NEOPHOTONICS CORP (Form: 10-Q, Received: 05/09/2017 16:27:48)

Three Months Ended

Gross profit as a % of revenue

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2017

☐ 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: 001-35061

NeoPhotonics Corporation

(Exact name of registrant as specified in its charter)

Delaware

94-3253730

(State or other jurisdiction

of incorporation or organization)

(I.R.S. Employer

Identification No.)

2911 Zanker Road

San Jose, California 95134

(Address of principal executive offices, zip code)

(408) 232-9200

(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 (“Exchange Act”) 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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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

Large accelerated filer	☐		Accelerated filer	☒
Non-accelerated filer	☐	(do not check if a smaller reporting company)	Smaller reporting company	☐
Emerging growth company	☐			

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

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

As of April 30, 2017, there were approximately 43,079,000 shares of the registrant’s Common Stock outstanding.

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NEOPHOTONICS CORPORATION

For the Quarter Ended March 31, 2017

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		Page
	Part I. Financial Information
Item 1.	Condensed Consolidated Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016	3
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2017 and 2016	4
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2017 and 2016	5
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	35
Item 4.	Controls and Procedures	35
	Part II. Other Information
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55
Item 3.	Defaults Upon Senior Securities	55
Item 4.	Mine Safety Disclosures	55
Item 5.	Other Information	55
Item 6.	Exhibits	55
	Signature	56

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PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NEOPHOTONICS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	As of
	March 31,		December 31,
(In thousands, except par data)	2017		2016
ASSETS
Current assets:
Cash and cash equivalents	$	81,699	$	82,500
Short-term investments		6,047		19,015
Restricted cash		3,714		4,085
Accounts receivable, net of allowance for doubtful accounts		70,877		80,610
Inventories		69,159		48,237
Assets held for sale		—		13,953
Prepaid expenses and other current assets		26,797		22,396
Total current assets		258,293		270,796
Property, plant and equipment, net		122,208		106,867
Purchased intangible assets, net		5,204		5,562
Goodwill		1,115		1,115
Other long-term assets		6,449		6,547
Total assets	$	393,269	$	390,887
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	82,750	$	84,766
Notes payable and short-term borrowing		29,484		30,190
Current portion of long-term debt		5,263		747
Accrued and other current liabilities		37,639		30,625
Total current liabilities		155,136		146,328
Long-term debt, net of current portion		6,028		10,215
Other noncurrent liabilities		12,836		8,939
Total liabilities		174,000		165,482
Commitments and contingencies (Note 10)
Stockholders’ equity:
Preferred stock, $0.0025 par value, 10,000 shares authorized, no shares issued or outstanding		—		—
Common stock, $0.0025 par value, 100,000 shares authorized
At March 31, 2017, 42,664 shares issued and outstanding; at December 31, 2016, 42,526 shares issued and outstanding		107		106
Additional paid-in capital		535,292		532,378
Accumulated other comprehensive loss		(5,930)		(8,401)
Accumulated deficit		(310,200)		(298,678)
Total stockholders’ equity		219,269		225,405
Total liabilities and stockholders’ equity	$	393,269	$	390,887

See accompanying Notes to Condensed Consolidated Financial Statements.

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NEOPHOTONICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended
	March 31,
(In thousands, except per share data)	2017		2016
Revenue	$	71,688	$	99,145
Cost of goods sold		53,185		68,023
Gross profit		18,503		31,122
Operating expenses:
Research and development		15,544		12,952
Sales and marketing		4,932		3,931
General and administrative		11,426		9,084
Amortization of purchased intangible assets		118		453
Acquisition and asset sale related costs		130		—
Restructuring charges		227		—
Gain on asset sale		(2,000)		—
Total operating expenses		30,377		26,420
Income (loss) from operations		(11,874)		4,702
Interest income		73		55
Interest expense		(137)		(102)
Other income (expense), net		249		(1,304)
Total interest and other income (expense), net		185		(1,351)
Income (loss) before income taxes		(11,689)		3,351
Income tax (provision) benefit		167		(1,041)
Net income (loss)	$	(11,522)	$	2,310

Basic net income (loss) per share	$	(0.27)	$	0.06
Diluted net income (loss) per share	$	(0.27)	$	0.05
Weighted average shares used to compute basic net income (loss) per share		42,615		41,121
Weighted average shares used to compute diluted net income (loss) per share		42,615		43,648

See accompanying Notes to Condensed Consolidated Financial Statements.

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NEOPHOTONICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)


	Three Months Ended
	March 31,
(in thousands)	2017		2016
Net income (loss)	$	(11,522)	$	2,310
Other comprehensive income:
Foreign currency translation adjustments, net of zero tax		2,468		2,065
Unrealized gains on available-for-sale securities, net of zero tax		3		28
Total other comprehensive income		2,471		2,093
Comprehensive income (loss)	$	(9,051)	$	4,403

See accompanying Notes to Condensed Consolidated Financial Statements.

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NEOPHOTONICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Three Months Ended
	March 31,
(In thousands)	2017		2016
Cash flows from operating activities
Net income (loss)	$	(11,522)	$	2,310
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		6,185		5,453
Stock-based compensation expense		1,872		3,439
Deferred taxes		548		5
Amortization of investment, debt and other		76		28
(Gain) loss on sale of assets and other writeoffs		(1,687)		31
Gain on foreign currency hedges		(652)		—
Allowance for doubtful accounts		80		(339)
Write-down of inventories		196		742
Foreign currency remeasurement and other, net		38		565
Change in assets and liabilities, net of effects of asset sale:
Accounts receivable		9,826		(3,628)
Inventories		(19,260)		3,037
Prepaid expenses and other assets		3,106		(2,122)
Accounts payable		(3,912)		3,178
Accrued and other liabilities		(3,642)		(7,515)
Net cash provided by (used in) operating activities		(18,748)		5,184
Cash flows from investing activities
Purchase of property, plant and equipment		(17,570)		(4,650)
Proceeds from sale of property, plant and equipment and other assets		21,745		6
Purchase of marketable securities		(38,806)		(32,045)
Proceeds from sale of marketable securities		45,286		15,516
Proceeds from maturity of marketable securities		6,458		1,500
Change in restricted cash		402		18
Settlement of foreign currency hedges		616		—
Net cash provided by (used in) investing activities		18,131		(19,655)
Cash flows from financing activities
Proceeds from exercise of stock options and issuance of stock under ESPP		499		1,233
Tax withholding on restricted stock units		(37)		(34)
Payments for public stock offering		(117)		—
Proceeds from bank loans, net of debt issuance costs		23,625		23,800
Repayment of bank loans		(24,020)		(24,017)
Proceeds from issuance of notes payable		2,966		4,984
Repayment of notes payable		(3,722)		(5,047)
Net cash provided by (used in) financing activities		(806)		919
Effect of exchange rates on cash and cash equivalents		622		203
Net decrease in cash and cash equivalents		(801)		(13,349)
Cash and cash equivalents at the beginning of the period		82,500		76,088
Cash and cash equivalents at the end of the period	$	81,699	$	62,739
Supplemental disclosure of noncash investing and financing activities:
Increase in unpaid property, plant and equipment	$	(1,226)	$	(1,355)

See accompanying Notes to Condensed Consolidated Financial Statements.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Note 1. Basis of presentation and significant accounting policies

Basis of Presentation and Consolidation

The condensed consolidated financial statements of NeoPhotonics Corporation (“NeoPhotonics” or the “Company”) as of March 31, 2017 and for the three months ended March 31, 2017 and 2016, have been prepared in accordance with the instructions on Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In accordance with those rules and regulations, the Company has omitted certain information and notes normally provided in the Company’s annual consolidated financial statements. In the opinion of management, the condensed consolidated financial statements contain all adjustments, consisting only of normal recurring items, except as otherwise noted, necessary for the fair presentation of the Company’s financial position and results of operations for the interim periods. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles (“U.S. GAAP”). These condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results expected for the entire fiscal year. All intercompany accounts and transactions have been eliminated.

Certain Significant Risks and Uncertainties

The Company operates in a dynamic industry and, accordingly, can be affected by a variety of factors. For example, any of the following areas could have a negative effect on the Company in terms of its future financial position, results of operations or cash flows: the general state of the U.S., China and world economies; the highly cyclical nature of the industries the Company serves; the loss of any of a small number of its larger customers; ability to obtain additional financing; inability to meet certain debt covenants; fundamental changes in the technology underlying the Company’s products; the hiring, training and retention of key employees; successful and timely completion of product design efforts; and new product design introductions by competitors.

Concentration

In the three months ended March 31, 2017, Huawei Technologies Co. Ltd. and their affiliate HiSilicon Technologies (together with Huawei Technologies Co. Ltd., “Huawei”) and Ciena Corporation (“Ciena”) accounted for approximately 41% and 14% of the Company’s total revenue, respectively, and the Company’s top ten customers represented approximately 90% of the Company’s total revenue. In the three months ended March 31, 2016, Huawei and Ciena accounted for approximately 54% and 16% of the Company’s total revenue, respectively, and the Company’s top ten customers represented approximately 92% of the Company’s total revenue.

