UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2011

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 000-30684

OCLARO, INC.

(Exact name of registrant as specified in its charter)

Delaware		20-1303994
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

2560 Junction Avenue, San Jose, California 95134
(Address of principal executive offices, zip code)

(408) 383-1400
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes þ    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes o    No þ

51,455,639 shares of common stock outstanding as of February 3, 2012

 

 

OCLARO, INC.
TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of December 31, 2011 and July 2, 2011			3
Condensed Consolidated Statements of Operations for the three and six months ended December 31, 2011 and January 1, 2011			4
Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2011 and January 1, 2011			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			29
Item 4. Controls and Procedures			30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			30
Item 1A. Risk Factors			31
Item 6. Exhibits			49
Signature			49
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

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

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

OCLARO, INC.

In June 2011, the FASB issued ASU No. 2011-05, an amendment to ASC Topic 220, Comprehensive Income , which amends current comprehensive income guidance. ASU No. 2011-05 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, 2012. The adoption of this update will require a change in the format of our current presentation.

In May 2011, the FASB issued 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 No. 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 update will be effective for our fiscal quarter beginning January 1, 2012. The adoption of this update is not expected to have a material effect on our consolidated financial statements, but may require certain additional disclosures.

NOTE 3. FAIR VALUE

We define fair value as the estimated price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. We apply the following fair value hierarchy, which ranks the quality and reliability of the information used to determine fair values:

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 instruments 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 the six months ended December 31, 2011, we have classified the earnout obligations 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 4, Business Combinations , for additional details regarding these earnout obligations.

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 condensed consolidated balance sheets, and are thus not included in the following tables.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value are shown in the table below by their corresponding balance sheet caption and consisted of the following types of instruments at December 31, 2011:

The following table provides details regarding the changes in accrued expenses and other liabilities classified within Level 3 from July 2, 2011 to December 31, 2011:

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 condensed consolidated statements of operations. As of December 31, 2011, we held nine 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 $7.0 million of put and call options which expire, or expired, at various dates ranging from January 2012 through September 2012. 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 December 31, 2011 will generally be reclassified into other income (expense) within the next 12 months. As of December 31, 2011, each of the nine designated cash flow hedges were determined to be fully effective; therefore, we recorded an unrealized loss of $12,000 to accumulated other comprehensive income related to recording the fair value of these foreign currency forward exchange contracts for accounting purposes.

NOTE 4. BUSINESS COMBINATIONS

Asset Sale

In December 2011, we entered into an asset sale agreement to sell certain assets related to a legacy product, including inventory, equipment and intangibles, in exchange for $3.9 million in initial consideration plus potential earnout consideration, based on the purchaser’s revenues from the legacy product over a 15 month period following the closing date. As of December 31, 2011, we have received $1.5 million in cash proceeds and are scheduled to receive the remaining $2.4 million of initial consideration in the third quarter of fiscal year 2012.

The transfer of assets under the agreement is expected to be completed in February 2012. As of December 31, 2011, we have deferred a $1.3 million net gain on the sale of these assets and classified this amount in accrued expenses and other liabilities in our condensed consolidated balance sheet. We expect to recognize this deferred gain when the asset transfer is complete. Earnout consideration, if any, will be recognized in the period it is reported to us as due, provided we believe cash collections are reasonably assured.

Acquisition of Mintera

In July 2010, we acquired Mintera. For accounting purposes, the total fair value of consideration given in connection with the acquisition of Mintera was $25.6 million. This acquisition is more fully discussed in Note 3, Business Combinations , to our consolidated financial statements included in our 2011 Form 10-K.

Under the terms of this acquisition, we agreed to pay certain 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 was more than $29.0 million in the 12 months following the acquisition and/or is more than $40.0 million in the 18 months following the acquisition. The earnout consideration is payable in cash or, at our option, newly issued shares of our common stock, or a combination of cash and stock.

During the three months ended October 1, 2011, we reviewed the fair value of the 12 month and 18 month earnout obligations and determined that the fair value of the obligations decreased by $3.8 million, to $12.4 million, based on revised estimates of revenues from Mintera products. The $3.8 million decrease in fair value was recorded as a decrease in restructuring, acquisition and related expenses in the condensed consolidated statement of operations.

During the three months ended December 31, 2011, we settled the 12 month earnout obligation with the former security holders by paying them $0.5 million in cash and issuing 0.8 million shares of our common stock valued at $2.8 million. We also reassessed the fair value of the 18 month earnout obligation, determining that the fair value of the obligations increased by $0.9 million, to $10.0 million, during the three months ended December 31, 2011. We estimated the fair value of the 18 month obligation using management estimates of the total amounts expected to be paid based on estimated future operating results, discounted to present value using our incremental borrowing cost. The $10.0 million has been recorded in accrued expenses and other liabilities in our condensed consolidated balance sheet at December 31, 2011. The 18 month obligation is payable in April 2012.

During the three and six months ended December 31, 2011, we recorded minimal amounts in interest expense related to the earnout obligations. During the three and six months ended January 1, 2011, we recorded $0.3 million and $0.5 million, respectively, in interest expense related to the earnout obligations.

The following table provides details regarding our inventories at the dates indicated:

The following table provides details regarding our property and equipment, net at the dates indicated:

The following table presents details regarding our accrued expenses and other liabilities at the dates indicated:

The following table presents the components of accumulated other comprehensive income at the dates indicated:

NOTE 6. FLOOD-RELATED EXPENSE

In October 2011, certain areas in Thailand suffered major flooding as a result of monsoons. This flooding had a material 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. As a result of this flooding, we experienced a significant decline in product sales and we incurred significant damage to our inventory and property and equipment located at the Chokchai facility. During the three months ended December 31, 2011, we recorded impairment charges of $4.2 million related to the write-off of the net book value of damaged inventory and $3.0 million related to the write-off of the net book value of property and equipment based on our preliminary estimates of the damage caused by the flooding. These impairment charges are recorded within the operating expense caption flood-related expense in our condensed consolidated statement of operations for the three and six months ended December 31, 2011. Flood-related expense for the three and six months ended December 31, 2011 also includes $1.9 million in personnel-related costs, professional fees and related expenses incurred in connection with our recovery efforts. We continue to evaluate our preliminary estimates of flood-related losses, and in future quarters we may record additional losses for damaged equipment and inventory.

While we maintain both property and business interruption insurance coverage, there can be no assurance as to the amount or timing of insurance recoveries. Insurance recoveries related to impairment losses previously recorded and other recoverable expenses will be recognized to the extent of the related loss or expense in the period that recoveries become probable and 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. 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 flood-related expense in the condensed consolidated statement of operations. As of December 31, 2011, we have not received any insurance recoveries, nor have we recorded any amounts relating to potential future insurance recoveries in the condensed consolidated statement of operations.

NOTE 7. CREDIT AGREEMENT

On July 26, 2011, Oclaro Technology Ltd., as “Borrower,” and Oclaro, Inc., as “Parent,” entered into an amendment and restatement to our existing senior secured credit facility (the Credit Agreement) with Wells Fargo Capital Finance, Inc. and other lenders, increasing the facility size from $25 million to $45 million and extending the term thereof to August 1, 2014. This Credit Agreement is more fully discussed in Note 6, Credit Agreement , and Note 16, Subsequent Event , to our consolidated financial statements included in our 2011 Form 10-K.

At December 31, 2011, there was $19.5 million outstanding under the Credit Agreement with an average interest rate of 3.37 percent and we were in compliance with all covenants under the Credit Agreement. As of July 2, 2011, there were no amounts outstanding under the Credit Agreement. At December 31, 2011 and July 2, 2011, there were $0.1 million and $1.1 million, respectively, in outstanding standby letters of credit secured under the Credit Agreement. These letters of credit expire at various intervals through April 2014.

