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OCLARO, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Risk Factors" appearing in Item 1A of this Annual Report on Form 10-K, "Selected Financial Data" appearing in Item 6 of this Annual Report on Form 10-K and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K, including Note 1, Basis of Preparation and Summary of Significant Accounting Policies, to such consolidated financial statements, which have been prepared assuming that we will continue as a going concern. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated by the forward-looking statements due to, among other things, our critical accounting estimates discussed below and important other factors set forth in this Annual Report on Form 10-K. Please see "Special Note Regarding Forward-Looking Statements" appearing elsewhere in this Annual Report on Form 10-K. Overview During our fiscal year 2014, we were one of the leading providers of optical components, modules and subsystems for the core optical transport, service provider, wireless backhaul, enterprise and data center markets. Leveraging over three decades of laser technology innovation, photonic integration, and subsystem design, we provide differentiated solutions for optical networks and high-speed interconnects driving the next wave of streaming video, cloud computing, voice over IP, Software as a Service ("SaaS") and other bandwidth-intensive and high-speed applications. Our customers include ADVA Optical Networking ("ADVA"); Alcatel-Lucent; Ciena Corporation ("Ciena"); Cisco Systems, Inc. ("Cisco"); Coriant GmbH ("Coriant"); Fujitsu Limited ("Fujitsu"); Huawei Technologies Co. Ltd ("Huawei"); Juniper Networks, Inc. ("Juniper"); Telefonaktiebolaget LM Ericsson ("Ericsson") and ZTE Corporation ("ZTE"). Recent Developments Business Combinations and Dispositions On August 5, 2014, Oclaro Japan, Inc. our wholly-owned subsidiary ("Oclaro Japan"), entered into a Master Separation Agreement ("MSA") with Ushio Opto Semiconductors, Inc. ("Ushio Opto") and Ushio, Inc. ("Ushio"), whereby Ushio Opto agreed to acquire the industrial and consumer business of Oclaro Japan located at its Komoro, Japan facility (the "Komoro Business"), by means of an absorption-type demerger under the Japanese Companies Act (such transaction, the "Transaction"). 37 -------------------------------------------------------------------------------- Table of Contents Consideration for the Transaction will consist of 1.85 billion Japanese yen (approximately $18.0 million based on the exchange rate on August 5, 2014) in cash, of which 1.6 billion Japanese yen (approximately $15.6 million based on the exchange rate on August 5, 2014) will be paid at the closing and 250 million Japanese yen (approximately $2.4 million) will be paid into escrow and released to Oclaro Japan upon the earlier of six months after the closing or the completion by Oclaro Japan of certain transition services, subject to a net asset valuation adjustment post-closing and after deduction for any indemnification amounts determined to be owed to Ushio Opto prior to release of the funds from escrow. On November 1, 2013, we sold our optical amplifier and micro-optics business (the "Amplifier Business") to II-VI Incorporated ("II-VI"). We received proceeds of $88.6 million, consisting of $79.6 million in cash which was received on November 1, 2013, $4.0 million subject to hold-back by II-VI until December 31, 2014 to address any post-closing claims and $5.0 million related to the exclusive option, which was received on September 12, 2013 and was credited against the purchase price upon closing of the sale. We entered into certain transition service and manufacturing service agreements to allow the Amplifier Business to continue operations during the ownership transition. Both parties provided customary and reciprocal representations, warranties and covenants in the Asset Purchase Agreement. On September 12, 2013, we sold our Oclaro Switzerland GmbH subsidiary and associated laser diodes and pump business (the "Zurich Business") to II-VI. We received proceeds of $90.6 million in cash on September 12, 2013, and $2.9 million in cash during the third quarter of fiscal year 2014 which related to a final settlement of the post-closing working capital adjustment. We will also receive an additional $6.0 million subject to hold-back by II-VI until December 31, 2014 to address any post-closing adjustments or claims. In addition, we retained approximately $14.7 million in accounts receivable related to the Zurich Business and approximately $9.6 million of supplier and employee related payables related to the Zurich Business which were not included in the Zurich subsidiary. As part of the agreement, II-VI purchased our Swiss subsidiary, which includes its GaAs fabrication facility, and also the corresponding high power laser diodes, VCSEL and 980 nm pump laser product lines, including intellectual property, inventory, equipment and a related research and development facility in Tucson, all of which are associated with the Zurich Business. As part of the transition services agreement, during fiscal year 2014, we temporarily supplied II-VI with back-end manufacturing of the 980 nm pump and certain high power laser diode products from our Shenzhen, China manufacturing facility. Also, as part of the agreement, II-VI purchased certain pieces of equipment which are located in our Caswell facility. We continue to operate this equipment on behalf of II-VI, and provide certain wafer processing services in Caswell as part of an ongoing manufacturing services agreement. Credit and Loan Agreements In connection with Amendment Number Two to the Credit Agreement with PECM Strategic Funding LP and Providence TMT Debt Opportunity Fund II LP ("Term Lenders"), and as further consideration for the term loan, we issued the Term Lenders warrants to purchase shares of our common stock. The holders of the warrants were entitled to exercise the warrants for 1,836,000 shares of common stock at an exercise price equal to $1.50 per share. On May 2, 2014, the holders of the warrants exercised the warrants in full. We delivered 978,457 shares of common stock in connection with the cashless exercise of the warrants, and will not receive any proceeds from the exercise. As previously announced, the offer and sale of the warrants, which were issued on May 6, 2013, was not registered under the Securities Act of 1933, as amended (the "Securities Act"), in reliance upon the exemption from registration under Section 4(a)(2) of the Securities Act as such transaction did not involve a public offering of securities. On March 14, 2014, we terminated our Credit Agreement with Wells Fargo Capital Finance and certain other lenders. Prior to terminating the Credit Agreement, we repaid all amounts owed to the lenders under the Credit Agreement, other than immaterial amounts attributable to obligations under the Credit Agreement in respect to letters of credit. On March 28, 2014, we entered into a loan and security agreement (the "Loan Agreement") with Silicon Valley Bank (the "Bank") pursuant to which the Bank provided us with a three-year revolving credit facility of up to $40.0 million. Under the Loan Agreement, advances are available based on up to 80 percent of "eligible accounts" as defined in the Loan Agreement. The Loan Agreement has a $10.0 million sub-facility for letters of credit, foreign exchange contracts and cash management services. Borrowings made under the Loan Agreement bear interest at a rate based on either the London Interbank Offered Rate plus 2.25 percent or Wall Street Journal's prime rate plus 1.00 percent. If the sum of (a) our unrestricted cash and cash equivalents that are subject to the Bank's liens less (b) the amount outstanding to the Bank under the Loan Agreement (such sum being "Net Cash") is less than $15.0 million, then the interest rates are increased by 0.75 percent until Net Cash exceeds $15.0 million for a calendar month. If interest paid under the Loan Agreement is less than $45,000 in any fiscal quarter, we are required to pay the Bank an additional amount equal to the difference between $45,000 and the actual interest paid during such fiscal quarter. The minimum interest payment is in lieu of a stand-by charge. The Loan Agreement contains covenants applicable to us, including a financial covenant that, on a consolidated basis, requires us to maintain a minimum fixed charge coverage ratio of no less than 1.10 to 1.00, if we do not maintain Net Cash of at least $15.0 million, and other customary covenants. 38-------------------------------------------------------------------------------- Table of Contents Convertible Notes On December 19, 2013, the holders of our Convertible Notes exercised their rights to exchange the Convertible Notes for our common stock. The exchange rate for the exchanges was 541.7118 shares of common stock per $1,000 in principal amount of Convertible Notes. We issued 13,542,791 shares of common stock in connection with the exchange, with cash paid in lieu of fractional shares. In addition, pursuant to the terms of the indenture governing the Convertible Notes, we made a redemption exchange make-whole payment of $8.3 million. Results of Operations On September 12, 2013 we announced the sale of our Zurich Business to II-VI, along with an exclusive option to purchase our Amplifier Business. On October 10, 2013, we entered into an Asset Purchase Agreement with II-VI for the sale of our Amplifier Business, which subsequently closed on November 1, 2013. We have classified the financial results of the Zurich and Amplifier Businesses as discontinued operations for all periods presented. The following presentations relate to continuing operations only and accordingly excludes the financial results of the Zurich and Amplifier Businesses, unless otherwise indicated. On July 23, 2012, we completed a merger with Opnext, Inc. ("Opnext"). The acquisition is more fully discussed in Note 3, Business Combinations and Dispositions to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statement of operations for the year ended June 29, 2013 include the results of operations of the combined entities from July 23, 2012, the date of the acquisition. 