As of March 31, 2017, one customer accounted for approximately 48% of the Company’s accounts receivable. As of December 31, 2016, three customers accounted for approximately 42%, 12% and 12%, respectively, of the Company’s accounts receivable.

Use of Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenue and expenses during the reporting period. Significant estimates made by management include: the useful lives of property, plant and equipment and intangible assets as well as future cash flows to be generated by those assets; fair values of identifiable assets acquired and liabilities assumed in business combinations; allowances for doubtful accounts; valuation allowances for deferred tax assets; valuation of excess and obsolete inventories; warranty reserves; litigation accrual and recognition of stock-based compensation, among others. Actual results could differ from these estimates.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Summary of Significant Accounting Policies

Effective January 1, 2017, the Company adopted ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies certain aspects of the accounting for shared-based payment transactions, including income taxes, classification of awards and classification on the statement of cash flows. It eliminates that requirement to delay the recognition of excess tax benefits until they reduce current taxes payable. Under this standard, previously unrecognized excess tax benefits shall be recognized on a modified retrospective basis. Upon adoption, the Company’s previously unrecognized excess tax benefits of $8.6 million had no impact on its accumulated deficit balance as the related U.S. deferred tax assets were fully offset by a valuation allowance. The Company elected to apply the change in presentation on the statements of cash flows prospectively and elected to continue to account for estimated forfeitures over the vest period of the shared-based awards.

Effective January 1, 2017, the Company also adopted ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 requires entities to measure most inventory “at the lower of cost and net realizable value” but does not apply to inventories that are measured by using either the last-in, first-out method or the retail inventory method. The impact on the Company’s consolidated financial statements upon the adoption of this standard was immaterial.

There have been no other significant changes in the Company’s significant accounting policies in the three months ended March 31, 2017, as compared to the significant accounting policies described in its Annual Report on Form 10-K for the year ended December 31, 2016.

Recent accounting pronouncements

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). This standard amends the goodwill impairment test to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, up to the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective prospectively for interim and annual periods beginning after December 15, 2019. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). This standard provides a framework in determining when a set of assets and activities is a business. ASU 2017-01 is effective for interim and annual periods beginning after December 15, 2017 on a prospective basis. The impact on the Company’s financial statements upon the adoption of this standard is expected to be immaterial.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASC 2016-18”). This standard provides guidance on the classification and presentation of restricted cash in the statement of cash flows and must be applied retrospectively. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”). This standard provides guidance on the tax accounting for the transferring and receiving entities upon transfer of an asset. ASU 2016-16 is effective for the Company’s interim and annual periods beginning after December 15, 2017 and should be applied on a modified retrospective basis. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). This standard provides guidance on the classification of certain cash receipts and payments in the statement of cash flows . It is effective, retrospectively, for the Company’s annual and interim reporting periods beginning after December 15, 2017 or prospectively from the earliest data practicable if retrospective application is impracticable. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 amends existing guidance on the impairment of financial assets and adds an impairment model that is based on expected losses rather than incurred losses and requires an entity to recognize as an allowance its estimate of expected credit losses for its financial assets. An entity will apply this guidance through a cumulative-effect adjustment to retained earnings upon adoption (a modified-retrospective approach) while a prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date. It is effective for the Company’s annual and interim reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 introduces a lessee model that requires recognition of assets and liabilities arising from qualified leases on the consolidated balance sheets and consolidated statements of operations and to disclose qualitative and quantitative information about lease transactions. It is effective for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition is required with certain optional practical expedients allowed. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 revises an entity’s accounting related to (1) the classification and measurement of investments in equity securities and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments and is effective for the Company’s annual and interim reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

In May 2014, the FASB issued ASU N o. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). The standard, along with the amendments issued in 2016 and 2015, provides companies with a single model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry-specific revenue guidance. The core principle of the model is to recognize revenue when control of the goods or services transfers to the customer, as opposed to recognizing revenue when the risks and rewards transfer to the customer under the existing revenue guidance. This standard, as amended, is effective for annual and interim periods beginning after December 15, 2017 and permits entities to early adopt for annual and interim reporting periods beginning after December 15, 2016. Companies are permitted to either apply the requirements retrospectively to all prior periods presented, or apply the requirements in the year of adoption, through a cumulative adjustment. The Company expects to adopt this standard, as amended, effective January 1, 2018 and is in the process of evaluating the impact of adoption on its consolidated financial statements.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Note 2. Net income (loss) per share

The following table sets forth the computation of the basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):


	Three Months Ended
	March 31,
	2017		2016
Numerator:
Net income (loss)	$	(11,522)	$	2,310
Denominator:
Weighted average shares used to compute per share amount:
Basic		42,615		41,121
Dilutive effect of equity awards		-		2,527
Diluted		42,615		43,648

Basic net income (loss) per share	$	(0.27)	$	0.06
Diluted net income (loss) per share	$	(0.27)	$	0.05

The Company has excluded the impact of the following employee stock options, restricted stock units and shares expected to be issued under its employee stock purchase plan from the computation of diluted net income (loss) per share, as their effect would have been antidilutive (in thousands):


	Three Months Ended
	March 31,
	2017	2016
Employee stock options	4,161	498
Restricted stock units	2,168	1
Employee stock purchase plan	378	148
	6,707	647

Note 3. Cash, cash equivalents, short-term investments, and restricted cash

The following table summarizes the Company’s cash, cash equivalents, short-term investments and restricted cash (in thousands):


	March 31,		December 31,
	2017		2016
Cash and cash equivalents:
Cash	$	57,890	$	58,691
Cash equivalents		23,809		23,809
Cash and cash equivalents	$	81,699	$	82,500
Short-term investments	$	6,047	$	19,015
Restricted cash	$	3,714	$	4,085

As of March 31, 2017 and December 31, 2016, restricted cash included approximately $2.0 million pursuant to an asset purchase agreement with Optoelectronics Components C o., Ltd. (“APAT OE”) relating to the asset sale closed in January 2017, in addition to the compensating balances relating to the Company’s notes payable issued under its line of

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

credit facilities in China (see Note 8). The following table summarizes the Company’s unrealized gains and losses related to its cash equivalents and short-term investments in marketable securities designated as available-for-sale (in thousands):


	As of March 31, 2017								As of December 31, 2016
		Amortized Cost	Gross Unrealized Gains		Gross Unrealized Loss		Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Loss		Fair Value
Marketable securities:
Money market accounts	$	23,809	$	—	$	—	$	23,809	$	23,809	$	—	$	—	$	23,809
Money market funds		2,306		—		—		2,306		199		—		—		199
Corporate debt securities		—		—		—		—		9,438		4		(3)		9,439
Government agency securities		2,253		—		(10)		2,243		3,767		—		(10)		3,757
U.S. government securities		1,504		—		(6)		1,498		5,008		—		(10)		4,998
Sovereign government bonds		—		—		—		—		622		—		—		622
Total	$	29,872	$	—	$	(16)	$	29,856	$	42,843	$	4	$	(23)	$	42,824
Reported as:
Cash equivalents	$	23,809	$	—	$	—	$	23,809	$	23,809	$	—	$	—	$	23,809
Short-term investments		6,063		—		(16)		6,047		19,034		4		(23)		19,015
Total	$	29,872	$	—	$	(16)	$	29,856	$	42,843	$	4	$	(23)	$	42,824

Maturities of marketable securities were as follows (in thousands):


	March 31,		December 31,
	2017		2016
Less than 1 year	$	26,115	$	36,054
Due in 1 to 2 years		3,741		6,468
Due in 3 to 5 years		—		302
Total	$	29,856	$	42,824

Realized gains and losses on the sale of marketable securities during the three months ended March 31, 2017 and 2016 were immaterial. The Company did not recognize any impairment losses on its marketable securities during the three months ended March 31, 2017 or 2016. As of March 31, 2017 and December 31, 2016 , the Company did not have any investments in marketable securities that were in an unrealized loss position for a period in excess of 12 months.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Note 4. Fair value disclosures

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents the Company's assets that are measured at fair value on a recurring basis (in thousands):


	As of March 31, 2017								As of December 31, 2016
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Cash equivalents and short-term investments:
Money market funds	$	2,306	$	—	$	—	$	2,306	$	199	$	—	$	—	$	199
U.S. government securities		1,498		—		—		1,498		4,998		—		—		4,998
Money market accounts		—		23,809		—		23,809		—		23,809		—		23,809
Corporate debt securities		—		—		—		—		—		9,439		—		9,439
Government agency securities		—		2,243		—		2,243		—		3,757		—		3,757
Sovereign government bonds		—		—		—		—		—		622		—		622
Total	$	3,804	$	26,052	$	—	$	29,856	$	5,197	$	37,627	$	—	$	42,824

Foreign currency forward contracts	$	—	$	*	$	—	$	*	$	—	$	*	$	—	$	*
Mutual funds held in Rabbi Trust, recorded in other long-term assets	$	814	$	—	$	—	$	814	$	622	$	—	$	—	$	622

*The fair value of the Company’s foreign currency forward contract was immaterial as of March 31, 2017 and December 31, 2016.