During the three and six months ended December 31, 2011, we contributed $0.3 million and $0.6 million, respectively, to our Swiss Plan. We currently anticipate contributing an additional $0.6 million to this pension plan during the remainder of fiscal year 2012.

NOTE 9. 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 those issued by our bankers in favor of certain suppliers or indemnification in favor of customers in respect of liabilities they may incur as a result of purchasing our products should such products infringe the intellectual property rights of a third party. We have not historically paid out any material amounts related to these indemnifications, therefore, no accrual has been made for these indemnifications.

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.

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 alleged that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in New Focus’ initial public offering and sought 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 was 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 reached a global settlement of the litigation under which the insurers are funding the full amount of the settlement share allocated to New Focus, Bookham Technology and Avanex, and New Focus, Bookham Technology and Avanex 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, receive complete dismissals from the case. The settlement was approved by the Court in 2009 and during the second fiscal quarter of 2012 all remaining appeals contesting the settlement were dismissed or withdrawn.

On December 6, 2010, a bankruptcy preferential transfer avoidance action was filed by Nortel Networks Inc. (Nortel) 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. Pursuant to a settlement agreement dated October 6, 2011, Oclaro Technology Ltd. and Oclaro (North America), Inc. settled the preference-related claims with Nortel Networks Inc. without any cash payment by Oclaro Technology Ltd. or Oclaro (North America), Inc.. The settlement agreement was approved by the Delaware Bankruptcy Court by an order dated November 28, 2011, and was dismissed by the plaintiff voluntarily and with prejudice on December 14, 2011.

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. The Court subsequently appointed the Connecticut Laborers’ Pension Fund (Pension Fund) as lead plaintiff for the putative class. On October 27, 2011, the Pension Fund filed an Amended Complaint, captioned as Westley v. Oclaro, Inc., No. 11 Civ. 2448 EMC, allegedly on behalf of persons who purchased our common stock between May 6 and October 28, 2010, alleging that defendants issued materially false and misleading statements during this time period regarding our current business and financial condition, including projections for demand for our products, as well as 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. On December 12, 2011, defendants filed a motion to dismiss the complaint. That motion is scheduled to be heard on March 23, 2012. Discovery has not commenced, and no trial has been scheduled in this action. We intend to defend this litigation vigorously. We are unable at this time to estimate the effects of these lawsuits on our financial position, results of operations or cash flows.

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. By Order dated September 14, 2011, the Guindani, Coney, and Braman actions were consolidated under In re Oclaro, Inc. Derivative Litigation , Lead Case No. 11 Civ. 3176 EMC. On October 5, 2011, the Aguilar action was voluntarily dismissed. Each remaining 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. Each purported derivative complaint seeks damages and costs of an unspecified amount, as well as injunctive relief. By Order dated November 23, 2011, the parties in the Moskal action agreed that defendants shall not be required to respond to the original complaint, that plaintiff would serve an amended complaint no later than March 9, 2012, and the stay of discovery would remain in effect until further order of the Court or agreement by the parties. By Order dated November 29, 2011, the parties to In re Oclaro, Inc. Derivative Litigation agreed to stay all proceedings, including motion practice and discovery, until such time as (a) the defendants file an answer to any complaint in the Westley Action; or (b) the Westley Action is dismissed in its entirety with prejudice. Discovery has not commenced, and no trial has been scheduled in any of these actions. We are unable at this time to estimate the effects of these lawsuits on our financial position, results of operations or cash flows.

Common Stock

In December 2009, we acquired Xtellus, Inc. (Xtellus). As part of the consideration, we were obligated to pay $7.0 million in consideration to the former Xtellus stockholders after an 18 month escrow period. During the three months ended October 1, 2011, we settled the $7.0 million liability with the former Xtellus stockholders by transferring approximately 0.9 million shares of common stock held in escrow, valued at $7.0 million. The transfer of the shares resulted in a $7.0 million increase to our additional paid-in capital and a corresponding decrease to our accrued expenses and other liabilities. The balance of 0.1 million shares of common stock held in escrow were returned to us, retired and returned to the status of authorized but unissued common stock in September 2011.

In connection with our July 2010 acquisition of Mintera, we paid $0.5 million in cash and issued 0.8 million shares of our common stock valued at $2.8 million to settle our 12 month earnout obligation in October 2011. The transfer of the shares resulted in a $2.8 million increase to our additional paid-in capital and a corresponding decrease to our accrued expenses and other liabilities.

Employee Stock Purchase Plan

On October 26, 2011, our 2011 Employee Stock Purchase Plan (ESPP) was approved by our stockholders. Under the ESPP, we have reserved 1.7 million shares of our common stock for issuance. The ESPP will be effective as of January 24, 2012.

NOTE 11. EMPLOYEE STOCK PLANS

We currently maintain the Amended and Restated 2004 Stock Incentive Plan (“Plan”). Under the Plan, there are a total of 7.8 million shares of common stock authorized for issuance, with full value awards being counted as 1.25 shares of common stock for purposes of the share limit. The Plan expires in October 2020.

As of December 31, 2011, there were approximately 2.5 million shares of our common stock available for grant under the Plan. We generally grant stock options that vest over a four year service period, and restricted stock awards and units that vest over a one to four year service period, and in certain cases each may vest earlier based upon the achievement of specific performance-based objectives as set by our board of directors.

In July 2011, our board of directors approved the grant of 0.2 million performance stock units (PSUs) to certain executive officers with an aggregate estimated grant date fair value of $0.9 million. These PSUs will be earned through June 30, 2013 based upon the achievement of certain revenue growth targets relative to certain comparable companies. Vesting is also contingent upon service conditions being met through August 2015. If the performance conditions are not achieved, then the corresponding PSUs will be forfeited in the first quarter of fiscal year 2014.

The following table summarizes the combined activity under all of our equity incentive plans for the six months ended December 31, 2011:

Supplemental disclosure information about our stock options outstanding as of December 31, 2011 is as follows:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the closing price of our common stock of $2.82 on December 30, 2011, which would have been received by the option holders had all option holders exercised their options as of that date. There were approximately 0.2 million shares of common stock subject to in-the-money options which were exercisable as of December 31, 2011. We settle employee stock option exercises with newly issued shares of common stock.

The amounts included in cost of revenues and operating expenses for stock-based compensation for the three and six months ended December 31, 2011 and January 1, 2011 were as follows:

As of December 31, 2011 and July 2, 2011, we had capitalized approximately $0.5 million and $0.4 million, respectively, of stock-based compensation as inventory.

Included in stock-based compensation for the three and six months ended December 31, 2011 is approximately $0.1 million and $0.1 million, respectively, in compensation cost related to the issuance of PSUs. As of December 31, 2011, we have determined that the achievement of the performance conditions associated with the PSUs is probable at 100 percent of the target level. The amount of stock-based compensation expense recognized in any one period can vary based on the achievement or anticipated achievement of the performance conditions. If the performance conditions are not met or not expected to be met, no compensation cost would be recognized on the underlying PSUs, and any previously recognized compensation expense related to those PSUs would be reversed.

NOTE 13. INCOME TAXES

For the three and six months ended December 31, 2011, our income tax provisions of $0.7 million and $2.0 million, respectively, primarily related to our foreign operations. For the three and six months ended January 1, 2011, our income tax provisions of $0.3 million and $0.8 million, respectively, primarily related to income taxes on our operations in Italy and China.