39-------------------------------------------------------------------------------- Table of Contents Fiscal Years Ended June 28, 2014 and June 29, 2013 The following table sets forth our consolidated results of operations for the fiscal years ended June 28, 2014 and June 29, 2013, and the year-over-year increase (decrease) in our results, expressed both in dollar amounts (thousands) and as a percentage of revenues, except where indicated: Year Ended Increase June 28, 2014 June 29, 2013 Change (Decrease) (Thousands) % (Thousands) % (Thousands) % Revenues $ 390,871 100.0 $ 404,629 100.0 $ (13,758 ) (3.4 ) Cost of revenues 338,424 86.6 376,461 93.0 (38,037 ) (10.1 ) Gross profit 52,447 13.4 28,168 7.0 24,279 86.2 Operating expenses: Research and development 64,218 16.4 79,266 19.6 (15,048 ) (19.0 ) Selling, general and administrative 70,937 18.2 78,618 19.4 (7,681 ) (9.8 ) Amortization of other intangible assets 1,680 0.4 5,029 1.3 (3,349 ) (66.6 ) Restructuring, acquisition (1 ) and related (income) expense, net 18,491 4.7 (7,631 ) (1.9 ) 26,122 n/m Flood-related (income) expense, net (1,797 ) (0.5 ) (29,510 ) (7.3 ) 27,713 (93.9 ) Impairment of goodwill, other intangible assets and long-lived assets 584 0.2 27,021 6.7 (26,437 ) (97.8 ) Loss on sale of property and equipment 665 0.2 170 - 495 291.2 Total operating expenses 154,778 39.6 152,963 37.8 1,815 1.2 Operating loss (102,331 ) (26.2 ) (124,795 ) (30.8 ) 22,464 (18.0 ) Other income (expense): Interest income (expense), net (9,228 ) (2.3 ) (3,271 ) (0.8 ) (5,957 ) 182.1 Loss on foreign currency transactions (1,158 ) (0.3 ) (14,542 ) (3.6 ) 13,384 (92.0 ) Other income (expense), net 1,227 0.3 (2,527 ) (0.6 ) 3,754 n/m (1 ) Gain on bargain purchase - - 24,866 6.1 (24,866 ) (100.0 ) Total other income (1 ) (expense) (9,159 ) (2.3 ) 4,526 1.1 (13,685 ) n/m Loss from continuing operations before income taxes (111,490 ) (28.5 ) (120,269 ) (29.7 ) 8,779 (7.3 ) Income tax (benefit) (1 ) provision (9,365 ) (2.4 ) 26 - (9,391 ) n/m Loss from continuing operations (102,125 ) (26.1 ) (120,295 ) (29.7 ) 18,170 (15.1 ) Income (loss) from (1 ) discontinued operations, net of tax 119,944 30.7 (2,450 ) (0.6 ) 122,394 n/m Net income (loss) $ 17,819 4.6 $ (122,745 ) (30.3 ) $ 140,564 n/m (1 ) (1) Not meaningful Revenues Revenues for the year ended June 28, 2014 decreased by $13.8 million, or 3 percent, compared to the year ended June 29, 2013. Compared to the year ended June 29, 2013, revenues from sales of our 40 Gb/s and 100 Gb/s transmission modules increased by $34.7 million, or 24 percent; revenues from sales of our 10 Gb/s transmission modules decreased by $52.5 million, or 22 percent; and revenues from sales of our industrial and consumer products increased by $4.1 million, or 16 percent. This reflects the continued growth in the market for higher speed products that are smaller in size and have lower power consumption. For the year ended June 28, 2014, Coriant GmbH ("Coriant") accounted for $77.1 million, or 20 percent, of our revenues, Cisco Systems, Inc. ("Cisco") accounted for $49.1 million, or 13 percent, of our revenues, and Huawei Technologies Co., Ltd. 40 -------------------------------------------------------------------------------- Table of Contents ("Huawei") accounted for $42.6 million, or 11 percent, of our revenues. For the fiscal year ended June 29, 2013, Cisco accounted for $56.4 million, or 14 percent, of our revenues, Coriant accounted for $55.7 million, or 14 percent, of our revenues, and Huawei accounted for $42.2 million, or 10 percent, of our revenues. Gross Profit Gross profit is calculated as revenues less cost of revenues. Gross margin rate is gross profit reflected as a percentage of revenues. Our cost of revenues consists of the costs associated with manufacturing our products, and includes the purchase of raw materials, labor costs and related overhead, including stock-based compensation charges and the costs charged by our contract manufacturers for the products they manufacture for us. Charges for excess and obsolete inventory are also included in cost of revenues. Costs and expenses related to our manufacturing resources incurred in connection with the development of new products are included in research and development expenses. Our gross margin rate increased to 13 percent for the year ended June 28, 2014, compared to 7 percent for the year ended June 29, 2013. Three percentage points of the the 6 percentage point improvement in gross margin rate related to the product mix of our sales, with an increased mix of our higher margin 100 Gb/s products during the year ended June 28, 2014, as compared to the year ended June 29, 2013. In addition, reduced manufacturing overhead costs contributed 2 percentage points of improvement, and the absence of certain acquisition costs combined with lower outsource transition costs in fiscal year 2014, as compared to fiscal year 2013, contributed 1 percentage point of improvement. Research and Development Expenses Research and development expenses consist primarily of salaries and related costs of employees engaged in research and design activities, including stock-based compensation charges related to those employees, costs of design tools and computer hardware, costs related to prototyping and facilities costs for certain research and development focused sites. Research and development expenses decreased by $15.0 million, or 19 percent, for the year ended June 28, 2014, compared to the year ended June 29, 2013. The decrease was related to a $6.2 million reduction in costs as a result of aligning and reducing combined research and development resources of Oclaro and Opnext in association with the merger, a decrease of $3.5 million related to our decision to no longer develop the WSS product line, a decrease of $3.2 million related to headcount reductions and other cost savings measures, a decrease of $1.6 million related to the impact of the depreciation of the Japanese Yen, and a decrease in stock compensation expense of $0.5 million. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of personnel-related expenses, including stock-based compensation charges related to employees engaged in sales, general and administrative functions, and other costs, including costs for audit, professional fees and insurance costs; information technology; insurance; sales and marketing; human resources and legal and other corporate costs. Selling, general and administrative expenses also include facilities expenses for sites which are not primarily focused on manufacturing or research and development. Selling, general and administrative expenses decreased by $7.7 million, or 10 percent, for the year ended June 28, 2014, compared to the year ended June 29, 2013. The decrease was primarily related to $10.1 million reduction in costs as a result of aligning and reducing combined selling, general and administrative resources of Oclaro and Opnext in association with the merger, a decrease of $0.8 million related to the impact of the depreciation of the Japanese Yen, and a $1.0 million reduction in expenses associated with the shutdown of the WSS product line. These reductions were partially offset by an increase in audit fees of $1.2 million, an increase in variable pay of $1.2 million, an increase in legal costs of $0.8 million, and increase in stock compensation costs of $1.0 million. Amortization of Other Intangible Assets Amortization of other intangible assets decreased to $1.7 million for the year ended June 28, 2014 from $5.0 million for the year ended June 29, 2013. The decrease in our amortization is a result of recording a $14.2 million impairment charge related to our other intangible assets during the fourth quarter of fiscal year 2013, including $6.4 million related to intangibles acquired in connection with our acquisition of Mintera, $2.6 million related to intangibles acquired in connection with our acquisition of Opnext, and $5.2 million related to intangibles acquired in connection with other earlier acquisitions. Based on the current levels of our other intangible assets, we expect the amortization of intangible assets to be $1.7 million in each fiscal year from 2015 through 2018, and $0.6 million in fiscal year 2019. 41-------------------------------------------------------------------------------- Table of Contents Restructuring, Acquisition and Related (Income) Expense, Net During the first quarter of fiscal year 2014, we initiated a restructuring plan to simplify our operating footprint, reduce our cost structure and focus our research and development investment in the optical communications market where we can leverage our core competencies. During the year ended June 28, 2014, we recorded restructuring charges of $13.2 million, consisting of $8.5 million related to workforce reductions, $2.9 million in costs related to transferring production capabilities of our 10G InP products in-house from one of our contract manufacturers, $0.8 million related to a facility lease loss liability, $0.7 million related to the write-off of certain fixed assets in connection with our relocation of our manufacturing and research and development facilities from Totsuka, Japan, and $0.3 million in other lease cancellations and commitments. In connection with the acquisition of Opnext, we initiated a restructuring plan to integrate the businesses in the first quarter of fiscal year 2013. In connection with the integration, we recorded $1.1 million and $12.1 million in restructuring charges during the year ended June 28, 2014 and June 29, 2013, respectively. The restructuring charges in fiscal year 2014 included $0.9 million related to external consulting charges and professional fees associated with reorganizing the infrastructure and $0.1 million related to facility exit costs. The restructuring charges in fiscal year 2013 included $10.5 million related to workforce reductions, $0.9 million related to the impairment of certain technology that is now considered redundant following the acquisition, $0.4 million related to the write-off of net book value inventory that supported this technology, and $0.3 million related to revised estimates for lease