The Company offers a Non-Qualified Deferred Compensation Plan (“NQDC Plan”) to a select group of its highly compensated employees. The NQDC Plan provides participants the opportunity to defer payment of certain compensation as defined in the NQDC Plan. A Rabbi Trust has been established to fund the NQDC Plan obligation, which was fully funded at March 31, 2017. The assets held by the Rabbi Trust are substantially in the form of exchange traded mutual funds and are included in the Company’s other long-term assets on its condensed consolidated balance sheets as of March 31, 2017 and December 31, 2016.

Effective July 1, 2016, the Company maintains a hedging program using forward exchange contracts as economic hedges, to protect against volatility of foreign exchange rate exposure when it is deemed economical to do so, based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The forward contracts are not designated for hedge accounting.

Under the hedging program, the Company enters into monthly forward exchange contracts, that have average maturities of one month, to offset the effects of exchange rate exposures for its net intercompany activities denominated in Chinese Renminbi, or RMB, by buying and selling the underlying foreign currency in the future at fixed exchange rates, to offset the consequences of changes in foreign exchange on the balance sheet. Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the re-measurement of the hedged assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. The net effect of fair value changes is reported in other income (expense), net. As of March 31, 2017, the fair value of the Company’s foreign currency forward contract was immaterial due to the short-term nature of the contract, which generally expires at each month-end. The total notional value of our foreign currency exchange contract as of March 31, 2017 was $26.4 million for RMB.

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

The following table presents the Company's liabilities that are measured at fair value on a recurring basis (in thousands):


	As of March 31, 2017								As of December 31, 2016
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Rusnano payment derivative	$	—	$	—	$	389	$	389	$	—	$	—	$	389	$	389
Foreign currency forward contracts		—		4		—		4		—		41		—		41
	$	—	$	4	$	389	$	393	$	—	$	41	$	389	$	430

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets or liabilities are measured at fair value on a nonrecurring basis. These assets consist primarily of non-financial assets such as goodwill and intangible assets accounted for under the cost method. In the three months ended March 31, 2017, the Company recorded a $6.7 million contingent liability within accrued and other current liabilities on its balance sheet in connection with the contingent indemnification commitments pursuant to an asset sale closed in January 2017. See Note 5. These assets and liabilities were measured at fair value based on events or circumstances the Company identified as having significant impact on their fair value during the period. To arrive at the valuation of these assets, the Company considered the discounted cash flows to determine fair value using best estimates and unobservable inputs (Level 3).

Assets and Liabilities Not Measured at Fair Value

The carrying values of accounts receivable, accounts payable, notes payable and short-term borrowings approximate their fair values due to the short-term nature and liquidity of these financial instruments.

The fair values of the Company’s long-term debt have been calculated using an estimate of the interest rate the Company would have had to pay on the issuance of liabilities with a similar maturity and discounting the cash flows at that rate which it considers to be a level 2 fair value measurement. The fair values, which approximate the carrying value of the long-term debt, do not necessarily give an indication of the amount that the Company would currently have to pay to extinguish any of this debt.

Note 5. Asset sale

In January 2017, the Company completed the sale of its Low Speed Transceiver Products’ assets to APAT OE pursuant to an asset purchase agreement dated December 14, 2016 for consideration of approximately $25.0 million (in RMB equivalent) plus approximately $1.4 million (in RMB equivalent) post-closing transaction service fees to be received under a transition services agreement with APAT OE in which the Company will provide short-term manufacturing and other specific services pursuant to such agreement. The related supply chain purchase commitments and value-added tax obligations have been assumed by APAT OE. The receivable and payable balances related to the transaction service arrangement are recorded within prepaid expenses and other current assets or accrued and other current liabilities on the Company’s consolidated financial statements.

As of December 31, 2016, assets held for sale was $13.9 million, consisted of $13.1 million in inventories and $0.8 million in property, plant and equipment. As a result of post-closing adjustments, total consideration was reduced by approximately $3.4 million for inventory. In addition, an immaterial amount of property, plant and equipment was reclassified from assets held for sale. Upon closing, assets sold to APAT OE were approximately $12.8 million, including approximately $12.1 million in inventories and $0.7 million in property, plant and equipment. The adjusted consideration received of approximately $21.6 million is subject to further reduction of up to $10.0 million for any indemnification claims. The Company recorded a reserve of $6.7 m illion within accrued and other current liabilities as of

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(Unaudited)

March 31, 2017 for potential claims and an estimated $0.2 million in additional property, plant and equipment purchases. The Company recognized a $2.0 million gain on the sale of these assets within operating income in the three months ended March 31, 2017.

All of the Low Speed Transceiver Products were part of the Company’s Network Products and Solution product group and included the low speed optical network (PON) products for which the end-of-life plan was announced in mid-2016.

Note 6. Balance sheet components

Accounts receivable, net

Accounts receivable, net consists of the following (in thousands):



	March 31, 2017		December 31, 2016
Accounts receivable	$	67,734	$	78,143
Trade notes receivable		3,273		2,892
Allowance for doubtful accounts		(130)		(425)
	$	70,877	$	80,610

Inventories, net

Inventories, net consist of the following (in thousands):



	March 31, 2017		December 31, 2016
Raw materials	$	31,759	$	23,348
Work in process		12,495		10,996
Finished goods (1)		24,905		13,893
	$	69,159	$	48,237

⁽¹⁾

Finished goods inventory at customer vendor managed inventory locations was $8.0 million and $8.3 million as of March 31, 2017 and December 31, 2016, respectively.

Prepaid expenses and other current assets

Prepaid expenses and other current assets consist of the following (in thousands):



	March 31, 2017		December 31, 2016
Prepaid taxes and taxes receivable	$	8,641	$	16,102
Deposits and other prepaid expenses		3,665		3,571
Transition service agreement related (Note 5)		11,785		—
Other receivable		2,706		2,723
	$	26,797	$	22,396

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Purchased intangible assets

Purchased intangible assets consist of the following (in thousands):


	March 31, 2017						December 31, 2016
	Gross		Accumulated		Net		Gross		Accumulated		Net
	Assets		Amortization		Assets		Assets		Amortization		Assets
Technology and patents	$	37,007	$	(33,660)	$	3,347	$	36,918	$	(33,316)	$	3,602
Customer relationships		15,121		(14,175)		946		15,039		(13,990)		1,049
Leasehold interest		1,235		(324)		911		1,226		(315)		911
	$	53,363	$	(48,159)	$	5,204	$	53,183	$	(47,621)	$	5,562

Amortization expense relating to technology and patents and the leasehold interest intangible assets is included within cost of goods sold and customer relationships within operating expenses. The following table presents details of the amortization expense of the Company’s purchased intangible assets as reported in the condensed consolidated statements of operations (in thousands):


	Three Months Ended
	March 31,
	2017		2016
Cost of goods sold	$	262	$	841
Operating expenses		118		453
Total	$	380	$	1,294

The estimated future amortization expense of purchased intangible assets as of March 31, 2017, is as follows (in thousands):


2017	$	960
2018		1,209
2019		806
2020		688
2021		688
Thereafter		853
	$	5,204

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Accrued and other current liabilities

Accrued and other current liabilities consist of the following (in thousands):



	March 31, 2017		December 31, 2016
Employee-related	$	13,564	$	18,654
Income and other taxes payable		1,304		3,956
Deferred revenue, current		1,065		956
Accrued warranty		582		678
Rusnano payment derivative		389		389
Asset sale related contingent liabilities (Note 5)		6,700		—
Transition service agreement related payables (Note 5)		7,742		—
Other accrued expenses		6,293		5,992
	$	37,639	$	30,625

Warranty Accrual

The table below summarizes the movement in the warranty accrual, which is included in accrued and other current liabilities (in thousands):


	Three Months Ended
	March 31,
	2017		2016
Beginning balance	$	678	$	1,175
Warranty accruals		(62)		102
Settlements		(34)		(134)
Ending balance	$	582	$	1,143

Other noncurrent liabilities

Other noncurrent liabilities consist of the following (in thousands):



	March 31, 2017		December 31, 2016
Pension and other employee-related	$	5,444	$	5,045
Deferred rent		1,952		1,509
Deferred revenue		2,055		1,184
Deferred income tax liabilities		52		46
Asset retirement obligations and other		3,333		1,155
	$	12,836	$	8,939

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Note 7. Restructuring

In January 2017, the Company initiated certain restructuring actions in connection with the sale of its Low Speed Transceiver Products’ assets. The actions consisted of workforce reductions in China. The related restructuring liability included in accrued and other current liabilities will be paid in May 2017. The Company recorded $0.3 million in r estructuring ch arges within cost of goods sold and operating expenses in the three months ended March 31, 2017. There were no restructuring charges in the three months ended March 31, 2016 or restructuring liabilities as of December 31, 2016.

