined from time-to-time by our board of directors. To date, we have not issued any preferred stock.
Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income, net of tax, are as follows:
Note 10. Employee Stock Plans
Our Amended and Restated 2004 Stock Incentive Plan (“Plan”) was amended by stockholder approval on October 27, 2010. The primary changes to the Plan resulting from this amendment include: (1) an increase in the number of shares available under the Plan from 3.8 million shares to 7.8 million shares, (2) issuance of full value awards being counted as 1.25 shares of common stock for purposes of the share limit, and (3) a prohibition on recycling of repurchased shares in cases where shares are used to exercise an award or shares are withheld for taxes. As amended, the Plan now expires on October 26, 2020.
On November 2, 2009, we filed a “Tender Offer Statement” on Schedule TO with the SEC, related to an offer by us to certain of our employees to exchange some or all of their outstanding options to purchase our common stock for fewer replacement stock options with exercise prices equal to $6.80 per share, which was the closing price per share of our common stock on December 2, 2009, the date of grant and the last day of the tender offer (“the Offer”). A stock option was eligible for exchange in the Offer if: (i) it had an exercise price of at least $10.00 per share; (ii) it was granted at least 12 months prior to the commencement of the Offer; (iii) it was held by an employee who was eligible to participate in the Offer; and (iv) it remained outstanding (i.e., unexpired and unexercised) as of the date of grant of the replacement options (“Eligible Options”). We made the Offer to all of our U.S. and international employees who held Eligible Options (“Eligible Employees”), except for (i) members of our board of directors and (ii) our named executive officers. As of December 2, 2009, when the Offer expired, Eligible Employees surrendered approximately 0.8 million Eligible Options with a weighted-average exercise price of $37.55 per share in exchange for approximately 0.4 million replacement stock options with an exercise price of $6.80 per share. The fair value of the replacement options granted was measured as the total of the unrecognized compensation cost of the original options tendered and the incremental compensation cost of the new options granted. The incremental compensation cost of the new options granted was measured as the excess of the fair value of the new options granted over the fair value of the original options immediately before cancellation. The total remaining unrecognized compensation expense related to the original options tendered will be recognized over the remaining requisite service period of the original options. The incremental compensation cost of the new options granted was $20,000.
During fiscal year 2010, we reduced our shares available for grant by 0.7 million shares, of which 0.6 million shares available for grant were cancelled in connection with the Offer and 0.1 million shares available for grant were cancelled upon the expiration of the Avanex Corporation 1998 Stock Plan in December 2009.
The following table summarizes the combined activity under all of our equity incentive plans for the three-year period ended July 2, 2011:
Supplemental disclosure information about our stock options outstanding as of July 2, 2011 was as follows:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on our closing stock price of $6.74 as of July 1, 2011, which would have been received by the option holders had all option holders exercised their options as of that date. There were approximately 0.6 million shares of common stock subject to in-the-money options which were exercisable as of July 2, 2011. We settle employee stock option exercises with newly issued shares of common stock.
Note 11. Stock-based Compensation
We recognize compensation expense in our 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. Estimating the grant date fair value of such share-based wards requires us to make judgments in the determination of inputs into the Black-Scholes-Merton stock option pricing model which we use to arrive at an estimate of the grant date fair value for such awards. This model requires assumptions to be made related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. While the risk-free interest rate is a less subjective assumption, typically based on factual data derived from public sources, the expected stock price volatility and option life assumptions require a greater level of judgment, which makes them critical accounting estimates. We have not issued and do not anticipate issuing dividends to stockholders and accordingly use a zero percent dividend yield assumption for all Black-Scholes-Merton stock option pricing calculations. We use an expected stock-price volatility assumption that is based on an implied and historical realized volatility of our underlying common stock during a period of time. With regard to the weighted-average option life assumption, we evaluate the exercise behavior of past grants and comparison to industry peer companies as a basis to predict future activity.
The weighted-average assumptions used in this model to value stock option grants for the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009 were as follows:
The amounts included in cost of revenues, operating expenses and income (loss) from discontinued operations for stock-based compensation expenses for the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009 were as follows:
As of July 2, 2011 and July 3, 2010, we had capitalized $0.4 million and $0.2 million, respectively, of stock-based compensation as inventory.
Note 12. Income Taxes
For financial reporting purposes, our income (loss) from continuing operations before income taxes includes the following:
The components of our income tax provision were as follows:
The primary differences between the effective tax rate and the U.S. federal statutory tax rate for fiscal year 2011 relates to taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate and benefited and unbenefited foreign and domestic tax attributes. The primary differences between the effective tax rate and the U.S. federal statutory tax rate for fiscal years 2010 and 2009 related to taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, benefited and unbenefited foreign and domestic tax attributes, and the release of valuation allowance on certain foreign deferred tax assets due to certainty around future profitability in relation to an established transfer pricing regime.