cancellations and commitments. Included in our restructuring charges during fiscal year 2013, we recorded $2.2 million relating to the separation agreement with our former Chief Executive Officer. During fiscal year 2012, we initiated a restructuring plan in connection with the transfer of our Shenzhen, China manufacturing operations to Venture Corporation Limited ("Venture"). This transition is scheduled to occur in a phased and gradual transfer of certain products, which is scheduled to be completed in fiscal year 2015. In connection with this transition, we recorded restructuring charges of $3.5 million and $5.1 million during the year ended June 28, 2014 and June 29, 2013, respectively. All of the restructuring charges in fiscal year 2014 and 2013 related to employee separation charges. We expect to incur an additional $4.0 million to $9.0 million, in aggregate, in restructuring charges over the course of the next year in connection with the these restructuring plans. During the second quarter of fiscal year 2013, we sold our thin film filter business and interleaver product line in exchange for $27.0 million in cash. During the year ended June 29, 2013, we recorded a gain of $24.8 million related to this sale in the restructuring, acquisition and related (income) expense, net in our consolidated statement of operations. Flood-Related (Income) Expense, Net In October 2011, certain areas in Thailand suffered major flooding as a result of monsoons. This flooding had a material and adverse impact on our business and results of operations. Our primary contract manufacturer, Fabrinet, suspended operations at two factories located in Chokchai, Thailand and Pinehurst, Thailand. The Chokchai factory suffered extensive flood damage and became inaccessible due to high water levels inside and surrounding the manufacturing facility. During the year ended June 28, 2014, we recorded $1.8 million in net flood-related income in our consolidated statement of operations, primarily consisting of $3.7 million in insurance settlement proceeds received in the second and third quarters of fiscal year 2014 and adjustments to retainers for professional services of $0.1 million, partially offset by an out-of-period adjustment of $2.0 million related to the impairment of leased assets assumed pursuant to the Opnext merger that had been damaged by the flooding. Approximately $1.5 million of the $3.7 million received in fiscal year 2014 represents payments against insurance claims filed under the former Opnext entity. During the year ended June 29, 2013, we recorded net flood-related income of $29.5 million comprised of $30.8 million in settlement payments, offset in part by $1.3 million in professional fees and related expenses incurred in connection with our recovery efforts. Approximately $14.0 million of the $30.8 million received in fiscal year 2013 represents payments against insurance claims filed under the former Opnext entity. 42-------------------------------------------------------------------------------- Table of Contents Flood-related (income) expense, net for the years ended June 28, 2014 and June 29, 2013 include the following: Year Ended June 28, 2014 June 29, 2013 (Thousands)Write-off of net book value of damaged property and equipment $ 2,009 $ - Personnel-related costs, professional fees and related expenses (143 ) 1,287 Settlement payments (3,663 ) (30,797 ) $ (1,797 ) $ (29,510 ) Impairment of Goodwill, Other Intangible Assets and Long-Lived Assets In fiscal year 2014, we recorded an impairment charge of $0.6 million related to the write-off of certain machinery that was not being utilized. During the fourth quarter of fiscal year 2014, we reviewed our other intangible assets for impairment. We compared their carrying amounts to market prices or the future undiscounted cash flows the assets are expected to generate. We determined that the carrying value of the assets did not exceed the fair value based on market prices or future discounted cash flows. We did not record any impairment charges related to other intangible assets in fiscal year 2014. During the fourth quarter of fiscal year 2013, we performed an annual analysis for potential impairment of our goodwill, which included examining. based on factors and conditions then existing, the impact of current general economic conditions on our future prospects, the decline in our market capitalization, and the anticipated resizing of our operations with the recent sale of certain of our products and/or businesses. The first step of testing goodwill for impairment is based on a reporting unit's "fair value," which is generally determined through market prices. In certain cases, due to the absence of market prices for a particular element of our business, we have elected to base our analysis on discounted future expected cash flows. Based on this analysis, we concluded that our remaining goodwill on our consolidated balance sheet, which relates to our acquisition of Mintera, was impaired. We performed a second step impairment analysis, which indicated that the goodwill in connection with the Mintera reporting unit was fully impaired. Based upon this evaluation, we recorded $10.9 million for the goodwill impairment loss in our consolidated statement of operations for the year ended June 29, 2013. The impairment did not result in any cash expenditures. In connection with our second step goodwill impairment analysis, we also evaluated the fair value of our other intangible assets in this reporting unit, and our other reporting units, and concluded that based on declines in our forecasts, our decision to sell or abandon certain product lines and other factors, certain of these other intangible assets were also impaired as of June 29, 2013. We recorded impairment losses of $6.4 million related to intangibles acquired in connection with our acquisition of Mintera, $2.6 million related to intangibles acquired in connection with our acquisition of Opnext, and $5.2 million related to intangibles acquired in connection with other earlier acquisitions. During fiscal year 2013, we also recorded $0.9 million related to the impairment of certain technology that was considered redundant following the acquisition of Opnext. Other Income (Expense) Other income (expense) decreased to $9.2 million in expense for the year ended June 28, 2014 from $4.5 million in income for the year ended June 29, 2013. This decrease was primarily due to a $24.9 million gain on bargain purchase in connection with our acquisition of Opnext in the first quarter of fiscal year 2013, and by a $6.9 million increase in interest expense primarily related to the make-whole payment from the conversion of the convertible notes into common stock in the second quarter of fiscal year 2014, partially offset by a $3.6 million impairment charge related to the revaluation of an investment during the year ended June 29, 2013, and as a result of recording lower foreign currency transaction losses of $13.4 million during the year ended June 28, 2014 as compared to the year ended June 29, 2013. The $13.4 million foreign currency transaction loss during the year ended June 29, 2013 was predominantly a result of revaluing intercompany receivables denominated in Japanese yen. Income Tax Provision For the fiscal year ended June 28, 2014, our income tax benefit of $9.4 million related primarily to our foreign operations and an adjustment relating to the income tax accounting for intra-period tax allocation during fiscal year 2014 between continuing operations and discontinued operations related to our sales of our Zurich and Amplifier Businesses. For the fiscal year ended June 29, 2013, our income tax provision was minimal and related primarily to our foreign operations, which operate on a cost-plus basis for services associated with manufacturing and research and development. 43 -------------------------------------------------------------------------------- Table of Contents Income from Discontinued Operations, Net of Tax During the year ended June 28, 2014, we recorded a gain of $68.9 million related to the sale of the Amplifier Business and a gain of $63.2 million related to the sale of the Zurich Business. During the year ended June 28, 2014, we recorded income from discontinued operations from the Amplifier and Zurich Businesses of $59.1 million and $60.8 million, respectively, which includes the gain on the sale of the businesses. For the year ended June 29, 2013, we recorded income from discontinued operations from the Amplifier Business of $1.5 million and a loss from discontinued operations from the Zurich Business of $3.9 million. The following table sets forth the results of the discontinued operations of our Zurich and Amplifier Businesses and the year-over-year increases (decreases) in our results: Year Ended June 28, 2014 June 29, 2013 Change (Thousands) Revenues $ 49,081 $ 181,399 $ (132,318 ) Cost of revenues 37,418 145,165 (107,747 ) Gross profit 11,663 36,234 (24,571 ) Operating expenses 8,971 36,195 (27,224 ) Other income (expense), net 130,518 (996 ) 131,514 Income (loss) from discontinued operations before income taxes 133,210 (957 ) 134,167 Income tax provision 13,266 1,493 11,773 Income (loss) from discontinued operations $ 119,944 $ (2,450 ) $ 122,394 44 -------------------------------------------------------------------------------- Table of Contents Fiscal Years Ended June 29, 2013 and June 30, 2012 The following table sets forth our consolidated results of operations for the fiscal years ended June 29, 2013 and June 30, 2012, and the year-over-year increase (decrease) in our results, expressed both in dollar amounts (thousands) and as a percentage of revenues, except where indicated: Year Ended Increase June 29, 2013 June 30, 2012 Change (Decrease) (Thousands) % (Thousands) % (Thousands) % Revenues $ 404,629 100.0 $ 194,208 100.0 $ 210,421 108.3 Cost of revenues 376,461 93.0 165,528 85.2 210,933 127.4 Gross profit 28,168 7.0 28,680 14.8 (512 ) (1.8 ) Operating expenses: Research and development 79,266 19.6 43,534 22.4 35,732 82.1 Selling, general and administrative 78,618 19.4 49,490 25.5 29,128 58.9 Amortization of other intangible assets 5,029 1.3 2,724 1.4 2,305 84.6 