Note 8. Debt

The table below summarizes the carrying amount and weighted average interest rate of the Company’s debt (in thousands, except percentages):


	March 31, 2017				December 31, 2016
	Carrying		Interest		Carrying		Interest
	Amount		Rate		Amount		Rate
Notes payable	$	5,684	—		$	6,390	—
Short-term borrowing-Comerica Bank		23,800	3.53	%		23,800	3.37	%
Total notes payable and short-term borrowing	$	29,484			$	30,190
Long-term debt, current and non-current:
Mitsubishi Bank loans	$	11,567	1.43	%	$	11,253	1.43	%
Unaccreted discount and issuance costs within current portion of long-term debt		(106)				(108)
Unaccreted discount and issuance costs within long-term debt, net of current portion		(170)				(183)
Total long-term debt, net of unaccreted discount and issuance costs	$	11,291			$	10,962

Reported as:
Current portion of long-term debt	$	5,263			$	747
Long-term debt, net of current portion		6,028				10,215
Total long-term debt, net of unaccreted discount and issuance costs	$	11,291			$	10,962

Notes payable

The Company regularly issues notes payable to its suppliers in China. These notes are supported by non-interest bearing bank acceptance drafts issued under the Company’s existing line of credit facilities and are due three to six months after issuance. As a condition of the notes payable arrangements, the Company is required to keep a compensating balance at the issuing banks that is a percentage of the total notes payable balance until the amounts are settled. As of March 31, 2017, the Company’s subsidiary in China had three short-term line of credit facilities with banking institutions:

Under the first line of credit facility, the Company can borrow up to RMB 120.0 million ($17.4 million) for short-term loans at varying interest rates, or up to approximately RMB 171.4 million ($24.9 million) for bank acceptance drafts (with a 30% compensating balance requirement). This line of credit facility expires in July 2019.

Under the second line of credit facility, which expires in September 2017, the Company can borrow up to RMB 266.0 million (approximately $38.6 million) for short-term loans at varying interest rates or up to

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

approximately RMB 380.0 million (approximately $55.1 million) for bank acceptance drafts (with a 30% compensating balance requirement) .

Under the third line of credit facility, which expires in July 2019, the Company can borrow up to RMB 30.0 million ($4.4 million) for short-term loans at varying interest rates, or up to approximately RMB 42.9 million ($6.2 million) for bank acceptance drafts (with a 30% compensating balance requirement).

Under these line of credit facilities, the non-interest bearing bank acceptance drafts issued in connection with the Company’s notes payable to its suppliers in China, had an outstanding balance of $5.7 million and $6.4 million as of March 31, 2017 and December 31, 2016, respectively. In addition to the outstanding notes payable, three letters of credit totaling $1.6 million to its suppliers were issued in 2016 for equipment purchases delivered by December 2016. These letters of credit require a 30% compensating balance requirement. As of December 31, 2016, the outstanding balance of these letters of credit was immaterial and was fully repaid as of March 31, 2017.

As of March 31, 2017 and December 31, 2016, compensating balances relating to these bank acceptance drafts and letters of credit issued to suppliers and the Company’s subsidiaries totaled $1.7 million and $2.1 million, respectively. Compensating balances are classified as restricted cash on the Company’s condensed consolidated balance sheets.

Short-Term Borrowing

The Company has a credit agreement, as amended, with Comerica Bank as lead bank in the U.S. (the “Comerica Bank Credit Facility”) with a borrowing capacity of up to $30.0 million. In September 2016, the Company amended the Comerica Bank Credit Facility to increase the limitation on the Company’s capital expenditures to $62.0 million and to provide for an extension of the maturity date to January 31, 2017. In January 2017, the Company amended the Comerica Bank Credit Facility to extend the maturity to April 30, 2017 and removed the covenant related to EBDITA. As of March 31, 2017 and December 31, 2016, the Company was in compliance with the covenants of the credit facility except for exceeding the capital expenditure limit as of December 31, 2016 for which a waiver was obtained subsequent to year end.

Borrowings under the Comerica Bank Credit Facility bear interest at an interest rate option of a base rate as defined in the agreement plus 1.75% or LIBOR plus 2.75%. Base rate is based on the greater of (a) the effective prime rate, (b) the Federal Funds effective rate plus one percent, and (c) the daily adjusting LIBOR rate plus one percent. As of March 31, 2017 and December 31, 2016, the rate on the LIBOR option was 3.53% and 3.37%, respectively, and the outstanding balance was $23.8 million.

Long-Term Debt

On February 25, 2015, the Company entered into certain loan agreements and related agreements with the Bank of Tokyo-Mitsubishi UFJ, Ltd. (the “Mitsubishi Bank”) that provided for (i) a term loan in the aggregate principal amount of 500 million JPY ($4.2 million) (the “Term Loan A”) and (ii) a term loan in the aggregate principal amount of one billion JPY ($8.4 million) (the “Term Loan B” and together with the Term Loan A, the “Mitsubishi Bank Loans”). The Mitsubishi Bank Loans are secured by a mortgage on certain real property and buildings owned by our Japanese subsidiary. Interest on the Mitsubishi Bank Loans accrues and is paid monthly based upon the annual rate of the monthly Tokyo Interbank Offer Rate (TIBOR) plus 1.40%. The Term Loan A requires interest only payments until the maturity date of February 23, 2018, with a lump sum payment of the aggregate principal amount on the maturity date. The Term Loan B requires equal monthly payments of principal equal to 8,333,000 JPY until the maturity date of February 25, 2025, with a lump sum payment of the balance of 8,373,000 JPY on the maturity date. Interest on the Term Loan B is accrued based upon monthly TIBOR plus 1.40% and is secured by real estate collateral. In conjunction with the

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

execution of the Bank Loans, the Company paid a loan structuring fee, including consumption tax, of 40,500,000 JPY ($0.3 million) .

The Mitsubishi Bank Loans contain customary representations and warranties and customary affirmative and negative covenants applicable to the Company’s Japanese subsidiary, including, among other things, restrictions on cessation in business, management, mergers or acquisitions. The Mitsubishi Bank Loans contain financial covenants relating to minimum net assets, maximum ordinary loss and a dividends covenant. Outstanding principal balance under the Mitsubishi Bank Loans and unamortized debt issuance costs were approximately 1.3 billion JPY (approximately $11.6 million) and 30.9 million JPY (approximately $0.3 million), respectively, as of March 31, 2017. The Company was in compliance with the related covenants.

In March 2017, the Company entered into a loan agreement and related agreements with the Mitsubishi Bank for a term loan of 690 million JPY (approximately $6.2 million) (the “2017 Mitsubishi Bank Loan”) to acquire manufacturing equipment for its Japanese subsidiary. This loan is secured by the manufacturing equipment acquired from the loan proceeds. Interest on the 2017 Mitsubishi Bank Loan is based on the annual rate of the monthly TIBOR rate plus 1.00%. The 2017 Mitsubishi Bank Loan matures on March 29, 2024 and requires monthly interest and principal payments over 72 months commencing in April 2018. The loan contains customary covenants relating to minimum net assets, maximum ordinary loss and a dividends covenant. The loan is available from March 31, 2017 to March 30, 2018 and 1.0 million JPY (approximately $9,000) under this loan was drawn on the closing date of March 31, 2017.

At March 31, 2017, maturities of total long-term debt were as follows (in thousands):


2017 (remaining nine months)	$	671
2018		5,370
2019		896
2020		896
2021		896
Thereafter		2,838
	$	11,567

Note 9. Japan pension plan

The pension liability related to the Company’s Retirement Allowance Plan (“RAP”) in Japan at March 31, 2017 and December 31, 2016 was $5.0 million and $4.8 million, respectively, of which $0.4 million and $0.4 million, respectively, was recorded in accrued and other current liabilities and the remainder in other noncurrent liabilities on the Company’s condensed consolidated balance sheet.

Net periodic pension cost associated with this plan was immaterial in the three months ended March 31, 2017 and 2016.

Note 10. Commitments and contingencies

Litigation

From time to time, the Company is subject to various claims and legal proceedings, either asserted or unasserted, that arise in the ordinary course of business. The Company accrues for legal contingencies if the Company can estimate the potential liability and if the Company believes it is probable that the case will be ruled against it. If a legal claim for which the Company did not accrue is resolved against it, the Company would record the expense in the period in which

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Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

the ruling was made. The Company believes that the likelihood of an ultimate amount of liability, if any, for any pending claims of any type (alone or combined) that will materially affect the Company’s financial position, results of operations or cash flows is remote. The ultimate outcome of any litigation is uncertain, however, and unfavorable outcomes could have a material negative impact on the Company’s financial condition and operating results. Regardless of outcome, litigation can have an adverse impact on the Company because of defense costs, negative publicity, diversion of management resources and other factors.