The total amount of our unrecognized tax benefits as of December 31, 2011 and July 2, 2011 were approximately $7.0 million. For the three and six months ended December 31, 2011, we had $1.9 million in unrecognized tax benefits that, if recognized, would affect our effective tax rate. We are currently under tax audit in France and the United States. We believe that an adequate provision has been made for any adjustments that may result from tax audits. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with our expectations, we could be required to adjust our income tax provision in the period such resolution occurs. Although timing of the resolution and/or closure of audits is not certain, we do not believe it is reasonably possible that our unrecognized tax benefits will materially change in the next 12 months.

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 three and six months ended December 31, 2011, we excluded 5.4 million and 4.8 million, respectively, of outstanding stock options, warrants and restricted stock units from the calculation of diluted net income per share because their effect would have been anti-dilutive. For the three and six months ended January 1, 2011, we excluded 5.1 million and 1.9 million, respectively, of outstanding stock options, warrants and restricted stock units from the calculation of diluted net income per share because their effect would have been anti-dilutive.

Significant Customers and Concentration of Credit Risk

For the three months ended December 31, 2011, Fujitsu Limited (Fujitsu) accounted for 14 percent, Infinera Corporation (Infinera) accounted for 11 percent and Ciena Corporation (Ciena) accounted for 10 percent of our revenues. For the six months ended December 31, 2011, Fujitsu accounted for 12 percent and Huawei Technologies Co., Ltd. (Huawei) accounted for 11 percent of our revenues.

For the three months ended January 1, 2011, Huawei accounted for 17 percent, Ciena accounted for 12 percent and Alcatel-Lucent accounted for 11 percent of our revenues. For the six months ended January 1, 2011, Huawei accounted for 16 percent, Alcatel-Lucent accounted for 12 percent and Ciena accounted for 10 percent of our revenues.

As of December 31, 2011, Infinera accounted for 12 percent and Huawei accounted for 10 percent of our accounts receivable. As of July 2, 2011, no customer accounted for 10 percent or more of our accounts receivable.

and assumptions based on information available to our management at the time the statements are made. There are a number of important factors that could cause our actual results or events to differ materially from those indicated by such forward-looking statements, including (i) the impact to our operations and financial condition attributable to the flooding in Thailand and our ability to obtain insurance recoveries for claims related to such flooding, (ii) our inability to enter into strategic relationships with contract manufacturers, (iii) the impact of continued uncertainty in world financial markets and any resulting or other reduction in demand for our products, (iv) our ability to maintain our gross margin, (v) our ability to respond to evolving technologies and customer requirements, (vi) our ability to develop and commercialize new products in a timely manner, (vii) our ability to protect our intellectual property rights and the resolution of allegations that we infringe the intellectual property rights of others, (viii) our dependence on a limited number of customers for a significant percentage of our revenues, (ix) our ability to effectively compete with companies that have greater name recognition, broader customer relationships and substantially greater financial, technical and marketing resources than we do, (x) the effect of fluctuating product mix, currency prices and consumer demand on our financial results, (xi) our performance following the closing of acquisitions, (xii) our potential inability to realize the expected benefits and synergies from our acquisitions, (xiii) increased costs related to downsizing and compliance with regulatory requirements in connection with such downsizing, (xiv) the impact of events beyond our control such as natural disasters, including additional information that will become available in the future regarding the impact of the flooding in Thailand on our results of operations, and political unrest, (xv) the outcome of our currently pending litigation and future litigation that may be brought by or against us, (xvi) our ability to increase our cash reserves and the potential lack of availability of credit or opportunity for equity-based financing on terms acceptable to us and (xvii) the risks associated with our international operations. You should not place undue reliance on forward-looking statements. We cannot guarantee any future results, levels of activity, performance or achievements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements. Several of the important factors that may cause our actual results to differ materially from the expectations we describe in forward-looking statements are identified in the sections captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Quarterly Report on Form 10-Q and the documents incorporated herein by reference.

OVERVIEW

We are 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. Increasingly, we have new opportunities with customers who are managing and building out wide area networks with certain characteristics common to telecom networks. 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. In all markets, our approach is to offer 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 vertically integrated approach to manufacturing and product development.

RECENT DEVELOPMENTS

We continue to be in negotiations to transition our Shenzhen assembly and test operations to a major contract manufacturer and we expect this could generate $30 million to $40 million in net cash proceeds in our third or fourth fiscal quarters of 2012, with potential additional consideration to be received in the future, and would include a long term supply agreement with the contract manufacturer. No guarantee can be provided that such transactions will occur, the supply agreement will result in the benefits that we expect or that the transactions will result in us receiving the anticipated cash proceeds and the timing of receipt of such proceeds.

We are continuing to evaluate the broader supply chain implications of the flooding in Thailand across our entire manufacturing operations. Although our management cannot fully quantify the possible impact of the flooding in Thailand on our business, the supply disruption materially and adversely impacted our results of operations, including our revenue, for the second fiscal quarter of 2012, and will materially and adversely affect our results of operations, including our revenue, for at least the next two fiscal quarters. While we believe our insurance coverage, both property and business interruption, will mitigate a portion of the adverse impact, there can be no assurance as to the amount or timing of insurance recoveries.

Revenues

Revenues for the three months ended December 31, 2011 decreased by $33.8 million, or 28 percent, compared with the three months ended January 1, 2011. The decrease was primarily due to the disruption in our business caused by the flooding of our contract manufacturer in Thailand which resulted in the suspension of the manufacturing of a significant number of our products, coupled with a decrease in demand in our telecommunications related markets, largely associated with uncertain global macroeconomic conditions. We expect our revenues to continue to be adversely affected by the flooding in Thailand for at least the next two fiscal quarters.

For the three months ended December 31, 2011, Fujitsu Limited (Fujitsu) accounted for $12.4 million, or 14 percent, Infinera Corporation (Infinera) accounted for $9.1 million, or 11 percent, and Ciena Corporation (Ciena) accounted for $8.3 million, or 10 percent, of our revenues. For the three months ended January 1, 2011, Huawei Technologies Co., Ltd. (Huawei) accounted for $20.9 million, or 17 percent, Ciena accounted for $14.7 million, or 12 percent, and Alcatel-Lucent accounted for $13.5 million, or 11 percent, of our revenues.

Revenues for the six months ended December 31, 2011 decreased by $49.3 million, or 20 percent, compared with the six months ended January 1, 2011. The decrease was largely due to the disruption in our business caused by the flooding of our contract manufacturer in Thailand which resulted in the suspension of the manufacturing of a significant number of our products and a decrease in demand in our telecommunications related markets, largely associated with uncertain global macroeconomic conditions.

For the six months ended December 31, 2011, Fujitsu accounted for $23.8 million, or 12 percent, and Huawei accounted for $21.0 million, or 11 percent, of our revenues. For the six months ended January 1, 2011, Huawei accounted for $39.1 million, or 16 percent, Alcatel-Lucent accounted for $29.5 million, or 12 percent, and Ciena accounted for $25.0 million, or 10 percent, of our revenues.

Cost of Revenues

Our cost of revenues for the three months ended December 31, 2011 decreased by $8.9 million, or 11 percent, compared with the three months ended January 1, 2011. The decrease was primarily related to reduced costs associated with lower volumes of revenue attributable to lower product sales. Our cost of revenues for the six months ended December 31, 2011 decreased by $13.7 million, or 8 percent, compared with the six months ended January 1, 2011. The decrease was primarily related to reduced costs associated with lower volumes of revenue attributable to lower product sales. As part of our Thailand flood recovery efforts, certain of our manufacturing employees were redirected to efforts to restore our production capacity. For the three and six months ended December 31, 2011, costs of revenues were $0.5 million lower than they would have been otherwise as these flood recovery costs have been included in flood-related expense.