Restructuring, acquisition (1 ) and related (income) expense, net (7,631 ) (1.9 ) 9,329 4.8 (16,960 ) n/m Flood-related (income) (1 ) expense, net (29,510 ) (7.3 ) 2,458 1.3 (31,968 ) n/m Impairment of goodwill, (1 ) other intangible assets and long-lived assets 27,021 6.7 - - 27,021 n/m (Gain) loss on sale of (1 ) property and equipment 170 - (11,182 ) (5.8 ) 11,352 n/m Total operating expenses 152,963 37.8 96,353 49.6 56,610 58.8 Operating loss (124,795 ) (30.8 ) (67,673 ) (34.8 ) (57,122 ) 84.4 Other income (expense): Interest income (expense), net (3,271 ) (0.8 ) (1,121 ) (0.6 ) (2,150 ) 191.8 Loss on foreign currency (1 ) transactions (14,542 ) (3.6 ) 4,585 2.4 (19,127 ) n/m Other income (expense), net (2,527 ) (0.6 ) 2,238 1.1 (4,765 ) n/m (1 ) Gain on bargain purchase 24,866 6.1 - - 24,866 n/m (1 ) Total other income (expense) 4,526 1.1 5,702 2.9 (1,176 ) (20.6 ) Loss from continuing operations before income taxes (120,269 ) (29.7 ) (61,971 ) (31.9 ) (58,298 ) 94.1 Income tax provision 26 - 2,026 1.0 (2,000 ) (98.7 ) Loss from continuing operations (120,295 ) (29.7 ) (63,997 ) (33.0 ) (56,298 ) 88.0 Loss from discontinued operations, net of tax (2,450 ) (0.6 ) (2,506 ) (1.3 ) 56 (2.2 ) Net loss $ (122,745 ) (30.3 ) $ (66,503 ) (34.2 ) $ (56,242 ) 84.6 (1) Not meaningful Revenues Revenues for the year ended June 29, 2013 increased by $210.4 million, or 108 percent, compared to the year ended June 30, 2012. The increase was primarily due to the inclusion of revenues in fiscal year 2013 generated through the acquisition of Opnext on July 23, 2012. Compared to the year ended June 30, 2012, revenues from sales of our 40 Gb/s and 100 Gb/s transmission modules increased by $75.2 million, or 111 percent; revenues from sales of our 10 Gb/s transmission modules increased by $109.4 million, or 86 percent; and revenues from sales of our industrial and consumer products increased by $25.8 million. The increase in revenue for these respective product groups was mainly attributable to our acquisition of Opnext and also our recovery from the flooding in Thailand. 45 -------------------------------------------------------------------------------- Table of Contents For the fiscal year ended June 29, 2013, Cisco accounted for $56.4 million, or 14 percent, of our revenues, Coriant accounted for $55.7 million, or 14 percent, of our revenues, and Huawei accounted for $42.2 million, or 10 percent, of our revenues. For the fiscal year ended June 30, 2012, Fujitsu Limited accounted for $38.4 million, or 20 percent, of our revenues, ADVA Optical Networking accounted for $21.3 million, or 11 percent, of our revenues, and Ciena Corporation accounted for $18.9 million, or 10 percent, of our revenues. Gross Profit Our gross margin rate decreased to 7 percent for the year ended June 29, 2013, compared to 15 percent for the year ended June 30, 2012. The 8 percentage point decline in gross margin rate was mainly attributable to product mix of our sales, with a higher mix of lower margin fixed wavelength 10 Gb/s transmission products, and a decline of approximately 3 percentage points which was attributable to higher excess and obsolete inventory valuation charges. The decrease in our gross margin rate was partially offset by the re-assignment of certain of our manufacturing employees to efforts to restore our production capacity following the flood in Thailand, which resulted in a $1.9 million higher gross profit than would have otherwise been recorded for the year ended June 30, 2012, as these costs were included in flood-related (income) expense during that period rather than being recorded in cost of revenues. Research and Development Expenses Research and development expenses increased by $35.7 million, or 82 percent, for the year ended June 29, 2013, compared to the year ended June 30, 2012. The increase was primarily related to the inclusion of research and development expenses in fiscal year 2013 to fund research and development associated with products acquired through the acquisition of Opnext on July 23, 2012, partially offset by a reduction in research and development expenses related to synergies from aligning and reducing combined research and development resources of Oclaro and Opnext in association with the merger, and other cost reduction efforts in response to softening market conditions and lower post-flood revenues. In addition, for the year ended June 30, 2012, research and development expenses were $1.2 million lower than they would have been otherwise as the redeployment of certain research and development personnel to flood recovery efforts, on a temporary basis during the recovery time period, have been included in flood-related (income) expense in fiscal year 2012. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $29.1 million, or 59 percent, for the year ended June 29, 2013, compared to the year ended June 30, 2012. The increase was primarily related to the inclusion of selling, general and administrative expenses in fiscal year 2013 attributable to the operations of Opnext, partially offset by a reduction in selling, general and administrative expenses related to synergies from aligning and reducing combined selling, general and administrative resources of Oclaro and Opnext in association with the merger, and other cost reduction efforts in response to softening market conditions and lower post-flood revenues. For the year ended June 29, 2013, selling, general and administrative expenses were $0.4 million lower than they would have been otherwise, as the redeployment of certain selling, general and administrative personnel to flood recovery efforts, on a temporary basis during the recovery time period, have been included in flood-related (income) expense in fiscal year 2012. Amortization of Other Intangible Assets Amortization of other intangible assets increased to $5.0 million for the year ended June 29, 2013 from $2.7 million for the year ended June 30, 2012. The increase in our amortization is a result of our acquisition of Opnext, for which we recorded $16.4 million in other intangible assets during the first quarter of fiscal year 2013 as our estimate of the fair value of acquired intangible assets. During the fourth quarter of fiscal year 2013, we completed our impairment analysis and concluded that based on the decline in our forecast, our decision to sell or abandon certain product lines and other factors, certain of our other intangible assets were impaired as of June 29, 2013. We recorded impairment losses of $6.4 million related to intangibles acquired in connection with our acquisition of Mintera, $2.6 million related to intangibles acquired in connection with our acquisition of Opnext, and $5.2 million related to intangibles acquired in connection with other earlier acquisitions. 46-------------------------------------------------------------------------------- Table of Contents Restructuring, Acquisition and Related (Income) Expense, Net In connection with the acquisition of Opnext, we recorded $12.1 million in restructuring charges during the year ended June 29, 2013, including $10.5 million related to workforce reductions, $0.9 million related to the impairment of certain technology that is now considered redundant following the acquisition, $0.4 million related to the write-off of net book value inventory that supported this technology, and $0.3 million related to revised estimates for lease cancellations and commitments. Included in our restructuring charges during fiscal year 2013, we recorded $2.2 million relating to the separation agreement with our former Chief Executive Officer. During the second quarter of fiscal year 2013, we sold our thin film filter business and interleaver product line in exchange for $27.0 million in cash. During the year ended June 29, 2013, we recorded a gain of $24.8 million related to this sale in the restructuring, acquisition and related (income) expense, net in our consolidated statement of operations. During fiscal year 2012, we initiated a restructuring plan in connection with the transfer of our Shenzhen, China manufacturing operations to Venture. We expect this transition to occur in a phased and gradual transfer of products over a three year period ending in 2015 and we expect it will result in approximately $35.0 million in lower working capital requirements, net of related costs incurred. In connection with this transition, we recorded restructuring charges of $5.1 million and $6.0 million for employee separation charges in fiscal years 2013 and 2012, respectively. Separation charges under the restructuring plan were accrued and charged to restructuring, acquisition and related (income) expense, net. We also incurred $1.4 million in fiscal year 2012 in employee separation costs in connection with previously announced restructuring plans. In addition, we incurred $3.9 million of expenses during the year ended June 30, 2012, in external consulting charges associated with the optimization of past acquisitions as we focused on the associated infrastructure and processes required to support sustainable growth, including external costs associated with potential transactions to outsource our Shenzhen manufacturing operations, which culminated in our transaction with Venture. Flood-Related (Income) Expense, Net During the year ended June 29, 2013, we recorded flood-related income of $29.5 million comprised of $30.8 million in settlement payments, offset in part by $1.3 million in professional fees and related expenses incurred in connection with our recovery efforts. As there were no contingencies associated with these payments, we recorded the payments within flood-related (income) expense, net in our consolidated statements of operations for the year ended June 29, 2013. During the year ended June 30, 2012, we recorded flood-related expenses of $2.5 million, including $8.2 million in impairment charges related to the write-off of the net book value of damaged inventory and property and equipment based on estimates of the damage caused by the flooding; $5.3 million in personnel-related costs, professional fees and related expenses incurred in connection with our recovery efforts; partially offset by $11.0 million in payments received