On January 5, 2010, Finisar Corporation, or Finisar, filed a complaint in the U.S. District Court for the Northern District of California, or the Court, against Source Photonics, Inc., MRV Communications, Inc., Oplink Communications, Inc. and the Company, or collectively, the co-defendants. In the complaint Finisar alleged infringement of certain of its U.S. patents. In 2010 the Company filed an answer to the complaint and counterclaims, asserting two claims of patent infringement and additional claims. The Court dismissed without prejudice all co-defendants (including the Company) except Source Photonics, Inc., on grounds that such claims should have been asserted in four separate lawsuits, one against each defendant. This dismissal does not prevent Finisar from bringing a new similar lawsuit against the Company. In 2011 the Company and Finisar agreed to suspend their respective claims and in 2012 the Company and Finisar further agreed to toll their respective claims. While there has been no action on this matter since 2012, the Company is currently unable to predict the outcome of this dispute and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

On January 2, 2013, the Company was served with a lawsuit, filed in Belgium by a distributor called Laser 2000 Beneluo SA (“Laser 2000”) claiming unpaid commissions. The distributor agreement was formally terminated as of January 3, 2012. The Company paid $492,000 to Laser 2000 as partial settlement of claims and to avoid penalties from the Belgian Court and submitted a legal brief to court on September 16, 2013. Laser 2000 filed a response on December 16, 2013 and the Company filed the final rebuttal brief on January 30, 2014. On March 23, 2015, the Belgian Court issued a ruling awarding Laser 2000 approximately one million euros in damages (approximately $1,100,000 at then-current exchange rates). The Company did not believe it would ultimately be liable for the full amount of damage and accrued $0.3 million in March 2015 for estimated probable net litigation expense relating to this matter. The Company appealed this verdict and, in April 2017, settled this case and paid approximately $250,000.

On December 27, 2016 the Company was served with a lawsuit filed by Lestina International Ltd. (“Lestina”), in Santa Clara County, CA. The lawsuit is regarding a dispute of approximately $3 million related to purchase orders for the Company’s Low Speed Transceiver Products that was soon thereafter sold by the Company to APAT OE in January 2017. The purchase orders in question were included in the asset sale and were assumed liabilities by the purchaser of the business. A motion to dismiss was filed by the Company in February 2017, with a court date on April 25, 2017. The arguments were heard in court and the judge took the matter under advisement. There has been no ruling to date. The Company is unable to predict with certainty the outcome of this matter, but is seeking to resolve the matter by the end of the second quarter of 2017 either through a court dismissal of the action or a resolution with the plaintiff and/or the purchaser of the Low Speed Transceiver Products’ assets. Because the purchase orders in question were an assumed liability of the Low Speed Transceiver Products’ assets that was transferred to the purchaser, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations or cash flows.

Indemnifications

In the normal course of business, the Company enters into agreements that contain a variety of representations and warranties and provide for general indemnification. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations. As of March 31, 2017, the Company did not have any material indemnification claims that were probable or reasonably possible.

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(Unaudited)

Leases

The Company leases various facilities under non-cancelable operating leases expiring through 2027. As of March 31, 2017, future minimum payments under these operating leases totaled approximately $26.9 million and future minimum sublease receipts was approximately $1.0 million. Rent expense was $1.0 million in the three months ended March 31, 2017 and $0.6 million in the three months ended March 31, 2016.

In September 2016, the Company entered into an office lease for approximately 64,000 square feet of office and laboratory space located adjacent to the Company’s current headquarters in San Jose (the “Lease”). The term of the Lease commenced on January 1, 2017. Upon commencement, the Lease has an initial term of one hundred and twenty-nine (129) months, ending on September 30, 2027 (the “Initial Term”), with a monthly rental rate of $144,000, escalating annually to a maximum monthly rental rate of approximately $194,000 in the last year of the Initial Term. The Landlord has agreed to provide the office and laboratory space to the Company free of charge for the first nine months of the Initial Term through September 30, 2017. Upon termination of the Lease, the Company anticipates a restoration cost of approximately $3.1 million.

Penalty Payment Derivative

In connection with a private placement transaction with Joint Stock Company “Rusnano” (formerly Open Joint Stock Company “RUSNANO”), or Rusnano, or in 2012, the Company agreed to certain performance obligations including establishing a wholly-owned subsidiary in Russia and making a $30.0 million investment commitment (the “Investment Commitment’) towards the Company’s Russian operations, which could be partially satisfied by cash and/or non-cash investment inside or outside of Russia and/or by way of non-cash asset transfers.

The Rights Agreement as amended in 2015 (the “Amended Rights Agreement”) limits the maximum amount of penalties and/or exit fee (the “Rusnano Payment”) to be paid by the Company to $5.0 million in the aggregate and allows such payment to be reduced when certain milestones are met over time. The Amended Rights Agreement also provides for an updated investment plan for the Company’s Russian subsidiaries that includes non-cash transfer of licensing rights to intellectual property, non-cash transfers of existing equipment and commitments to complete the remaining investment milestones through 2019. The Company fulfilled its investment commitment required by 2016 and had contributed over $18.8 million in cash and assets to its subsidiaries in Russia as of December 31, 2016. Therefore, the Company would not be held liable for the Rusnano Payment as of each of December 31, 2016 and March 31, 2017.

In the event certain of the Investment Commitments are not achieved by 2019, the Company has the ability to cease the operations of its Russian subsidiaries by paying exit fees of $2.0 million at that time.

In August 2016, the Company entered into a letter of agreement with Rusnano to agree to transfer a 10G SFP+ transceiver product line and incur expected costs of approximately $0.1 million, by July 30, 2017, which will not be counted toward the Company’s overall Investment Commitment. Since the asset sale of the Company’s Low Speed Transceiver Products was completed in January 2017, the Company intends to undertake such expense by spending such amount in another manner to be discussed and agreed between the parties.

Rusnano has non-transferable veto rights over the Company’s Russian subsidiaries’ annual budget during the investment period and must approve non-cash asset transfers to be made in satisfaction of the Investment Commitment. The Company accounted for the Rusnano Payment as an embedded derivative instrument. The fair value of the Penalty Payment derivative has been estimated at the date of the original common stock sale (April 27, 2012) and at each subsequent balance sheet date using a probability-weighted discounted future cash flow approach using unobservable inputs, which are classified as Level 3 within the fair value hierarchy. The primary inputs for this approach include the probability of achieving the Investment Commitment and a discount rate that approximates the Company’s incremental borrowing rate. After the initial measurement, changes in the fair value of this derivative were recorded in other income (expense), net. The estimated fair value of this derivative was $0.4 million as of each of March 31, 2017 and December 31, 2016, and reported within accrued and other current liabilities on the Company’s condensed consolidated balance sheets (see Note 4).

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(Unaudited)

Note 11. Stockholders’ equity

Common Stock

As of March 31, 2017, the Company had reserved 8,509,302 common stock shares for issuance under its stock option plans and 627,848 common stock shares for issuance under its employee stock purchase plan.

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss, net of related taxes, were as follows (in thousands):


	Foreign Currency Translation Adjustments		Unrealized Gain (Loss) on Available-For-Sale Securities		Defined Benefit Pension Plan Adjustment		Total Accumulated Other Comprehensive Loss
Balance at December 31, 2016	$	(8,235)	$	(19)	$	(147)	$	(8,401)
Other comprehensive income, net of taxes of zero and reclassifications		2,468		3		—		2,471
Balance at March 31, 2017	$	(5,767)	$	(16)	$	(147)	$	(5,930)

No material amounts were reclassified out of accumulated other comprehensive income during the three months ended March 31, 2017 and 2016 for realized gains or losses on available-for-sale securities.

Accumulated Deficit

Approximately $8.7 million of the Company’s retained earnings within its total accumulated deficit at March 31, 2017 and December 31, 2016 was subject to restriction due to the fact that the Company’s subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year end to fund statutory common reserves as well as allocate a discretional portion of their after-tax profits to their staff welfare and bonus fund.

Note 12. Stock-based compensation

The following table summarizes the stock-based compensation expense recognized in the three months ended March 31, 2017 and 2016 (in thousands):


	Three Months Ended
	March 31,
	2017		2016
Cost of goods sold	$	147	$	589
Research and development		662		971
Sales and marketing		464		887
General and administrative		599		992
	$	1,872	$	3,439

The vesting of stock options covering approximately 1.1 million shares of the Company’s common stock and stock appreciation units (“SAUs”) of approximately 0.2 million shares with a market-based vesting condition were accelerated

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in September 2016 as the market-based condition of these stock options and SAUs was satisfied when the average closing price of the Company’s common stock over a period of 20 consecutive trading days equal to or exceeded $15.00 per share and the recipients remained in the continuous service with the Company. Outstanding SAUs are re-measured each reporting period at fair value until settlement.