Gross Profit

Gross profit is calculated as revenues less cost of revenues. Gross margin rate is gross profit reflected as a percentage of revenues.

Our gross margin rate decreased to 13 percent for the three months ended December 31, 2011, compared with 30 percent for the three months ended January 1, 2011. The decrease in gross margin rate was primarily related to the impact of our fixed costs on lower revenues, and correspondingly lower production volumes, caused by the disruption in our business from the flooding in Thailand. While we experienced a significant decline in sales of our products, many of our costs are fixed and did not decline with our revenue. Our gross profit was also unfavorably impacted by approximately $0.5 million as a result of the U.K. pound sterling and the Swiss franc strengthening relative to the U.S. dollar. As part of our Thailand flood recovery efforts, certain of our manufacturing employees were redirected to efforts to restore our production capacity. For the three and six months ended December 31, 2011, gross profit was $0.5 million higher than it would have been otherwise as these flood recovery costs have been included in flood-related expense.

Our gross margin rate decreased to 18 percent for the six months ended December 31, 2011, compared with 29 percent for the six months ended January 1, 2011. The decrease in gross margin rate was primarily due to the impact of our fixed costs on lower revenues, and correspondingly lower production volumes, which is a result of the disruption in our business from the flooding in Thailand, coupled with a lower mix of relatively higher margin 10 Gbps transmission products and a higher mix of less mature 40 Gbps transmission products that are not yet margin optimized. While we experienced a significant decline in sales of our products, many of our costs are fixed and did not decline with our revenue. Our gross profit was also unfavorably impacted by approximately $1.4 million as a result of the Swiss franc strengthening relative to the U.S. dollar and the U.K. pound sterling weakening relative to the U.S. dollar.

Research and Development Expenses

Research and development expenses increased by $1.3 million, or 9 percent, for the three months ended December 31, 2011, compared with the three months ended January 1, 2011. The increase was primarily due to increased investment in research and development resources, primarily personnel-related. Personnel-related costs increased to $9.8 million for the three months ended December 31, 2011, compared with $8.8 million for the three months ended January 1, 2011. Other costs, including the costs of design tools and facilities-related costs increased to $7.2 million for the three months ended December 31, 2011, compared with $6.9 million for the three months ended January 1, 2011. As part of our Thailand flood recovery efforts, certain of our research and development employees were redirected to efforts to restore our production capacity. For the three and six months ended December 31, 2011, research and development expenses were $0.6 million lower than they would have been otherwise as these flood recovery costs have been included in flood-related expense.

Research and development expenses increased by $5.3 million, or 18 percent, for the six months ended December 31, 2011, compared with the six months ended January 1, 2011. The increase was primarily due to increased investment in research and development resources, primarily personnel-related. Personnel-related costs increased to $20.3 million for the six months ended December 31, 2011, compared with $17.1 million for the six months ended January 1, 2011. Other costs, including engineering materials, the costs of design tools and facilities-related costs increased to $14.4 million for the six months ended December 31, 2011, compared with $12.3 million for the six months ended January 1, 2011. Research and development expenses were unfavorably impacted by approximately $0.7 million as a result of the U.K. pound sterling and Swiss franc strengthening relative to the U.S. dollar.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased by $0.7 million, or 5 percent, for the three months ended December 31, 2011, compared with the three months ended January 1, 2011. Personnel-related costs increased to $9.3 million for the three months ended December 31, 2011, compared with $8.3 million for the three months ended January 1, 2011. Other costs, including legal and professional fees, facilities expenses and other miscellaneous expenses, decreased to $5.1 million for the three months ended December 31, 2011, compared with $6.8 million for the three months ended January 1, 2011.

Selling, general and administrative expenses increased by $2.0 million, or 7 percent, for the six months ended December 31, 2011, compared with the six months ended January 1, 2011. Personnel-related costs increased to $19.4 million for the six months ended December 31, 2011, compared with $16.2 million for the six months ended January 1, 2011. Other costs, including legal and professional fees, facilities expenses and other miscellaneous expenses, decreased to $12.6 million for the six months ended December 31, 2011, compared with $13.8 million for the six months ended January 1, 2011. Selling, general and administrative expenses were unfavorably impacted by approximately $0.6 million as a result of the U.K. pound sterling and Swiss franc strengthening relative to the U.S. dollar.

Restructuring, Acquisition and Related Costs

During the three months ended December 31, 2011 and January 1, 2011, we accrued $0.5 million and $0.4 million, respectively, in employee separation costs related to ongoing restructuring plans. During the three months ended December 31, 2011 and January 1, 2011, we also incurred $1.8 million and $0.6 million, respectively, in external consulting charges associated with the next phase of our optimization of past acquisitions as we focus on the associated infrastructure and processes required to support sustainable growth, including, for the three months ended December 31, 2011, external costs associated with potential transactions to outsource our Shenzhen manufacturing operations.

During the three months ended December 31, 2011, we reviewed the fair value of certain remaining earnout obligations arising from the acquisition of Mintera Corporation (Mintera) and determined that their fair value increased by $0.9 million based on revised estimates of revenues from Mintera products. This $0.9 million increase in fair value was recorded as an increase in restructuring, acquisition and related expenses in the three months ended December 31, 2011.

During each of the six months ended December 31, 2011 and January 1, 2011, we accrued $1.1 million in employee separation costs related to ongoing restructuring plans. We also incurred $2.9 million and $0.6 million of expenses during the six months ended December 31, 2011 and January 1, 2011, respectively, in external consulting charges associated with the next phase of our optimization of past acquisitions as we focus on the associated infrastructure and processes required to support sustainable growth, including, for the six months ended December 31, 2011, external costs associated with potential transactions to outsource of Shenzhen manufacturing operations.

During the six months ended December 31, 2011, we reviewed the fair value of certain remaining earnout obligations arising from the acquisition of Mintera and determined that their fair value decreased by $2.9 million based on revised estimates of revenues from Mintera products. This $2.9 million decrease in fair value was recorded as a decrease in restructuring, acquisition and related expenses during the six months ended December 31, 2011.

Flood-Related Expense

In October 2011, certain areas in Thailand suffered major flooding as a result of monsoons. This flooding had a material 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. As a result of this flooding, we experienced a significant decline in products sales and we incurred significant damage to our inventory and property and equipment located at the Chokchai facility. During the three months ended December 31, 2011, we recorded impairment charges of $4.2 million related to the write-off of the net book value of damaged inventory and $3.0 million related to the write-off of the net book value of property and equipment based on our preliminary estimates of the damage caused by the flooding. These impairment charges are recorded within the operating expense caption flood-related expense in our condensed consolidated statement of operations for the three and six months ended December 31, 2011. Flood-related expense for the three and six months ended December 31, 2011 also includes $1.9 million in personnel-related costs, professional fees and related expenses incurred in connection with our recovery efforts. We continue to evaluate our preliminary estimates of flood-related losses, and in future quarters we may record additional losses for damaged equipment and inventory.

Legal Settlements

Legal settlements expense of $1.7 million during the three and six months ended January 1, 2011 includes amounts reserved in connection with a legal settlement with QinetiQ Limited and in connection with other legal settlements and related legal costs.

Other Income (Expense)

Other income (expense) for the three months ended December 31, 2011 increased by $4.9 million compared with the three months ended January 1, 2011. This increase was primarily due to a $2.2 million gain on the sale of a minority equity investment in a private company in the second quarter of 2012 and a $2.4 million increase in foreign exchange gains from the re-measurement of short term receivables and payables among certain of our wholly-owned international subsidiaries for fluctuations in the U.S. dollar relative to our other local functional currencies during the corresponding periods.