from one of our insurers relating to losses we incurred due to the flooding in Thailand. Flood-related (income) expense, net for the years ended June 29, 2013 and June 30, 2012 include the following: Year Ended June 29, 2013 June 30, 2012 (Thousands) Adjustment to net book value for damaged inventory $ - $ 4,246 Write-off of net book value of damaged property and equipment - 3,927 Personnel-related costs, professional fees and related expenses 1,287 5,274 Settlement payments (30,797 ) (10,989 ) $ (29,510 ) $ 2,458 Impairment of Goodwill, Other Intangible Assets and Long-Lived Assets During the first quarter of fiscal year 2013, we recorded $0.9 million related to the impairment of certain technology that was considered redundant following the acquisition of Opnext. During the fourth quarter of fiscal year 2013, we completed our annual first step analysis for potential impairment of our goodwill, which included, based on factors and conditions then existing, examining the impact of current general economic conditions on our future prospects, the decline in our market capitalization, and the anticipated resizing of our operations with 47-------------------------------------------------------------------------------- Table of Contents the recent sale of certain of our products and/or businesses, and we concluded that goodwill related to our Mintera reporting unit was impaired. During the fourth quarter of fiscal year 2013, we also completed our second step analysis of goodwill impairment, determining that the $10.9 million of goodwill related to our Mintera reporting unit was fully impaired. Based upon this evaluation, we recorded $10.9 million for the goodwill impairment loss in our consolidated statement of operations for fiscal year 2013. In connection with our second step goodwill impairment analysis, we also evaluated the fair value of our other intangible assets of our Mintera reporting unit, and our other reporting units, and concluded that based on the decline in our forecast, our decision to sell or abandon certain product lines and other factors, certain of these other intangible assets were also impaired as of June 29, 2013. We recorded impairment losses of $6.4 million related to intangibles acquired in connection with our acquisition of Mintera, $2.6 million related to intangibles acquired in connection with our acquisition of Opnext, and $5.2 million related to intangibles acquired in connection with other earlier acquisitions. (Gain) Loss on Sale of Property and Equipment During fiscal year 2012, we sold our Shenzhen, China manufacturing facility for 136.0 million Chinese yuan (approximately $21.5 million on the date of the transaction). We received approximately $18.7 million in net proceeds after transfer taxes of approximately $2.5 million and transaction costs of approximately $0.4 million. For the year ended June 30, 2012, we recorded a $13.6 million gain on the sale of this facility, recognizing $11.3 million of this amount in gain (loss) on sale of property and equipment in our consolidated statement of operations in the fourth quarter of fiscal year 2012, and deferring $2.3 million of the gain, which is being amortized ratably against rent expense as part of our lease back of the facility. Other Income (Expense) Other income (expense) decreased to $4.5 million in income for the year ended June 29, 2013 from $5.7 million in income for the year ended June 30, 2012. This decrease was primarily due to (i) recording a $14.5 million loss on foreign currency transactions during the year ended June 29, 2013 due to the significant weakening of the Japanese yen relative to the U.S. dollar and its impact on the revaluation of our Japanese yen-denominated intercompany receivables, as compared to recording a $4.6 million gain on foreign currency transactions during the year ended June 30, 2012; (ii) an increase of $2.2 million in interest expense during the fiscal year 2013 as a result of higher average borrowings under our Credit Agreement, entering into a new term loan and issuing convertible notes during fiscal year 2013; (iii) a $3.6 million impairment charge related to the revaluation and sale of an investment in a privately-held company in fiscal year 2013, as compared to a $2.2 million gain on the sale of a minority equity investment in a private company in fiscal year 2012; partially offset by (iv) a $24.9 million gain on bargain purchase in connection with our acquisition of Opnext in the first quarter of fiscal year 2013. Income Tax Provision For the fiscal year ended June 29, 2013 and June 30, 2012, our income tax provision of $26,000 and $2.0 million, respectively, related primarily to our foreign operations. Income from Discontinued Operations, Net of Tax During the year ended June 29, 2013, we recorded income from discontinued operations from the Amplifier Business of $1.5 million and a loss from discontinued operations from the Zurich Business of $3.9 million, respectively. For the year ended June 30, 2012, we recorded income from discontinued operations from the Amplifier Business of $2.1 million and a loss from discontinued operations from the Zurich Business of $4.6 million. 48-------------------------------------------------------------------------------- Table of Contents The following table sets forth the results of the discontinued operations of our Zurich and Amplifier Businesses and the year-over-year increases (decreases) in our results: Year Ended June 29, 2013 June 30, 2012 Change (Thousands) Revenues $ 181,399 $ 191,250 $ (9,851 ) Cost of revenues 145,165 149,885 (4,720 ) Gross profit 36,234 41,365 (5,131 ) Operating expenses 36,195 37,444 (1,249 ) Other income (expense), net (996 ) (1,469 ) 473 Income (loss) from discontinued operations before income taxes (957 ) 2,452 (3,409 ) Income tax (benefit) provision 1,493 4,958 (3,465 ) Income (loss) from discontinued operations $ (2,450 ) $ (2,506 ) $ 56 Liquidity and Capital Resources The consolidated statements of cash flows and the discussion below on cash flows from operating activities, investing activities and financing activities have not been adjusted for the effects of the discontinued operations. Cash flows from Operating Activities Net cash used in operating activities for the year ended June 28, 2014 was $81.2 million, primarily resulting from a loss from continuing operations before income taxes of $111.5 million, adjusted for accumulated non-cash charges of $38.4 million (excluding the gains on the sale of the Zurich and Amplifier Businesses) and a $5.3 million decrease in cash due to changes in operating assets and liabilities. The $38.4 million of non-cash adjustments primarily consisted of $26.4 million of expense related to depreciation and amortization, $6.2 million expense related to stock-based compensation, $4.3 million related to the amortization and write-off of the issuance costs of a term loan and $2.0 million related to non-cash flood-related impairments, partially offset by $2.1 million from the amortization of the deferred gain from two sales-leaseback transactions. The $5.3 million decrease in cash due to changes in operating assets and liabilities was primarily comprised of a $27.2 million decrease in accounts payable, a $14.7 million decrease in accrued expenses and other liabilities and a $7.0 million increase in prepaid expenses and other current assets, partially offset by a $26.5 million decrease in accounts receivable, net, a $15.5 million decrease in inventory, and a $1.5 million decrease in other non-current assets. Net cash used in operating activities for the year ended June 29, 2013 was $87.5 million, primarily resulting from a net loss of $122.7 million, partially offset by $28.4 million of non-cash adjustments and a $6.9 million increase in cash due to changes in operating assets and liabilities. The $28.4 million of non-cash adjustments was primarily comprised of $42.2 million of expense related to depreciation and amortization, $26.0 million related to the impairment of goodwill and other intangibles, $7.2 million of expense related to stock-based compensation, $3.6 million related to the impairment of an investment in a privately-held company, and $1.1 million charge related to other non-cash transactions, partially offset by $24.9 million for the bargain purchase gain related to our acquisition of Opnext, $24.8 million related to the gain on the sale of the thin film filter business and interleaver product line, and $2.1 million from the amortization of the deferred gain from two sales-leaseback transactions. The $6.9 million increase in cash due to changes in operating assets and liabilities was primarily comprised of a $33.9 million decrease in accounts receivable, net, and a $14.4 million decrease in inventory, partially offset by a $23.4 million decrease in accounts payable, a $15.0 million increase in prepaid expenses and other current assets, and a $2.9 million decrease in accrued expenses and other liabilities. Net cash used in operating activities for the year ended June 30, 2012 was $26.7 million, primarily resulting from a net loss of $66.5 million, partially offset by $18.2 million of non-cash adjustments and a $21.7 million increase in cash due to changes in operating assets and liabilities. The $18.2 million of non-cash adjustments was primarily comprised of $22.3 million of expense related to depreciation and amortization, $8.2 million of expense related to our non-cash flood-related impairments and $6.6 million of expense related to stock-based compensation, partially offset by a $11.3 million gain on the sale of our building in Shenzhen, China, $2.2 million due to the revaluation of the Mintera earnout liability, $2.2 million gain on the sale of an investment, $1.9 million gain from the sale of certain assets related to a legacy product and $1.0 million from the amortization 49-------------------------------------------------------------------------------- Table of Contents of deferred gain from two sales-leaseback transactions. The $21.7 million increase in cash due to changes in operating assets and liabilities was primarily comprised of a $14.9 million decrease in inventory, a $6.7 million increase in accrued expenses and other liabilities and a $6.3 million decrease in accounts receivable, partially offset by a $5.1 million decrease in accounts payable, a $0.6 million increase in other non-current assets and a $0.5 million increase in prepaid expenses and other current assets. Cash flows from Investing Activities Net cash provided by investing activities for the year ended June 28, 2014 was $169.2 million, primarily consisting of $93.5 million in proceeds from the sale of the Zurich Business, $84.6 million in proceeds from the sale of the Amplifier Business, $2.1 million from the sale of certain assets, partially offset by $8.8 million in capital expenditures and $2.3 million increase in restricted cash. Net cash provided by investing activities for the year ended June 29, 2013 was $66.8 million, primarily consisting of $36.1 million cash acquired in the acquisition of Opnext, $26.0 million in proceeds from the sale of the thin film filter business and interleaver product line, a $17.9 million reduction in restricted cash and $3.9 million in proceeds from the sale of an investment in a privately-held company, which were partially offset by $17.2 million used in capital expenditures. Net cash provided by investing activities for the year ended June 30, 2012 was $6.1 million, primarily consisting of $18.7 million in net proceeds from the sale of the manufacturing facility in Shenzhen, China, $3.9 million in proceeds from the sale of certain assets related to a legacy product, $3.4 million in proceeds from the sale of a minority investment and $0.4 million in proceeds from the sale of other property and equipment, partially offset by $20.3 million used in capital expenditures. Cash Flows from Financing Activities Net cash used in financing activities for the year ended June 28, 2014 was $72.1 million, primarily consisting of $65.0 million in repayments on a term loan and our revolving credit facility and $7.1 million in payments on capital leases. Net cash provided by financing activities for the year ended June 29, 2013 was $30.8 million, primarily consisting of $22.8 million in proceeds from the sale of convertible notes, $22.5 million from borrowings under a term loan, $15.3 million in borrowings under our revolving credit facility and $1.6 million in proceeds from the issuance of common stock through stock option exercises and our employee stock purchase plan, partially offset by $16.0 million in repayments on a note payable and our revolving credit facility, $8.6 million in payments in connection with the remaining earnout obligations related to our acquisition of Mintera, and $6.7 million in payments on capital lease obligations. Net cash provided by financing activities for the year ended June 30, 2012 was $22.8 million, primarily consisting of $25.5 million in borrowings under our revolving credit facility and $0.1 million in proceeds from the issuance of common stock through stock option exercises, partially offset by $2.8 million in payments in connection with earnout obligations related to our acquisition of Mintera. Effect of Exchange Rates on Cash and Cash Equivalents for the Years Ended June 28, 2014, June 29, 2013 and June 30, 2012 The effect of exchange rates on cash and cash equivalents for the year ended June 28, 2014 was a decrease of $1.6 million, primarily consisting the revaluation of the U.S. dollar denominated operating intercompany payables and receivables of our foreign subsidiaries and the revaluation of foreign currency cash balances to the functional currency of the respective subsidiaries. The effect of exchange rates on cash and cash equivalents for the year ended June 29, 2013 was an increase of $12.8 million, primarily consisting of a gain of approximately $5.1 million due to the revaluation of foreign currency cash balances to the functional currency of the respective subsidiaries and a gain of $7.7 million related to the revaluation of U.S. dollar denominated operating intercompany payables and receivables of our foreign subsidiaries. The effect of exchange rates on cash and cash equivalents for the year ended June 30, 2012 was a decrease of $3.3 million, primarily consisting of a loss of approximately $4.0 million related to the revaluation of U.S. dollar denominated operating intercompany payables and receivables of our foreign subsidiaries, partially offset by a $0.7 million gain due to the revaluation of foreign currency cash balances to the functional currency of the respective subsidiaries. Credit Line and Notes As of June 28, 2014, we had a $40.0 million revolving credit facility with Silicon Valley Bank. As of June 28, 2014, there were no amounts outstanding under this credit facility. See Note 7, Credit Line and Notes, for additional information regarding this credit facility. 50-------------------------------------------------------------------------------- Table of Contents Prior to establishing our credit facility with Silicon Valley Bank, we maintained a credit facility with Wells Fargo Capital Finance, Inc. ("Wells Fargo") and certain other lenders, which was terminated on March 14, 2014. All amounts outstanding under this credit facility were repaid during fiscal year 2014. As of June 29, 2013, there was $40.0 million outstanding under this credit facility. See Note 7, Credit Line and Notes, for additional information regarding this credit facility. On May 6, 2013, we secured a $25.0 million term loan (the "Term Loan"), which was subsequently repaid during the first quarter of fiscal year 2014, with the proceeds from the sale of our Zurich Business. See Note 7, Credit Line and Notes, for additional information regarding this Term Loan. On December 14, 2012, we closed a private placement of $25.0 million aggregate principal amount 7.50% Exchangeable Senior Secured Second Lien Notes due 2018. The sale of the convertible notes resulted in net proceeds of approximately $22.8 million. On December 19, 2013, the holders exercised their rights to exchange the convertible notes for our common stock. The exchange rate for the exchanges was 541.7118 shares of common stock per $1,000 in principal amount of convertible notes. We issued 13,542,791 shares of common stock in connection with the exchange, with cash payable in lieu of fractional shares. In addition, pursuant to the terms of the indenture governing the convertible notes, we made a redemption exchange make-whole payment of $8.3 million. See Note 7, Credit Line and Notes, for additional information regarding these convertible notes. Future Cash Requirements As of June 28, 2014, we held $104.1 million in cash and short-term investments, comprised of $99.0 million in cash and cash equivalents, $5.1 million in restricted cash and $0.1 million of short-term investments; and we had working capital of $175.2 million. On September 12, 2013, we completed the sale of our Zurich Business under which we expect to receive $6.0 million in additional proceeds which are subject to hold-back by II-VI until December 31, 2014 to address any post-closing adjustments or claims. On November 1, 2013, we completed the sale of our Amplifier Business under which we expect to receive $4.0 million in additional proceeds which are subject to hold-back by II-VI until December 31, 2014 to address any post-closing claim. Based on our current cash and cash equivalent balances, we believe that we have sufficient funds to support our operations through the next 12 months, including costs associated with the implementation of our restructuring activities. In the event we need additional liquidity beyond our current expectations, such as to fund future growth or strengthen our balance sheet or to fund the cost of restructuring activities, we may find it necessary to lower our operating income break-even level and undertake additional cost cutting measures. We will continue to explore other sources of additional liquidity. These additional sources of liquidity could include one, or a combination, of the following: (i) issuing equity securities, (ii) incurring indebtedness secured by our assets, (iii) issuing debt and/or convertible debt securities, or (iv) selling product lines, other assets and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all. We have incurred significant operating losses from continuing operations and generated negative cash flows from operations for fiscal year 2014. Recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon us having sufficient resources to operate our business. In addition to the availability of our cash resources as of June 28, 2014, the continued operation of our business is dependent upon our achieving cash flows expected to be generated from the execution of our current operating plan, including anticipated restructuring plans, together with amounts expected to be available under our Credit Agreement and from the sale of our Komoro, Japan industrial and consumer business. We can make no assurances that we will be successful concluding the sale of our Komoro, Japan industrial and consumer business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should we be unable to continue in existence. In addition, we have been operating in China for an extended period of time and have accumulated significant intercompany balances with our related entities. Our ability to repay or collect these balances may be restricted by Chinese laws and, as a result, we may be unable to successfully pay down or collect on these balances. As a consequence, we may be assessed additional taxes in China if we are unable to claim bad debt deductions or incur debt forgiveness income from the cancellation of these intercompany balances. Additionally, if we are found not to have complied with the various local laws surrounding cross border payments, we may incur penalties and fines for non-compliance. Any such taxes, penalties and/or fines could be significant in amount and, as a result, could have a material adverse effect on our financial condition, including our cash and cash equivalent balances. 