Determining Fair Value

The Company estimated the fair value of certain stock-based awards using a Black-Scholes-Merton valuation model or a binomial lattice model with the following assumptions:


	Three Months Ended
	March 31,
Stock options	2017	2016
Weighted-average expected term (years)	—	4.96
Weighted-average volatility	— %	64%
Risk-free interest rate	— %	1.76%
Expected dividends	— %	— %
Stock appreciation units
Weighted-average expected term (years)	2.45	3.03
Weighted-average volatility	71%	61%
Risk-free interest rate	0.51%-1.47%	0.65 %- 1.47%
Expected dividends	— %	— %
ESPP
Weighted-average expected term (years)	0.70	0.70
Weighted-average volatility	54%	70%
Risk-free interest rate	0.45%-0.59%	0.08%-0.33%
Expected dividends	— %	— %

Stock Options and Restricted Stock Units (RSUs)

The following table summarizes the Company’s stock option and RSU activity during the three months ended March 31, 2017 :


	Stock Options			Restricted Stock Units
		Weighted			Weighted
		Average			Average
	Number of	Exercise		Number of	Grant Date
	Shares	Price		Units	Fair Value
Balance at December 31, 2016	4,301,340	$	5.18	2,089,473	$	10.15
Granted	—		—	101,082		9.96
Exercised/Converted	(133,287)		3.68	(8,332)		8.50
Cancelled/Forfeited	(6,666)		11.61	(13,675)		10.93
Balance at March 31, 2017	4,161,387	$	5.22	2,168,548	$	10.14

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Stock appreciation units

SAUs are liability classified share-based awards. The Company did not grant any SAUs during the three months ended March 31, 2017 or 2016. As of March 31, 2017 and December 31, 2016, there were 278,007 and 286,768 SAUs outstanding, respectively, and related SAU liabilities were $1.6 million and $2.0 million, respectively.

Employee Stock Purchase Plan (“ESPP”)

As of March 31, 2017, there was $0.5 million of unrecognized stock-based compensation expense for employee stock purchase rights that will be recognized over the remaining offering period through November 2017.

Note 13. Income taxes

The income tax (provision) benefit for income taxes in the periods presented is based upon the income (loss) before income taxes:


	Three Months Ended
	March 31,
(in thousands)	2017		2016
Income tax (provision) benefit	$	167	$	(1,041)

The Company’s income tax (provision) benefit in the three months ended March 31, 2017 and 2016 was primarily related to income taxes of the Company’s non-U.S. operations.

The Company conducts its business globally and its operating income is subject to varying rates of tax in the U.S., China and Japan. Consequently, the Company’s effective tax rate is dependent upon the geographic distribution of its earnings or losses and the tax laws and regulations in each geographical region. Historically, the Company has experienced net losses in the U.S. and in the short term, expects this trend to continue. One of the Company’s subsidiaries in China historically qualified for a preferential 15% tax rate available for high technology enterprises as opposed to the statutory 25% tax rate. In June 2016, the State Administration of Taxation issued a notice to adjust the requirements for high technology enterprise status. As a result, the Company’s China subsidiary did not meet the requirements for the tax year 2016. Therefore, the Company computed its China subsidiary’s tax provision (benefit) for 2016 and the three months ended March 31, 2017 based on the 25% regular corporate income tax rate.

Due to historic losses in the U.S., the Company has a full valuation allowance on its U.S. federal and state deferred tax assets. Management continues to evaluate the realizability of deferred tax assets and the related valuation allowance. If management's assessment of the deferred tax assets or the corresponding valuation allowance were to change, the Company would record the related adjustment to income during the period in which management makes the determination.

As of March 31, 2017, there were no material changes to either the nature or the amounts of the uncertain tax positions previously determined for the year ended December 31, 2016.

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NeoPhotonics Corporation

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

Note 14. Subsequent events

Subsequent events included the following:

Comerica Credit Facility

In April 2017, the Company repaid the outstanding balance under its Comerica Bank Credit Facility, which was $23.8 million as of March 31, 2017.

The Company also amended its Comerica Bank Credit Facility in April 2017 to extend the maturity date from April 30, 2017 to July 31, 2017 and amend certain covenants.

Restructuring

In May 2017, the Company initiated further restructuring actions to implement a series of cost saving measures in light of both the sale of its Low Speed Transceiver Products and the current lower market outlook from China. These measures are expected to include reorganizing the Company’s product lines, reducing real estate footprint and reducing workforce. The Company expects to incur pre-tax restructuring charges of approximately $0.7 million to $1.0 million in the second quarter of 2017.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q for the period ended March 31, 2017 and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2016 included in our Annual Report on Form 10-K. References to “NeoPhotonics,” “we,” “our,” and “us” are to NeoPhotonics Corporation unless otherwise specified or the context otherwise requires.

This Quarterly Report on Form 10-Q for the period ended March 31, 2017 contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q for the period ended March 31, 2017 that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Terminology such as “believe,” “may,” “might,” “objective,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “predict,” “potential,” or the negative of these terms or other similar expressions is intended to identify forward-looking statements.

We have based these forward-looking statements largely on our current expectations and projections about future events and industry and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in “Part II —Item 1A. Risk Factors” below, and those discussed in the sections titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 16, 2017. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Business overview

We develop, manufacture and sell optoelectronic products that transmit, receive and switch high speed digital optical signals for communications networks. We sell our products to the world’s leading network equipment manufacturers, including Nokia (formerly Alcatel-Lucent, which was acquired by Nokia in January 2016), Ciena Corporation, Cisco Systems, Inc., HiSilicon Technologies, Ltd., an affiliate of Huawei Technologies, Co., Ltd. and Huawei Technologies Co., Ltd. (collectively “Huawei”). These companies are among our largest customers and a focus of our strategy due to their leading market positions.

We have research and development and wafer fabrication facilities in San Jose and Fremont, California and in Tokyo, Japan that coordinate with our research and development and manufacturing facilities in Dongguan, Shenzhen and Wuhan, China and Ottawa, Canada. We also perform limited research and development and manufacturing in Moscow, Russia. We use proprietary design tools and design-for-manufacturing techniques to align our design process with our precision nanoscale, vertically integrated manufacturing and testing. We believe we are one of the highest volume PIC manufacturers in the world and that we can further expand our manufacturing capacity to meet market needs.

Recognizing our focus on growth in our 100Gbps (“100G”) and beyond products, we align our product group reporting to “High Speed Products” which includes products designed for 100G and beyond applications and “Network Products and Solutions,” which comprises all products designed for applications below 100G.

In December 2016, we entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with APAT Optoelectronics Components Co., Ltd. (the “Purchaser”) for the sale of certain assets of our access and low speed

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transceiver product lines (the “Low Speed Transceiver Products”) which was completed in January 2017. All of these products were part of our Network Products and Solutions group and included the low speed passive optical network, or PON, products for which the end-of-life plan was announced in mid-2016. In 2016, the Low Speed Transceiver Products generated approximately 15% of our total revenue.

The asset sale consisted of approximately $25.0 million in cash consideration plus approximately $1.4 million post-closing transition services under a transition services agreement with the Purchaser. After closing, the consideration was reduced by $3.4 million for inventory adjustments to approximately $21.6 million and is subject to other adjustments of up to $10.0 million for any potential indemnification claims for which we recorded a reserve of $6.7 million as of March 31, 2017. We recognized a $2.0 million gain on asset sale in the three months ended March 31, 2017.

In May 2017, we initiated restructuring actions to implement a series of cost saving measures in light of both the sale of our Low Speed Transceiver Products and the current lower market outlook for China. These measures include reorganizing our product lines, reducing our real estate footprint and reducing our workforce. We expect to incur pre-tax restructuring charges of approximately $0.7 million to $1.0 million in the second quarter of 2017. These restructuring actions are expected to provide annualized cost savings, particularly in operating expenses, of approximately $6 million to $9 million to be realized fully on a quarterly basis in the second half of 2017. We are seeking to continue, with limited critical hiring, to maintain our key research and development efforts and production capabilities to meet future growth.

In the three months ended March 31, 2017, High Speed Products represented approximately 82% of total revenue and Network Products and Solutions represented approximately 18% of total revenue. In the three months ended March 31, 2016, High Speed Products was 65% of total revenue and Network Products and Solutions represented approximately 35% of total revenue.

Revenue was $71.7 million in the three months ended March 31, 2017, compared to $99.1 million in the same period in 2016 primarily due to the sale of our Low Speed Transceiver Products’ assets in January 2017 and by delays in demand in the China market. Our gross profit was 25.8% of revenue in the three months ended March 31, 2017, compared to 31.4% of revenue in the three months ended March 31, 2016, primarily attributable to unfavorable direct material procurement costs, mix shift due to customer inventory level in China and under-utilization attributable to lower volumes in our plants.

We have announced a number of new products. Targeting growth in Metro, provincial China backbone, and data center interconnect networks are our 100G and 200G coherent pluggable module (CFP-DCO), our 64 Gbaud Micro-Modulator for 400G and 600G transponders, our announced partnership with Ciena for a 400G 5x7 transponder based on the Ciena Wavelogic Ai chipset, and we demonstrated a 64 Gbaud/64 QAM Coherent CFP2-ACO module for 400G to 600G applications. For applications inside the data center we introduced our 400G pluggable module (CFP8-LR8), new non-hermetic laser arrays to drive short reach silicon photonics modules (QSFP28) and our low power consumption, 28Gbaud externally modulated laser (EML) with integrated driver, designed for 10 km to 80 km reaches for 100G, 200G and 400G applications. We expect continued volume growth for our High Speed Products, although quarter-to-quarter results may show considerable variability as is usual in a rapid initial ramp-up following the introduction of new technologies and the slower demand in China. Similar to revenue, our gross margins may fluctuate materially depending on a variety of factors including average selling price changes, product mix, volume, manufacturing utilization and ongoing manufacturing process improvements.