Other income (expense) for the six months ended December 31, 2011 increased by $10.3 million compared with the six months ended January 1, 2011. This increase was primarily due to a $2.2 million gain on the sale of a minority equity investment in a private company in the second quarter of 2012 and a $7.4 million increase in foreign exchange gains from the re-measurement of short term receivables and payables among certain of our wholly-owned international subsidiaries for fluctuations in the U.S. dollar relative to our other local functional currencies during the corresponding periods.

Income Tax Provision

For the three months ended December 31, 2011, our income tax provision of $0.7 million primarily related to our foreign operations. For the three months ended January 1, 2011, our income tax provision of $0.3 million primarily related to income taxes on our operations in Italy and China.

For the six months ended December 31, 2011, our income tax provision of $2.0 million primarily related to our foreign operations. For the six months ended January 1, 2011, our income tax provision of $0.8 million primarily related to income taxes on our operations in Italy and China.

Recent Accounting Pronouncements

See Note 1, Basis of Preparation , to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for information regarding the effect of new accounting pronouncements on our financial statements.

Application of Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements contained elsewhere in this Quarterly Report on Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of our financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses and other financial information. Actual results may differ significantly from those based on our estimates and judgments or could be materially different if we used different assumptions, estimates or conditions. In addition, our financial condition and results of operations could vary due to a change in the application of a particular accounting standard.

We identified our critical accounting policies in our Annual Report on Form 10-K for the year ended July 2, 2011 (2011 Form 10-K) related to revenue recognition and sales returns, inventory valuation, business combinations, impairment of goodwill and other intangible assets, accounting for stock-based compensation and income taxes. It is important that the discussion of our operating results be read in conjunction with the critical accounting policies discussed in our 2011 Form 10-K.

Based on the adverse effects the flooding in Thailand has had on our business and the potential for significant insurance recoveries, we have designated our accounting policy for insurance recoveries as a critical accounting policy beginning in the three months ended December 31, 2011.

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. 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 flood-related expense in the condensed consolidated statement of operations. As of December 31, 2011, we have not received any insurance recoveries, nor have we recorded any amounts relating to potential future insurance recoveries in the condensed consolidated statement of operations.

Liquidity and Capital Resources

Cash Flows from Operating Activities

Net cash used by operating activities for the six months ended December 31, 2011 was $20.7 million, primarily resulting from a net loss of $41.3 million, partially offset by $16.2 million of non-cash adjustments and a $4.4 million increase in cash due to changes in operating assets and liabilities. The $16.2 million of non-cash adjustments was primarily comprised of $11.2 million of expense related to depreciation and amortization, $7.2 million related to our non-cash flood-related impairments and $3.3 million of expense related to stock-based compensation, partially offset by $2.9 million due to the revaluation of the Mintera earnout liability, $2.2 million gain on the sale of investments and $0.5 million from the amortization of deferred gain from a sales-leaseback transaction. The $4.4 million increase in cash due to changes in operating assets and liabilities was primarily comprised of a $20.1 million decrease in accounts receivable, an $11.7 million decrease in inventory, a $0.3 million decrease in prepaid expenses and other current assets, partially offset by a $25.9 million decrease in accounts payable and a $1.8 million decrease in accrued expenses and other liabilities.

Although our management cannot yet definitively quantify the total impacts of the flooding in Thailand on our business, it is likely that the supply disruption will materially and adversely affect our results of operations, including our revenue, for at least the next two fiscal quarters. There is no assurance that the adverse impact will be limited to the next two fiscal quarters. While we believe our insurance coverage, both property and business interruption, will mitigate a portion of the adverse impact, there can be no assurance as to the amount or timing of insurance recoveries.

Net cash used by operating activities for the six months ended January 1, 2011 was $7.3 million, primarily resulting from an $18.0 million decrease in cash due to changes in operating assets and liabilities, partially offset by net income of $0.1 million and non-cash adjustments of $10.6 million. The $18.0 million decrease in cash due to changes in operating assets and liabilities was comprised of a $14.5 million increase in inventory, a $6.1 million increase in accounts receivable, a $5.3 million decrease in accrued expenses and other liabilities and a $0.2 million increase in prepaid expense and other current assets, partially offset by cash generated from an $8.0 million increase in accounts payable and a $0.1 million decrease in other non-current assets. The $10.6 million of non-cash adjustments was primarily comprised of $8.1 million of expense related to depreciation and amortization and $3.0 million of expense related to stock-based compensation, partially offset by $0.5 million from the amortization of deferred gain from a sales-leaseback transaction.

Cash Flows from Investing Activities

Net cash used in investing activities for the six months ended December 31, 2011 was $5.6 million, primarily consisting of $9.0 million used in capital expenditures and a $0.1 million increase in restricted cash related to contractual commitments, partially offset by $3.4 million in proceeds from the sale of an investment.

Net cash used in investing activities for the six months ended January 1, 2011 was $25.4 million, primarily consisting of $10.5 million used in the acquisition of Mintera and $18.7 million used in capital expenditures to support new product introductions and our anticipated revenue growth, partially offset by a reduction of $3.7 million in restricted cash related to a facility lease from which we exited during the first quarter of the current fiscal year.

Cash Flows from Financing Activities

Net cash provided by financing activities of $19.6 million for the six months ended December 31, 2011 primarily consisted of $19.5 million in borrowings under our revolving credit facility and $0.1 million in proceeds from the issuance of common stock through stock option exercises.

Net cash provided by financing activities of $0.6 million for the six months ended January 1, 2011 primarily resulted from $0.3 million in additional proceeds related to our May 2010 follow-on stock offering due to finalization of our previous estimates of offering related expenses and $0.3 million received from issuance of common stock, primarily through stock option exercises.

Effect of Exchange Rates on Cash and Cash Equivalents for the Six months Ended December 31, 2011 and January 1, 2011

The effect of exchange rates on cash and cash equivalents for the six months ended December 31, 2011 was a decrease of $2.4 million, primarily consisting of $0.7 million in net loss due to the revaluation of foreign currency cash balances to the functional currency of the respective subsidiaries and from a loss of approximately $1.7 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 six months ended January 1, 2011 was an increase of $2.2 million, primarily consisting of $0.8 million in net gain due to the revaluation of foreign currency cash balances to the functional currency of the respective subsidiaries and from gains of approximately $0.8 million related to the revaluation of U.S. dollar denominated operating intercompany payables and receivables of our foreign subsidiaries.

Credit Facility

As of December 31, 2011, we had a $45.0 million senior secured revolving credit facility with Wells Fargo Capital Finance, Inc. and other lenders (the Credit Agreement) with an expiration date of August 1, 2014. See Note 7, Credit Agreement , to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for additional information regarding this credit facility. As of December 31, 2011, there was $19.5 million outstanding under the Credit Agreement and we were in compliance with all covenants. As of July 2, 2011, there were no amounts outstanding under the Credit Agreement. At December 31, 2011 and July 2, 2011, there were $0.1 million and $1.1 million, respectively, in outstanding standby letters of credit secured under the Credit Agreement. These letters of credit expire at various intervals through April 2014.

Future Cash Requirements

As of December 31, 2011, we held $53.6 million in cash and cash equivalents and $0.6 million in restricted cash. In the future, in order to strengthen our financial position, in the event of unforeseen circumstances, in the event we need to fund our growth in future financial periods, or in the event insurance proceeds are not sufficient or timely enough to offset our expenses or lost revenue associated with the flooding in Thailand, we may need to raise additional funds by any 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 other 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 continue to be in negotiations to transition our Shenzhen assembly and test operations to a major contract manufacturer and we expect this could generate $30 million to $40 million in proceeds in our third or fourth fiscal quarters of 2012, with potential additional consideration to be received in the future, and which would include a long term supply agreement with the contract manufacturer. In addition to the $6.4 million insurance coverage advance payment we received in February 2012 associated with the flooding in Thailand, we also expect to receive substantial additional insurance proceeds, although neither the amounts nor the timing of such payments can be reasonably estimated at this time.