Reconciliations of our income tax provision at the statutory rate to our income tax provision are as follows:
We have not provided for U.S. federal and state income taxes on non-U.S. subsidiaries’ undistributed earnings as of July 2, 2011 because such earnings are intended to be reinvested in the operations of our international subsidiaries indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to applicable U.S. federal and state income taxes.
Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets are as follows:
Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses and our forecast of future taxable income, which are consistent with the plans and estimates we are using to manage our underlying businesses.
In the fourth quarter of fiscal year 2010, we determined that it is more-likely-than-not that we will utilize net operating losses in one of our foreign jurisdictions due to current earnings and projections of future profitability. Accordingly, we released $1.3 million of our valuation allowance against $1.3 million of previously unrecognized deferred tax assets during the fourth quarter of fiscal year 2010. This amount represented the entire remaining deferred tax asset related to the accumulated net operating losses of the foreign jurisdiction. Due to the uncertainty surrounding the realization of the tax attributes in other jurisdictions, we have recorded a full valuation allowance against our remaining foreign and domestic deferred tax assets as of July 2, 2011.
As of July 2, 2011, we had foreign net operating loss carry forwards of approximately $480.9 million, $19.3 million, $0.1 million and $2.3 million in the United Kingdom, Switzerland, Canada and France, respectively. The United Kingdom and France net operating losses do not expire, the Swiss net operating loss will expire at various times from 2012 through 2019 if unused, and the Canada net operating loss will expire at various times from 2028 through 2031. We also have U.S. federal and California net operating losses of approximately $151.3 million and $78.8 million, respectively, which will expire in various years from 2012 through 2032 if unused. As of July 2, 2011, we had U.S. federal, California and foreign research and development credits of approximately $0.7 million, $1.0 million and $1.7 million, respectively. The U.S. federal credits will expire from 2012 through 2032. The California credits may be carried forward indefinitely and the foreign credits will expire at various times from 2027 through 2030 if unused.
Utilization of net operating loss carryforwards and credit carryforwards are subject to annual limitations due to ownership changes as provided in the Internal Revenue Code of 1986, as amended, as well as similar state and foreign tax laws. This annual limitation may result in the expiration of a significant portion of the net operating loss carryforwards and tax credits before utilization.
Our total amount of unrecognized tax benefits as of July 2, 2011 was approximately $6.9 million. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $1.8 million as of July 2, 2011. While it is often difficult to predict the final outcome of any particular uncertain tax position, we do not expect that changes to our unrecognized tax benefits will be significant in the next twelve months. Unrecognized deferred tax benefits related to stock-based awards totaled $1.1 million and $0.1 million for federal and state as of July 2, 2011, respectively, and if and when realized through a reduction in income taxes payable, will be accounted for as a credit to additional paid-in capital.
A reconciliation of the beginning balance and the ending balance of gross unrecognized tax benefits, net of interest and penalties, for fiscal year ended July 2, 2011 and July 3, 2010 is as follows:
We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on our consolidated statements of operations. As of July 2, 2011 and July 3, 2010, we had accrued approximately $0.3 million and $18,000 for payment of interest and penalties related to unrecognized tax benefits, respectively.
We file U.S. federal, state and foreign tax returns and have determined that our major tax jurisdictions are the United States, the United Kingdom, Italy, France, Switzerland and China. Certain jurisdictions remain open to examination by the appropriate governmental agencies; U.S. federal, Italy, France, and China tax years 2006 to 2010, various U.S. states tax years 2005 to 2010, and the United Kingdom tax years 2004 to 2010. We are currently under audit in the United States and France.
Note 13. Net Income (loss) Per Share
The following table presents the calculation of basic and diluted net income (loss) per share:
Basic net income (loss) per share is computed using only the weighted-average number of shares of common stock outstanding for the applicable period, while diluted net income (loss) per share is computed assuming conversion of all potentially dilutive securities, such as stock options, unvested restricted stock awards, warrants and obligations under escrow agreements during such period.
For fiscal years 2011 and 2009, there were no stock options, unvested restricted stock awards, warrants or obligations under escrow agreements factored into the computation of diluted shares outstanding since we incurred a net loss in these periods which would have resulted in their inclusion having an anti-dilutive effect.
For fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, we excluded 5.1 million, 3.2 million and 4.5 million, respectively, of outstanding stock options, warrants and restricted stock units from the calculation of diluted net income (loss) per share because their effect would have been anti-dilutive.
Note 14. Geographic and Customer Concentration Information
Geographic Information
The following table shows revenues by geographic area for the fiscal years ended July 2, 2011, July 3, 2010 and June 27, 2009, based on the delivery locations of our products:
The following table sets forth our long-lived tangible assets and total assets by geographic region as of the dates indicated:
Significant Customers and Concentration of Credit Risk
For the fiscal year ended July 2, 2011, Huawei Technologies Co., Ltd. (“Huawei”) accounted for 15 percent and Alcatel-Lucent accounted for 11 percent of our revenues. For the fiscal year ended July 3, 2010, Huawei accounted for 13 percent and Alcatel-Lucent accounted for 10 percent of our revenues. For the fiscal year ended June 27, 2009, Huawei accounted for 17 percent and Nortel accounted for 14 percent of revenues.