Critical accounting policies and estimates

There have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2017 from those disclosed in Note 1 in Notes to Condensed Consolidated Financial Statements in Item 1, Part I of this Report and in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2016.

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Results of operations

Revenue

Our business is focused on the highest speed digital optics and signal processing communications applications. In 2016, we entered into an Asset Purchase Agreement for the sale of assets of our Low Speed Transceiver Products within our Network Products and Solutions product group. In 2016, the Low Speed Transceiver Products represented approximately 15% of total revenue. The asset sale was closed on January 2017.

We sell substantially all of our products to original equipment manufacturers, or OEMs. Revenue is recognized when the product is shipped and title has transferred to the buyer. We price our products based on market and competitive conditions and may periodically reduce the price of our products as market and competitive conditions change and as manufacturing costs are reduced. Historically, our first quarter revenue is generally seasonally lower than the rest of the year primarily due to lower capacity utilization during the holidays in China and customer pricing schedules. However, this historical pattern should not be considered a reliable indicator of our future revenue or financial performance. Our sales transactions to customers are denominated primarily in U.S. dollars, with some portions in Chinese Renminbi (“RMB”) or Japanese Yen (“JPY”).


	Three Months Ended
	March 31,
(in thousands)	2017		2016		$ Change		% Change
Total revenue	$	71,688	$	99,145	$	(27,457)	(28)	%

We have generated most of our revenue from a limited number of customers. Customers accounting for more than 10% of our total revenue and revenue from our top ten customers in the three months ended March 31, 2017 and 2016 were as follows:


	Three Months Ended
	March 31,
	2017		2016
Percent of revenue from customers accounting for 10% or more of total revenue:
Huawei Technologies Co., Ltd (1)	41	%	54	%
Ciena Corporation	14	%	16	%
Percent of revenue from top ten customers	90	%	92	%

⁽¹⁾

Huawei’s percentage of revenue included its affiliate, HiSilicon Technologies Co. Ltd. (“HiSilicon”). Revenue from HiSilicon represented approximately 38% and 35% of total revenue, respectively, in the three months ended March 31, 2017 and 2016.

We expect that a significant portion of our revenue will continue to be derived from a limited number of customers. As a result, the loss of, or a significant reduction in, orders from any of our key customers would materially affect our revenue and results of operations. Similarly, our accounts receivable are from a limited number of customers. As of March 31, 2017, one customer accounted for 48% of total accounts receivable and as of December 31, 2016, three customers accounted for 42%, 12% and 12% of our total accounts receivable.

Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016

Revenue decreased $27.5 million, or 28%, in the three months ended March 31, 2017, compared to the same period in 2016, primarily due to the lower revenue from Low Speed Transceiver Products as we completed the related asset sale in January 2017 and by delays in demand in the China market. Revenue generated by Low Speed Transceiver Products before the asset sale was $1.5 million in three months ended March 31, 2017, compared to $21.9 million in the same 2016 period. Further, in 2016, our historical seasonality pattern shifted from the first quarter to the second quarter due to certain price reductions being delayed beyond the first quarter in part due to surging volumes in the first quarter supporting 100G build-outs, notably in China. In the three months ended March 31, 2017, High Speed Products represented approximately 82% of total revenue, compared to 65% of total revenue in the same period in 2016 while

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Network Products and Solutions represented approximately 18% of total revenue in the three months ended March 31, 2017, compared to approximately 35% of total revenue in the same period a year ago. In the three months ended March 31, 2017, revenue from China, United States, Japan and rest of the world was 54%, 14%, 5% and 27% of total revenue, respectively, compared to 62%, 18%, 5% and 15% of total revenue, respectively, in the same period in 2016.

Cost of Goods Sold and Gross Profit

Our cost of goods sold consists primarily of the cost to produce wafers and to manufacture and test our products. Additionally, our cost of goods sold generally includes stock-based compensation, write-downs of excess and obsolete inventory, amortization of certain purchased intangible assets, depreciation, acquisition-related fair value adjustments, restructuring charges, warranty costs, royalty payments, logistics and allocated facilities costs.

Gross profit as a percentage of total revenue, or gross margin, has been and is expected to continue to be affected by a variety of factors including the introduction of new products, production volume, production volume compared to sales over time, the mix of products sold, inventory changes, changes in the average selling prices of our products, changes in the cost and volumes of materials purchased from our suppliers, changes in labor costs, changes in overhead costs or requirements, stock-based compensation, write-downs of excess and obsolete inventories and warranty costs. In addition, we periodically negotiate pricing with certain customers which can cause our gross margins to fluctuate, particularly in the quarters in which the negotiations occurred. Historically, our first quarter gross margins are generally seasonally lower than the fourth quarter of the prior year due to customer pricing schedules as well as lower capacity utilization during the holidays in China and the lower installment of outside plant equipment by customers in winter.


	Three Months Ended
	March 31,
(in thousands, except percentages)	2017		2016		$ Change		% Change
Cost of goods sold	$	53,185	$	68,023	$	(14,838)		(22)	%
Gross profit		18,503		31,122		(12,619)		(41)	%

Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016

Gross profit decreased $12.6 million, or 41%, to $18.5 million in the three months ended March 31, 2017, compared to $31.1 million in the same period in 2016. Gross margin decreased by approximately five percentage points to 26% in the three months ended March 31, 2017, compared to the same period in 2016. The decreases are primarily attributable to unfavorable direct material procurement costs, mix shift toward lower margin products and under-utilization attributable to lower volumes in our plants. Further, in 2016, our historical seasonality pattern shifted from the first quarter to the second quarter due to certain price reductions being delayed beyond the first quarter in part due to surging volumes in the first quarter of 2016 supporting 100G build-outs, notably in China.

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Operating expenses

Personnel costs are the most significant component of operating expenses and consist of costs such as salaries, benefits, bonuses, stock-based compensation and, with regard to sales and marketing expense, other variable compensation. In connection with our restructuring plan initiated in May 2017, we expect to yield annualized cost savings of approximately $6 million to $9 million to be realized fully on a quarterly basis in the second half of 2017. In 2016, the vesting of our stock options and stock appreciation units (“SAUs”) with a market-based vesting condition was accelerated as such condition was satisfied when the average closing price of our common stock over a period of 20 consecutive trading days exceeded $15.0 per share in September 2016. Stock-based compensation related to outstanding SAUs are subject to remeasurement until settlement dates. Our operating expenses are denominated primarily in U.S. dollars, or USD, Chinese Renminbi, or RMB and Japanese Yen, or JPY.


	Three Months Ended
	March 31,
(in thousands, except percentages)	2017		2016		$ Change		% Change
Research and development	$	15,544	$	12,952	$	2,592		20	%
Sales and marketing		4,932		3,931		1,001		25	%
General and administrative		11,426		9,084		2,342		26	%
Amortization of purchased intangible assets		118		453		(335)		(74)	%
Acquisition and asset sale related costs		130		—		130		100	%
Restructuring charges		227		—		227		100	%
Gain on asset sale		(2,000)		—		(2,000)		(100)	%
Total operating expenses	$	30,377	$	26,420	$	3,957		15	%

Research and development

Research and development expense consists of personnel costs, including stock-based compensation, for our research and development personnel, and product development costs, including engineering services, development software and hardware tools, depreciation of equipment and facility costs. We record all research and development expense as incurred.

Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016

Research and development expense increased by $2.6 million, or 20%, in the three months ended March 31, 2017 compared to the same period in 2016. The increase was primarily due to a $1.0 million increase in salaries and related expenses, a $0.8 million increase in development projects including prototype and materials, a $0.5 million increase in net allocated expenses including facilities and a $0.4 million increase in outside development services, partially offset by a $0.3 million decrease in stock-based compensation expense and a $0.3 million decrease in variable compensation in the three months ended March 31, 2017, compared to the same 2016 period.

Sales and marketing

Sales and marketing expense consists primarily of personnel costs, including stock-based compensation and other variable compensation, costs related to sales and marketing programs and services and facility costs.

Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016

Sales and marketing expense increased by $1.0 million, or 25%, in the three months ended March 31, 2017 compared to the same period in 2016 primarily due to a $0.7 million increase in salaries and related expenses, a $0.4 million reversal of bad debt expense in the 2016 period due to collection, a $0.2 million increase in product promotion initiatives and a $0.2 million increase in employee training, partially offset by a $0.4 million decrease in stock-based compensation expense and a $0.3 million decrease in commission.

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General and administrative

General and administrative expense consists primarily of personnel costs, including stock-based compensation, for our finance, human resources and information technology personnel and certain executive officers, as well as professional services costs related to accounting, tax, banking, legal and information technology services, depreciation and facility costs.

Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016

General and administrative expense increased by $2.3 million, or 26%, in the three months ended March 31, 2017 compared to the same period in 2016, mainly due to a $2.2 million increase in audit and legal fees primarily attributable to additional procedures and a $0.7 million increase in salaries and related expenses, partially offset by a $0.4 million decrease in variable compensation and a $0.4 million decrease in stock-based compensation expense.