51-------------------------------------------------------------------------------- Table of Contents For additional information on the risks we face related to future cash requirements, see Item 1A. Risk Factors under "- Risks Related to Our Business - We have a history of large operating losses and we may not be able to achieve profitability in the future and maintain sufficient levels of liquidity," Note 1, Basis of Preparation and Summary of Significant Accounting Policies - Basis of Preparation, and the Report of Independent Registered Public Accounting Firm included elsewhere in this Annual Report on Form 10-K. As of June 28, 2014, $74.7 million of the $99.0 million of our cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we could be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S., except for our Shanghai, China; Korean; and Japanese entities where closure will eventually follow our decision to exit certain businesses in fiscal year 2014. Risk Management - Foreign Currency Risk As our business is multinational in scope, we are subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues and pay expenses. We expect that a majority of our revenues will 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 Japanese yen. Fluctuations in the exchange rate between the U.S. dollar, the U.K. pound sterling, the Japanese yen 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 and the Euro in which we pay expenses in connection with operating our facilities in Shenzhen and Shanghai, China; 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. From time to time, we have entered 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, and 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 June 28, 2014 and June 29, 2013, we did not have any outstanding foreign currency forward exchange contracts. Contractual Obligations Our contractual obligations at June 28, 2014, by nature of the obligation and amount due over identified periods of time, are set out in the table below: Capital Operating Lease Lease Sublease Purchase Obligations(1) Obligations Income Obligations (Thousands) Fiscal Year: 2015 $ 5,947 $ 10,538 $ (272 ) $ 81,731 2016 2,953 9,001 (84 ) - 2017 1,379 7,983 (78 ) - 2018 50 7,601 (19 ) - 2019 33 7,408 - - Thereafter 88 64,202 - - $ 10,450 $ 106,733 $ (453 ) $ 81,731 (1) Amounts include interest. The purchase obligations consist of our total outstanding purchase order commitments at June 28, 2014. Any capital purchases to which we are committed are included in these outstanding purchase order commitments, with the exception of capital purchases made under capital leases, which are shown separately. Operating leases are future annual commitments under non-cancelable operating leases, including rents payable for land and buildings. We continue to lease one building in Acton, Massachusetts, which we previously used to house the manufacturing and research and development related to certain of our products which was considered redundant, following the acquisition of Opnext and its product lines. The lease for the building is scheduled to expire on January 31, 2016, with a current rental cost of approximately $0.5 million annually. In determining our facility lease loss liability, various assumptions were made, including the time period over which the buildings will be vacant, expected sublease terms and expected sublease rates. During the fourth quarter of fiscal year 2014, we recorded a lease loss liability of $0.8 million related to this facility. Adjustments to this accrual will be made in future periods, if events and circumstances change. 52-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements We indemnify our directors and certain employees as permitted by law, and have entered into indemnification agreements with our directors and executive officers. We have not recorded a liability associated with these indemnification arrangements as we historically have not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that we maintain, however, such insurance may not cover any, or may cover only a portion of, the amounts we may be required to pay. In addition, we may not be able to maintain such insurance coverage in the future. We also have indemnification clauses in various contracts that we enter into in connection with acquisitions, divestitures and during 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. Other than as set forth above, we are not currently party to any material off-balance sheet arrangements. Recent Accounting Pronouncements See Note 1, Basis of Preparation and Summary of Significant Accounting Policies, to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for information regarding the effect of new accounting pronouncements on our consolidated financial statements. Application of Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of our financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses and other financial information. Actual results may differ significantly from those based on our estimates and judgments or could have been materially different if we had used different assumptions, estimates or conditions. In addition, our financial condition and results of operations could vary due to a change in the application of a particular accounting standard. We regard an accounting estimate or assumption underlying our financial statements as a "critical accounting estimate" where: • the nature of the estimate or assumption is material due to the level of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and • the impact of such estimates and assumptions on our financial condition or operating performance is material. Our significant accounting policies are described in Note 1, Basis of Preparation and Summary of Significant Accounting Policies, to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Not all of these significant accounting policies, however, require that we make estimates and assumptions that we believe are "critical accounting estimates." We have discussed our accounting policies with the audit committee of our board of directors, and we believe that the policies described below involve critical accounting estimates. Revenue Recognition and Sales Returns Revenue represents the amounts, excluding sales taxes, derived from the sale of goods and services to third-party customers during a given period. Specifically, we recognize product revenue when persuasive evidence of an arrangement exists, the product has been shipped, title has transferred, collectability is reasonably assured, fees are fixed or determinable and there are no uncertainties with respect to customer acceptance. For certain sales, we are required to determine, in particular, whether the delivery has occurred, whether items will be returned and whether we will be paid under normal commercial terms. For certain products sold to customers, we specify delivery terms in the agreement under which the sale was made and assess each shipment against those terms, and only recognize revenue when we are certain that the delivery terms have been met. 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 for sales returns are based on historical sales return rates, other known factors and our return policy. Before accepting a new customer, we review publicly available information and credit rating databases to provide ourselves with reasonable assurance that the new customer will pay all outstanding amounts in accordance with our standard terms. For existing customers, we monitor historic payment patterns and we perform ongoing credit evaluations to assess whether we can expect payment in accordance with the terms set forth in the agreement under which the sale was made. 53-------------------------------------------------------------------------------- Table of Contents Inventory Valuation In general, our inventories are valued at the lower of cost to acquire or manufacture our products or market value, less write-offs of inventory we believe could prove to be unsalable. Manufacturing costs include the cost of the components purchased to produce our products and related labor and overhead. We review our inventory on a quarterly basis to determine if it is saleable. Products may be unsalable because they are technically obsolete due to substitute products, specification changes or excess inventory relative to customer forecasts. We currently reduce the cost basis for inventory using methods that take these factors into account. If we find that the cost of inventory is greater than the current market price, we will write the inventory down to the estimated selling price, less the estimated cost to complete and sell the product. Business Combinations Our acquisitions are accounted for pursuant to Accounting Standards Codification (ASC) Topic 805, Business Combinations. Under ASC Topic 805, there are significant management estimates that impact our financial position and operating results, including: • Tangible and identifiable intangible assets acquired and liabilities assumed as of the acquisition date are recorded at the acquisition date fair value. Such valuations require management to make significant estimates and assumptions, especially with respect to the identifiable intangible assets. • Goodwill is recognized for any excess of purchase price over the net fair value of assets acquired and liabilities assumed. A bargain purchase gain results if the fair value of the purchase price is less than the net fair value of the assets acquired and liabilities assumed. We recorded a $24.9 million bargain purchase gain related to our acquisition of Opnext during fiscal year 2013. For tangible assets acquired in any acquisition, such as plant and equipment, we estimate useful lives by considering comparable lives of similar assets, past history, the intended use of the assets and their condition. In estimating the useful life of acquired intangible assets with definite lives, we consider the industry environment and specific factors relating to each product relative to our business strategy and the likelihood of technological obsolescence. Acquired intangible assets primarily include core and current technology, patents, supply agreements, capitalized licenses and customer contracts. We amortize our acquired intangible assets with definite lives over periods generally ranging from 1 to 11 years and, in the case of one specific customer contract, 16 years. Management makes estimates of fair value based upon assumptions believed