As of July 2, 2011, no customer accounted for 10 percent or more of our accounts receivable. As of July 3, 2010, Alcatel-Lucent accounted for 15 percent and Huawei accounted for 14 percent of our accounts receivable.
Note 15. Related Party Transactions
In connection with the merger with Avanex on April 27, 2009, we entered into a one year consulting agreement with Giovanni Barbarossa, which became effective upon consummation of the merger. Under the consulting agreement, Dr. Barbarossa provided consulting services to us for the purpose of assisting in the integration of Avanex’s operations into those of Oclaro, including, among other things, advice and assistance on strategic and technological matters and customer relations. Under the consulting agreement, Dr. Barbarossa received consulting fees of $300,000 and $60,000 for the fiscal years ended July 3, 2010 and June 27, 2009, respectively.
Note 16. Subsequent Event
On August 2, 2006, Oclaro, Inc., along with Oclaro Technology Ltd., Oclaro Photonics, Inc. and Oclaro Technology, Inc., each a wholly-owned subsidiary of Oclaro (collectively the “Original Borrowers”), entered into a credit agreement, or the “Original Credit Agreement,” with Wells Fargo Capital Finance, Inc. and certain other lenders, which Original Credit Agreement has previously been amended from time to time. See Note 6, Credit Agreement, for additional information.
On July 26, 2011, Oclaro Technology Ltd., as “Borrower,” and Oclaro, Inc., as “Parent,” entered into an amendment and restatement to the Original Credit Agreement, or the “Credit Agreement,” with Wells Fargo Capital Finance, Inc. and the other lenders regarding the senior secured revolving credit facility, increasing the facility size from $25 million to $45 million and extending the term thereof to August 1, 2014. Under the Credit Agreement, advances are available based on 80 percent of “qualified accounts receivable,” as defined in the Credit Agreement.
The obligations of the Borrower under the Credit Agreement are guaranteed by Parent and all significant subsidiaries of Parent and Borrower (collectively, the “Guarantors”), and are secured, pursuant to two security agreements (the “Security Agreements”), by substantially all of the assets of Borrower and Guarantors, including a pledge of the capital stock holdings of the Borrower and certain Guarantors in their direct subsidiaries.
Borrowings made under the Credit Agreement bear interest at a rate based on either the London Interbank Offered Rate plus 2.50 percentage points or the bank’s prime rate plus 1.50 percentage points. In the absence of an event of default, any amounts outstanding under the Credit Agreement may be repaid and re-borrowed at any time until maturity, which is August 1, 2014.
The Credit Agreement contains negative covenants applicable to Parent, Borrower and their subsidiaries, including a financial covenant that, on a consolidated basis, requires Parent to maintain a minimum fixed charge coverage ratio of no less than 1.10 to 1.00, if Parent and its subsidiaries have not maintained “minimum liquidity” (defined as $15 million of qualified cash and excess availability, each as defined in the Credit Agreement). The Credit Agreement also contains restrictions on liens, certain investments, indebtedness, fundamental changes to the Borrower’s business, certain dispositions of property, making certain restricted payments (including restrictions on dividends and stock repurchases), entering into new lines of business and transactions with affiliates.
The obligations of the Borrower under the Credit Agreement may be accelerated upon the occurrence of an event of default under the Credit Agreement, which includes customary events of default, including payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, a cross-default related to indebtedness in an aggregate amount of $2.0 million or more, bankruptcy and insolvency related defaults, defaults relating to such matters as the Employee Retirement Income Security Act and certain judgments in excess of $2.0 million and a change of control default.
In connection with the Credit Agreement, the Borrower paid a closing fee of $250,000 and agreed to pay a monthly servicing fee of $3,000 and a variable unused line fee equal to between 0.375 and 0.50 percentage points per annum, payable monthly on the unused amount of revolving credit commitments. To the extent there are letters of credit outstanding under the Credit Agreement, the Borrower is obligated to pay the administrative agent a letter of credit fee at a rate equal to 3.3 percentage points per annum.
Note 17. Selected Quarterly Consolidated Financial Data (Unaudited)
The following tables set forth our unaudited condensed consolidated statements of operations data for each of the eight quarterly periods ended July 2, 2011. We have prepared this unaudited information on a basis consistent with our audited consolidated financial statements, reflecting all normal recurring adjustments that we consider necessary for a fair presentation of our financial position and operating results for the fiscal quarters presented. Basic and diluted net income (loss) per share is computed independently for each of the quarters presented. Therefore, the sum of quarterly basic and diluted per share information may not equal annual basic and diluted net income (loss) per share.
Financial Statement Schedule II: Valuation and Qualifying Accounts
For the Years Ended July 2, 2011, July 3, 2010 and June 27, 2009
EXHIBIT INDEX
(1)
Portions of this exhibit have been omitted pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission.
(2)
Management contract or compensatory plan or arrangement.
(3)
Filed herewith.