From time to time, we have engaged in discussions with third parties concerning potential acquisitions of product lines, technologies and businesses, such as our merger with Avanex, our acquisitions of Xtellus and Mintera, our exchange of assets agreement with Newport and our sale of a legacy product line in the second quarter of fiscal year 2012. We continue to consider potential acquisition candidates. Any such transactions could result in us issuing a significant number of new equity or debt securities (including promissory notes), the incurrence or assumption of debt, and the utilization of our cash and cash equivalents. We may also be required to raise additional funds to complete any such acquisition, through either the issuance of equity securities and/or borrowings. If we raise additional funds or acquire businesses or technologies through the issuance of equity securities, our existing stockholders may experience significant dilution.

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 the normal course of business, such as indemnification in favor of customers in respect of liabilities they may incur as a result of purchasing our products should such products infringe the intellectual property rights of a third party. We have not historically paid out any material amounts related to these indemnifications; therefore, no accrual has been made for these indemnifications.

Other than as set forth above, we are not currently party to any material off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rates

We finance our operations through a mixture of the issuance of equity securities, finance leases, working capital and by drawing on our Credit Agreement. Our primary exposure to interest rate fluctuations is on our cash deposits and for amounts borrowed under our Credit Agreement. As of December 31, 2011, we had $19.5 million in outstanding borrowings at an average interest rate of 3.37 percent and $0.1 million in outstanding standby letters of credit secured under our Credit Agreement. An increase in our average interest rate on our Credit Agreement of 1.0 percent would increase our annual interest expense by $0.2 million.

We monitor our interest rate risk on cash balances primarily through cash flow forecasting. Cash that is surplus to immediate requirements is generally invested in short-term deposits with banks accessible within one day’s notice and invested in overnight money market accounts. We believe our interest rate risk is immaterial.

Foreign currency

As our business is multinational in scope, we are subject to fluctuations based upon changes in the exchange rates between the currencies in which we collect revenues and pay expenses. A significant majority of our revenues are be denominated in U.S. dollars, while a significant portion of our expenses are 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 December 31, 2011, our U.K. subsidiary had $53.7 million, net, in U.S. dollar denominated operating intercompany payables and $55.3 million in U.S. dollar denominated net 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 $0.2 million (U.S. dollar strengthening), or a loss of $0.2 million (U.S. dollar weakening) on the translation of these receivables, which would be recorded as gain (loss) on foreign exchange in our condensed 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 fluctuations between the U.S. dollar and the U.K. pound sterling. We do not currently hedge our exposure to the Chinese yuan, the Korean won, the Israeli shekel, the 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 December 31, 2011, we held nine outstanding foreign currency forward exchange contracts with a notional value of $7.0 million which include put and call options which expire, or expired, at various dates from January 2012 to September 2012. We have recorded an unrealized loss of $12,000 to accumulated other comprehensive income in connection with marking these contracts to fair value as of December 31, 2011. It is estimated that a 10 percent fluctuation in the dollar between December 31, 2011 and the maturity dates of the put and call instruments underlying these contracts would lead to a profit of $0.5 million dollars (U.S. dollar weakening) or loss of $0.5 million dollars (U.S. dollar strengthening) on our outstanding foreign currency forward exchange contracts, should they be held to maturity.

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. The Court subsequently appointed the Connecticut Laborers’ Pension Fund (Pension Fund) as lead plaintiff for the putative class. On October 27, 2011, the Pension Fund filed an Amended Complaint, captioned as Westley v. Oclaro, Inc., No. 11 Civ. 2448 EMC, allegedly on behalf of persons who purchased our common stock between May 6 and October 28, 2010, alleging that defendants issued materially false and misleading statements during this time period regarding our current business and financial condition, including projections for demand for our products, as well as 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. On December 12, 2011, defendants filed a motion to dismiss the complaint. That motion is scheduled to be heard on March 23, 2012. Discovery has not commenced, and no trial has been scheduled in this action. We intend to defend this litigation vigorously. We are unable at this time to estimate the effects of these lawsuits on our financial position, results of operations or cash flows.

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. By Order dated September 14, 2011, the Guindani, Coney, and Braman actions were consolidated under In re Oclaro, Inc. Derivative Litigation , Lead Case No. 11 Civ. 3176 EMC. On October 5, 2011, the Aguilar action was voluntarily dismissed. Each remaining 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. Each purported derivative complaint seeks damages and costs of an unspecified amount, as well as injunctive relief. By Order dated November 23, 2011, the parties in the Moskal action agreed that defendants shall not be required to respond to the original complaint, that plaintiff would serve an amended complaint no later than March 9, 2012, and the stay of discovery would remain in effect until further order of the Court or agreement by the parties. By Order dated November 29, 2011, the parties to In re Oclaro, Inc. Derivative Litigation agreed to stay all proceedings, including motion practice and discovery, until such time as (a) the defendants file an answer to any complaint in the Westley Action; or (b) the Westley Action is dismissed in its entirety with prejudice. Discovery has not commenced, and no trial has been scheduled in any of these actions. We are unable at this time to estimate the effects of these lawsuits on our financial position, results of operations or cash flows.

Item 1A. Risk Factors

Investing in our securities involves a high degree of risk. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity and stock price materially and adversely. You should carefully consider the risks and uncertainties described below in addition to the other information included or incorporated by reference in this Quarterly Report on Form 10-Q. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall and you could lose all or part of your investment.

RISKS RELATED TO OUR BUSINESS

Our results of operations have been and will be materially and adversely affected by the flooding in Thailand.

In October 2011, certain areas in Thailand suffered major flooding as a result of monsoons. This flooding had a material 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. As a result of this flooding, we experienced a significant decline in products sales and we incurred significant damage to our inventory and property and equipment located at the Chokchai facility. During the three and six months ended December 31, 2011, we recorded impairment charges of $4.2 million related to the write-off of the net book value of damaged inventory and $3.0 million related to the write-off of the net book value of property and equipment based on our preliminary estimates of the damage caused by the flooding and we incurred $1.9 million in personnel-related costs, professional fees and related expenses incurred in connection with our recovery efforts. We continue to evaluate our preliminary estimates of flood-related losses, and in future quarters we may record additional losses for damaged equipment and inventory.

It is possible that our customers could experience supply chain disruptions as a result of other suppliers whose manufacturing operations in Thailand have been impacted by the flooding which could impact our customers’ demand, or the timing of their demand, for our products. It is also possible that our customers will seek alternative suppliers of comparable products if we are unable to meet their supply needs as a result of the flooding in Thailand. Although our management cannot yet definitively quantify the total impacts of the flooding in Thailand on our business, it is likely that the supply disruption will continue to materially and adversely affect our results of operations, including our revenue, for at least the next two fiscal quarters. There is no assurance that the adverse impact will be limited to the next two fiscal quarters. While we believe our insurance coverage, both property and business interruption, will mitigate a portion of the adverse impact, there can be no assurance as to the amount or timing of insurance recoveries, or that the timing or amounts will be sufficient to fully compensate for negative impacts on our operating cash flow during the recovery period. If we do not efficiently and effectively mitigate the impact of the flooding on our business or if the adverse impact extends for a longer period of time than expected, our results of operations would be materially and adversely affected.