to be reasonable and that of a market participant. For instance, in our Mintera acquisition, we agreed to pay additional revenue-based consideration whereby former security holders of Mintera were 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 estimated fair value of these obligations were determined using management estimates of the total amounts expected to be paid based on estimated operating results, discounted to their present value using our incremental borrowing cost. Our preliminary estimates of fair value are inherently uncertain and subject to refinement. As a result, during the measurement period for a business combination, which may be up to one year, we may record adjustments to the values of assets acquired and liabilities assumed. After the conclusion of the measurement period or our final determination of the values of assets acquired or liabilities assumed, whichever comes first, subsequent adjustments affecting earnings are recorded within our consolidated statements of operations. For example, in the fourth quarter of fiscal year 2013, we made significant adjustments to the preliminary purchase price allocation of the assets acquired and liabilities assumed in our acquisition of Opnext upon the completion of our valuation. See Note 3, Business Combinations and Dispositions, included elsewhere in this Annual Report on Form 10-K, for additional information. Insurance Recoveries Insurance recoveries related to impairment losses previously recorded and other recoverable expenses will be recognized up to the amount of the related loss or expense in the period that recoveries become realizable. Insurance recoveries under business interruption coverage and insurance recovery gains in excess of amounts previously written off related to impaired inventory and equipment or in excess of other recoverable expenses previously recognized will be recognized when they become realizable and all contingencies have been resolved. During the year ended June 28, 2014 and June 29, 2013, we received $3.7 million and $30.8 million in settlement payments, respectively, relating to losses we incurred due to the flooding in Thailand. As there were no contingencies associated with these payments, we recorded the payments within flood related income (expense), net in our consolidated statements of operations. 54-------------------------------------------------------------------------------- Table of Contents The evaluation of insurance recoveries requires estimates and judgments about future results which affect reported amounts and certain disclosures. Actual results could differ from those estimates. Insurance recoveries we receive in future periods will be recorded net of the related expense in the consolidated statement of operations. Impairment of Goodwill and Other Intangible Assets Goodwill is tested annually for impairment, in our case during the fourth quarter of each fiscal year, or more often if an event or circumstance suggests impairment has occurred. In addition, we review identifiable intangibles, excluding goodwill, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. During the fourth quarter of fiscal year 2013 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, the decline in our market capitalization, and the anticipated resizing of our operations with the recent sale of certain of our products and/or businesses. Circumstances which could trigger an impairment test include, but are not limited to, significant decreases in the market price of the asset, significant adverse changes to the business climate or legal factors, current period cash flow or operating losses or a forecast of continuing losses associated with the use of the asset and a current expectation that the asset will more likely than not be sold or disposed of significantly below carrying value before the end of its estimated useful life. The first step of testing goodwill for impairment is based on a reporting unit's "fair value," which is generally determined through market prices. In certain cases, due to the absence of market prices for a particular element of our business, we have elected to base our testing on discounted future expected cash flows. Although the discount rates and other input variables may differ, the model we use in this process is the same model we use to evaluate the fair value of acquisition candidates and the fairness of offers to purchase businesses that we are considering for divestiture. The forecasted cash flows we use are derived from the annual long-range planning process that we perform and present to our board of directors. In this process, each reporting unit is required to develop reasonable sales, earnings and cash flow forecasts for the next three to seven years based on current and forecasted economic conditions. For purposes of testing for impairment, the cash flow forecasts are adjusted as needed to reflect information that becomes available concerning changes in business levels and general economic trends. The discount rates used for determining discounted future cash flows are generally based on our weighted-average cost of capital and are then adjusted for "plan risk" (the risk that a business will fail to achieve its forecasted results) and "country risk" (the risk that economic or political instability in the countries in which we operate will cause a business unit's projections to be inaccurate). Finally, a growth factor beyond the three to seven-year period for which cash flows are planned is selected based on expectations of future economic conditions. Virtually all of the assumptions used in our models are susceptible to change due to global and regional economic conditions as well as competitive factors in the industry in which we operate. Unanticipated changes in discount rates from one year to the next can also have a significant effect on the results of the calculations. While we believe the estimates and assumptions we use are reasonable, various economic factors could cause the results of our goodwill testing to vary significantly. During the fourth quarter of fiscal year 2013, we completed our annual first step analysis for potential impairment of our goodwill, which included, based on factors and conditions then existing, examining the impact of current general economic conditions on our future prospects, the decline in our market capitalization, and the anticipated resizing of our operations with the recent sale of certain of our products and/or businesses, and we concluded that the goodwill related to our Mintera reporting unit was impaired. We completed our full evaluation of the second step impairment analysis, which indicated that the goodwill was fully impaired and we recorded $10.9 million for impairment losses in our consolidated statement of operations for the year ended June 29, 2013. In connection with our second step goodwill impairment analysis, we also evaluated the fair value of our other intangible assets of this reporting unit, and our other reporting units, and concluded that based on the decline in our forecast, our decision to sell or abandon certain product lines and other factors, certain of these other intangible assets were also impaired as of June 29, 2013. We recorded impairment losses in the fourth quarter of fiscal year 2013 of $6.4 million related to intangibles acquired in connection with our acquisition of Mintera, $2.6 million related to intangibles acquired in connection with our acquisition of Opnext, and $5.2 million related to intangibles acquired in connection with other earlier acquisitions. During the fourth quarter of fiscal year 2014, we reviewed our other intangible assets for impairment. We compared their carrying amounts to market prices or the future undiscounted cash flows the assets are expected to generate. We determined that the carrying value of the assets did not exceed the fair value based on market prices or future discounted cash flows. We did not record any impairment charges in fiscal year 2014. Accounting for Stock-Based Compensation We recognize in our statement of operations all stock-based compensation, including grants of employee stock options, grants of restricted stock and purchase rights under our Employee Stock Purchase Plan, based on their fair values on the grant dates. Estimating the grant date fair value of employee stock options and purchase rights requires us to make judgments in the determination of inputs into the Black-Scholes valuation model which we use to arrive at an estimate of the fair value for such 55-------------------------------------------------------------------------------- Table of Contents awards. These inputs are based upon highly subjective assumptions as to the volatility of the underlying stock, risk free interest rates and the expected life of the options. Judgment is also required in estimating the number of share-based awards that are expected to be forfeited during any given period. As required under the accounting standards, we review our valuation assumptions at each grant date, and, as a result, our valuation assumptions used to value employee stock options granted and purchase rights in future periods may change. If actual results or future changes in estimates differ significantly from our current estimates, stock-based compensation expense and our consolidated results of operations could be materially impacted. During the years ended June 28, 2014, June 29, 2013 and June 30, 2012, we recognized $6.0 million, $6.4 million and $5.9 million of stock-based compensation expense, respectively. See Note 12, Stock-based Compensation, to the accompanying consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further information. 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. Recognition of deferred tax assets is appropriate when realization of these assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance, recorded cumulative net losses in prior fiscal periods and uncertainty about the timing of future profits, we have provided a full valuation allowance against most of our U.S. and foreign deferred tax assets. Our valuation allowance decreased by $97.2 million and increased by $177.4 million in fiscal years 2014 and 2013, respectively. |