We depend on a limited number of suppliers who could disrupt our business if they stopped, decreased, delayed or were unable to meet our demand for shipments of their products.

We depend on a limited number of suppliers of raw materials and equipment used to manufacture our products. We also depend on a limited number of contract manufacturers, principally Fabrinet in Thailand, to manufacture certain of our products. Some of these suppliers are sole sources. We typically have not entered into long-term agreements with our suppliers other than Fabrinet and, therefore, these suppliers generally may stop supplying us materials and equipment at any time. Our reliance on a sole supplier or limited number of suppliers could result in delivery problems, reduced control over product pricing and quality, and an inability to identify and qualify another supplier in a timely manner. Given the recent macroeconomic downturn, some of our suppliers that may be small or undercapitalized may experience financial difficulties that could prevent them from supplying us materials and equipment. In addition, our suppliers, including our sole source suppliers, may experience manufacturing delays or shut downs due to circumstances beyond their control such as earthquakes, floods, fires or other natural disasters.

Fabrinet’s manufacturing operations are located in Thailand. In October 2011, due to flooding in Thailand, Fabrinet suspended operations at both of their factories that supply us with finished goods. Thailand has also been subject to political unrest in the recent past, including the temporary interruption of service at one of its international airports, and may again experience such political unrest in the future. If Fabrinet is unable to supply us with materials or equipment, or if they are unable to ship our materials or equipment out of Thailand due to future flooding or political unrest, this could materially adversely affect our ability to fulfill customer orders and our results of operations.

Any supply deficiencies relating to the quality or quantities of materials or equipment we use to manufacture our products could materially adversely affect our ability to fulfill customer orders and our results of operations. Lead times for the purchase of certain materials and equipment from suppliers have increased and in some cases have limited our ability to rapidly respond to increased demand, and may continue to do so in the future. These conditions have been exacerbated by suppliers, customers and companies reducing their inventory levels in response to the recent macroeconomic downturn. We are currently evaluating the capabilities of additional potential contract manufacturing partners to ensure we have a scalable and cost effective manufacturing strategy appropriate for executing our business objectives over a long-term horizon. To the extent we introduce additional contract manufacturing partners, introduce new products with new partners and/or move existing internal or external production lines to new partners, we could experience supply disruptions during the transition process. In addition, due to our customers’ requirements relating to the qualification of our suppliers and contract manufacturing facilities and operations, we cannot quickly enter into alternative supplier relationships, which prevents us from being able to respond immediately to adverse events affecting our suppliers.

We are negotiating the transition of our Shenzhen assembly and test operations, and a corresponding long term supply agreement, to a major contract manufacturer.

There can be no assurance that our negotiations to transition our Shenzhen assembly and test operations and to enter into a corresponding long term supply agreement with a major contract manufacturer will result in definitive agreements, the closing of such agreements or result in the benefits that we expect. There can be no assurance, therefore, that we will receive the $30 million to $40 million we would expect from such a transition, or the potential additional consideration to be received in the future, or enter into a long term supply agreement on terms acceptable to us. In addition, there can be no assurance that announcing these negotiations will not have an adverse impact on the efficiency of our Shenzhen manufacturing facility prior to, or subsequent to, resolution of these negotiations, which could have an adverse impact on our production output and/or the levels and gross margins of the corresponding product revenues supported by the production output.

In addition, during a similar transition by a competitor, the competitor experienced a work stoppage by their employees. There can be no assurance that transitioning our Shenzhen assembly and test operations will not result in similar adverse impacts, which may negatively impact our revenues and ability to deliver products to our customers.

We have a history of large operating losses and we may not be able to achieve profitability in the future.

We have historically incurred losses and negative cash flows from operations since our inception. As of December 31, 2011, we had an accumulated deficit of $1,167.3 million. For the six months ended December 31, 2011, we incurred a net loss of $41.3 million. For the year ended July 2, 2011 we incurred a loss from continuing operations of $46.4 million. Even though we generated income of $11.0 million from continuing operations for the year ended July 3, 2010, our results of operations are currently being materially and adversely impacted by the flooding in Thailand, and we may not be able to achieve profitability in any future periods. If we are unable to do so, we may need additional financing, which may not be available to us on commercially acceptable terms or at all, to execute on our current or future business strategies. In addition, we are likely to incur material operating losses for at least the next two fiscal quarters as a result of decreased revenue attributable to the flooding in Thailand discussed above.

We may not be able to maintain gross margin levels.

We may not be able to maintain or improve our historical gross margin levels, due to the current economic uncertainty, changes in customer demand (including a change in product mix between different areas of our business) and pricing pressure from increased competition or other factors. During fiscal year 2011, our gross margin decreased compared with fiscal year 2010, and has further decreased for the six months ended December 31, 2011. We attempt to reduce our product costs and improve our product mix to offset price competition and erosion expected in most product categories, but there is no assurance that we will be successful. Our gross margins have been, and will be in the future, adversely impacted for reasons including, but not limited to, fixed manufacturing costs that will not decrease in tandem with lower revenues due to the flooding in Thailand, unfavorable production yields or variances, increases in costs of input parts and materials, the timing of movements in our inventory balances, warranty costs and related returns, changes in foreign currency exchange rates, and possible exposure to inventory valuation reserves. Any failure to maintain, or improve, our gross margins will adversely affect our financial results, including our goal to achieve sustainable cash flow positive operations.

Our business and results of operations may be negatively impacted by general economic and financial market conditions and such conditions may increase the other risks that affect our business.

Over the past few years, the world’s financial markets have experienced significant turmoil, resulting in reductions in available credit, increased costs of credit, extreme volatility in security prices, potential changes to existing credit terms, rating downgrades of investments and reduced valuations of securities generally. In light of these economic conditions, many of our customers reduced their spending plans, leading them to draw down their existing inventory and reduce orders for our products. It is possible that economic conditions could result in further setbacks, and that these customers, or others, could as a result significantly reduce their capital expenditures, draw down their inventories, reduce production levels of existing products, defer introduction of new products or place orders and accept delivery for products for which they do not pay us due to their economic difficulties or other reasons. These actions could have an adverse impact on our revenues. In addition, the financial downturn affected the financial strength of certain of our customers, including their ability to obtain credit to finance purchases of our products, and could adversely affect additional customers in the future. Our suppliers may also be adversely affected by economic conditions that may impact their ability to provide important components used in our manufacturing processes on a timely basis, or at all.

These conditions could also result in reduced capital resources because of the potential lack of credit availability, higher costs of credit and the stretching of payables by creditors seeking to preserve their own cash resources. We are unable to predict the likely duration, severity and potential continuation of any disruption in financial markets and adverse economic conditions in the U.S. and other countries, but the longer the duration the greater the risks we face in operating our business.

Our success will depend on our ability to anticipate and respond to evolving technologies and customer requirements.

The market for telecommunications equipment is characterized by substantial capital investment, rapid and unpredictable changes in customer demand and diverse and evolving technologies. For example, the market for optical components is currently characterized by a trend toward the adoption of pluggable components and tunable transmitters that do not require the customized interconnections of traditional fixed wavelength “gold box” devices and the increased integration of components on subsystems. Our ability to anticipate and respond to these and other changes in technology, industry standards, customer requirements and product offerings and to develop and introduce new and enhanced products will be significant factors in our ability to succeed. We expect that new technologies will continue to emerge as competition in the telecommunications industry increases and the need for higher and more cost efficient bandwidth expands. The introduction of new products embodying new technologies or the emergence of new industry standards could render our existing products or products in development uncompetitive from a pricing standpoint, obsolete or unmarketable, which would negatively affect our financial condition and results of operations.

We depend on a limited number of customers for a significant percentage of our revenues.

Historically, we have generated most of our revenues from a limited number of customers. Our dependence on a limited number of customers is due to the fact that the optical telecommunications systems industry is dominated by a small number of large companies. These companies in turn depend primarily on a limited number of major telecommunications carrier customers to purchase their products that incorporate our optical components. For example, for the six months ended December 31, 2011 and the years ended July 2, 2011 and July 3, 2010, our three largest customers accounted for 33 percent, 36 percent and 29 percent of our revenues, respectively. Because we rely on a limited number of customers for significant percentages of our revenues, a decrease in demand for our products from any of our major customers for any reason (including due to market conditions, catastrophic events or otherwise) could have a materially adverse impact on our financial conditions and results of operations. For example, our revenues for the fiscal quarter ended July 2, 2011 were adversely impacted by a change in customer demand expectations, including a significant change in demand expectations from a particular major customer. Further, the industry in which our customers operate is subject to a trend of consolidation. To the extent this trend continues, we may become dependent on even fewer customers to maintain and grow our revenues.

The majority of our long-term customer contracts do not commit customers to specified buying levels, and our customers may decrease, cancel or delay their buying levels at any time with little or no advance notice to us.

The majority of our customers typically purchase our products pursuant to individual purchase orders or contracts that do not contain purchase commitments. Some customers provide us with their expected forecasts for our products several months in advance, but many of these customers may decrease, cancel or delay purchase orders already in place, and the impact of any such actions may be intensified given our dependence on a small number of large customers. If any of our major customers decrease, stop or delay purchasing our products for any reason, our business and results of operations would be harmed. Cancellation or delays of such orders may cause us to fail to achieve our short-term and long-term financial and operating goals and result in excess and obsolete inventory. For example, in mid-September 2010, we did experience certain deferrals and cancellation of orders which adversely impacted our financial results. In addition, our revenues for the fiscal quarter ended July 2, 2011 were adversely impacted by a change in customer demand expectations, including a significant change in demand expectations from a particular major customer.

We have significant manufacturing and research and development operations in China, which exposes us to risks inherent in doing business in China.

The majority of our assembly and test operations, chip-on-carrier operations and manufacturing and supply chain management operations are concentrated in our facility in Shenzhen, China. In addition, we have substantial research and development related activities in Shenzhen and Shanghai, China. To be successful in China we will need to:

	•		qualify our manufacturing lines and the products we produce in Shenzhen, as required by our customers;
	•		attract and retain qualified personnel to operate our Shenzhen facility; and
	•		attract and retain research and development employees at our Shenzhen and Shanghai facilities.

We cannot be assured that we will be able to do any of these.

Employee turnover in China is high due to the intensely competitive and fluid market for skilled labor. To operate our Shenzhen facility under these conditions, we will need to continue to hire direct manufacturing personnel, administrative personnel and technical personnel; obtain and retain required legal authorization to hire such personnel; and incur the time and expense to hire and train such personnel.

Inflation rates in China are higher than in most jurisdictions in which we operate. We believe that salary inflation rates for the skilled personnel we hire and seek to retain in Shenzhen and Shanghai are likely to be higher than overall inflation rates.

Operations in China are subject to greater political, legal and economic risks than our operations in other countries. In particular, the political, legal and economic climate in China, both nationally and regionally, is fluid and unpredictable. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations such as those related to, among other things, taxation, import and export tariffs, environmental regulations, land use rights, intellectual property, currency controls, employee benefits and other matters. In addition, we may not obtain or retain the requisite legal permits to continue to operate in China, and costs or operational limitations may be imposed in connection with obtaining and complying with such permits.

We intend to continue to export the products manufactured at our Shenzhen facility, whether we own and operate the Shenzhen facility or whether we contract with a provider that owns and operates the facility. Under current regulations, upon application and approval by the relevant governmental authorities, we will not be subject to certain Chinese taxes and will be exempt from certain duties on imported materials that are used in the manufacturing process and subsequently exported from China as finished products. However, Chinese trade regulations are in a state of flux, and we may become subject to other forms of taxation and duties in China or may be required to pay export fees in the future. In the event that we become subject to new forms of taxation or export fees in China, our business and results of operations could be materially adversely affected. We may also be required to expend greater amounts than we currently anticipate in connection with increasing production at our Shenzhen facility. Any one of the factors cited above, or a combination of them, could result in unanticipated costs or interruptions in production, which could materially and adversely affect our business.

Our results of operations may suffer if we do not effectively manage our inventory, and we may incur inventory-related charges.

We need to manage our inventory of component parts and finished goods effectively to meet changing customer requirements. Accurately forecasting customers’ product needs is difficult. Even though our inventory balances decreased to $83.3 million as of December 31, 2011 from $102.2 million as of July 2, 2011, our quarterly revenues also decreased, to $86.5 million for the fiscal quarter ended December 31, 2011 from $109.2 million for the fiscal quarter ended July 2, 2011. Some of our products and supplies have in the past, and may in the future, become obsolete while in inventory due to rapidly changing customer specifications or a decrease in customer demand. We also have exposure to contractual liabilities to our contract manufacturers for inventories purchased by them on our behalf, based on our forecasted requirements, which may become excess or obsolete. Our inventory balances also represent an investment of cash. To the extent our inventory turns are slower than we anticipate based on historical practice, our cash conversion cycle extends and more of our cash remains invested in working capital. If we are not able to manage our inventory effectively, we may need to write down the value of some of our existing inventory or write off non-saleable or obsolete inventory. We have from time to time incurred significant inventory-related charges. Any such charges we incur in future periods could materially and adversely affect our results of operations. Should we enter into a contract to transition our Shenzhen manufacturing facility to a major contract manufacturer we may need to invest in additional inventories during the corresponding transition period, and in the future may be exposed to contractual liabilities to the new contract manufacturer for inventories purchased by them on our behalf.

We may undertake mergers or acquisitions that do not prove successful.

From time to time we consider mergers or acquisitions, collectively referred to as “acquisitions,” of other businesses, assets or companies that would complement our current product offerings, enhance our intellectual property rights or offer other competitive opportunities. However, we may not be able to identify suitable acquisition candidates at prices we consider appropriate. In addition, we are in an industry that is actively consolidating and, as a result, there is no guarantee that we will successfully and satisfactorily bid against third parties, including competitors, when we identify a critical target we want to acquire. Our management may not be able to effectively implement our acquisition plans and internal growth strategy simultaneously.

We cannot readily predict the timing, size or success of our future acquisitions. Failure to successfully implement our acquisition plans could have a material adverse effect on our business, prospects, financial condition and results of operations. Even successful acquisitions could have the effect of reducing our cash balances, diluting the ownership interests of existing stockholders or increasing our indebtedness. For example, our acquisition of Xtellus required an immediate issuance of a significant number of newly issued shares of our common stock. In addition, during the first quarter of fiscal year 2012, we issued 0.9 million shares of our common stock related to the settlement of our Xtellus escrow liability. In October 2011, we also issued 0.8 million shares of our common stock to pay a portion of the 12 month Mintera earnout obligation. We could also choose to use shares of our common stock to pay a portion the 18 month Mintera earnout obligation.

We cannot predict with certainty which strategic, financial or operating synergies or other benefits, if any, will actually be achieved from any transaction we undertake, the timing of any such benefits, or whether those benefits which have been achieved will be sustainable on a long-term basis. Our failure to identify, consummate or integrate suitable acquisitions could adversely affect our business and results of operations.

Acquisitions could involve a number of other potential risks to our business, including the following, any of which could harm our business:

	•		failure to realize the potential financial or strategic benefits of the acquisition;
	•		increased costs associated with acquired operations;