Amortization of purchased intangible assets

Our intangible assets are being amortized over their estimated useful lives. Amortization expense relating to technology, patents and leasehold interests are included within cost of goods sold, while customer relationships and other agreements are recorded within operating expenses. Amortization of purchased intangibles included in operating expenses decreased in the three months ended March 31, 2017 compared to the same period in 2016 primarily due to certain intangible assets being fully amortized in 2016.

Acquisition and asset sale related transaction costs

We incurred $0.1 million in acquisition and asset sale related costs primarily related to legal, accounting and other professional services in the three months ended March 31, 2017. There were no acquisition and asset sale related transaction related costs in the three months ended March 31, 2016.

Restructuring charges

Restructuring charges in the three months ended March 31, 2017 were $0.3 million, of which $0.2 million was included in operating expenses and the remainder in cost of goods sold, pertaining to our restructuring actions initiated in the first quarter of 2017 in connection with the sale of our Low Speed Transceiver Products’ assets closed in January 2017 and consisting of workforce reductions in China. The related restructuring liabilities will be paid in May 2017. There were no restructuring charges in the three months ended March 31, 2016.

Gain on Asset Sale

In the three months ended March 31, 2017, we recognized a $2.0 million gain associated with the sale of our Low Speed Transceiver Products’ assets. See Note 5 in Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report.

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Interest and other income (expense), net

Interest income consists of income earned on our cash, cash equivalents and short-term investments, as well as restricted cash. Interest expense consists of amounts paid for interest on our bank and other borrowings. Other income (expense), net is primarily made up of government subsidies as well as foreign currency transaction gains and losses. The functional currency of our subsidiaries in China is the RMB and of our subsidiary in Japan is the JPY. The foreign currency transaction gains and losses of our subsidiaries in China and Japan primarily result from their transactions in U.S. dollars.


	Three Months Ended
	March 31,
(in thousands)	2017		2016		$ Change		% Change
Interest income	$	73	$	55	$	18		33	%
Interest expense		(137)		(102)		(35)		34	%
Other income (expense), net		249		(1,304)		1,553		(119)	%
Total	$	185	$	(1,351)	$	1,536		(114)	%

Total interest and other income (expense), net decreased by $1.5 million in the three months ended March 31, 2017, compared to the same period in 2016. The decrease was primarily due to a favorable change in other income (expense), net primarily attributable to a lower foreign currency exchange impact in the 2017 period.

Income taxes

We conduct our business globally and our operating income is subject to varying rates of tax in the U.S., China, Japan and other various foreign jurisdictions. Consequently, our effective tax rate is dependent upon the geographic distribution of our earnings or losses and the tax laws and regulations in each geographical region. Historically, we have experienced net losses in the U.S. and in the short term, we expect this trend to continue.


	Three Months Ended
	March 31,
(in thousands)	2017		2016		$ Change		% Change
Income tax (provision) benefit	$	167	$	(1,041)	$	1,208		(116)	%

Our income tax (provision) benefit in the three months ended March 31, 2017 and 2016 was primarily related to income taxes of our non-U.S. operations. In June 2016, the State Administration of Taxation issued a notice to adjust the requirements for high technology enterprise status. As a result, one of our China subsidiaries which had historically qualified for a preferential 15% tax rate available for high technology enterprises changed to the statutory 25% tax rate for the tax year 2016. Therefore, since September 2016, we have computed our China subsidiary’s tax (provision) benefit based on a 25% regular corporate income tax rate.

Liquidity and capital resources

At March 31, 2017, we had working capital of $103.2 million and total cash, cash equivalents, short-term investments and restricted cash of $91.5 million. Approximately 42% of our total cash, cash equivalents, short-term investments and restricted cash was held by our foreign entities, including approximately $27.0 million in accounts held by our subsidiaries in China, of which $3.7 million was in restricted cash, and approximately $10.9 million in accounts held by our subsidiary in Japan. Cash, cash equivalents, investments and restricted cash held outside of the U.S. may be subject to taxes if repatriated and may not be immediately available for our working capital needs.

Approximately $8.7 million of our retained earnings within our total accumulated deficit at December 31, 2016 was subject to restrictions due to the fact that our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year end to fund statutory common reserves as well as allocate a discretionary portion of their after-tax profits to their staff welfare and bonus fund. This restricted amount is not distributable as cash dividends except in the event of liquidation.

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In January 2017, we completed the sale of certain Low Speed Transceiver Products’ assets for an approximately $25.0 consideration plus an approximately $1.4 million post-closing transition services fees. The consideration was reduced by $3.4 million for inventory adjustment after closing to approximately $21.6 million, which is subject to other adjustments of up to $10.0 million for any potential claims. See Note 5 in Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report.

We have a bank credit agreement, as amended, with Comerica Bank in the U.S. (the “Comerica Bank Credit Facility”). Amounts borrowed under the Comerica Bank Credit Facility are due on or before July 31, 2017 and borrowings bear interest at an interest rate option of a base rate as defined in the agreement plus 1.75% or LIBOR plus 2.75%. See Note 8 of Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report. As of March 31, 2017, the outstanding balance was $23.8 million, which was repaid in full in April 2017.

We regularly issue short-term notes payable to our suppliers in China in exchange for accounts payable. These notes are supported by non-interest bearing bank acceptance drafts and are due three to six months after issuance. As a condition of the notes payable arrangements, we are required to keep a compensating balance at the issuing banks that is a percentage of the total notes payable balance until the amounts are settled. As of March 31, 2017, our subsidiary in China had three short-term line of credit facilities with banking institutions. As of March 31, 2017 and December 31, 2016, the non-interest bearing bank acceptance drafts issued in connection with our notes payable to our suppliers in China under these line of credit facilities had an outstanding balance of $5.7 million and $6.4 million, respectively. Compensating balances relating to these credit facilities totaled $1.7 million and $2.1 million, respectively, as of March 31, 2017 and December 31, 2016. Compensating balances are classified as restricted cash on our consolidated balance sheets. See Note 3 and Note 8 of Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report. We also held approximately $2.0 million in restricted cash as compensation for any breach of closing provisions under the asset purchase agreement for the asset sale closed in January 2017.

As of March 31, 2017, we had three loan arrangements with the Bank of Tokyo-Mitsubishi UFJ, Ltd. (collectively the “Mitsubishi Bank Term Loans”). One of Mitsubishi Bank Term Loans requires interest only payments until the maturity date of February 23, 2018, with a lump sum payment of the aggregate principal amount on the maturity date while the other requires equal monthly payments of principal equal to 8,333,000 JPY until the maturity date of February 25, 2025, with a lump sum payment of the balance of 8,373,000 JPY on the maturity date. Interest on these loans accrues and is paid monthly based upon the annual rate of the monthly Tokyo Interbank Offer Rate (TIBOR) plus 1.40% and is secured by real estate collateral. The third term loan of 690 million JPY (approximately $6.2 million) (the “2017 Mitsubishi Bank Loan”) was entered into in March 2017 to acquire manufacturing equipment for our Japanese subsidiary and has an annual interest rate of the monthly TIBOR rate plus 1.00%. The 2017 Mitsubishi Bank Loan requires monthly interest and principal payments over 72 months commencing in April 2018. This loan is available from March 31, 2017 to March 30, 2018 and 1.0 million JPY (approximately $9,000) under this loan was drawn on the closing date of March 31, 2017. As of March 31, 2017, our total outstanding principal balance under the Mitsubishi Bank Term Loans was 1.3 billion JPY (approximately $11.6 million). See Note 8 of Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report.

From time to time we accept notes receivable in exchange for accounts receivable from certain of our customers in China. These notes receivable are non-interest bearing and are generally due within six months. Historically, we have collected on the notes receivable in full at the time of maturity.

We believe that our existing cash, cash equivalents and cash flows from our operating activities will be sufficient to meet our anticipated cash needs for at least the next 12 months. During the three months ended March 31, 2017, we used $14.1 million in cash, cash equivalent, short-term investments and restricted cash such that we had $91.5 million as of March 31, 2017. We have several credit facilities available to support operations. These facilities include credit lines in China with maximum borrowing limit of approximately $21.8 million through July 2019 and an additional $38.6 million through September 2017 to fund our operations in China. In addition, we are in discussion to further extend our $30.0 million credit facility with Comerica Bank beyond its current July 2017 term to support our working capital needs worldwide. Further, we are implementing cost saving measures to reduce spending. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of a recovery in China spending, the timing and extent of our spending, the expansion of sales and marketing activities, the introduction of new and enhanced products,

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costs to increase our manufacturing capacity and continuing market acceptance of our products and acquisitions of businesses and technology. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be adversely affected.

Rusnano Rights Agreement

Under our amended rights agreement, dated June 30, 2015, with Rusnano, one of our principal stockholders, we agreed to make a $30.0 million investment commitment (the “Investment Commitment”) toward our Russian operations. The Investment Commitment can be partially satisfied by cash and/or non-cash investment inside or outside of Russia. Our $18.8 million investment milestone for 2016 was met as of December 31, 2016. If certain of the Investment Commitments are not achieved in the indicated time frames through 2019, we have the ability to exit our Russian operations by paying an exit fee of up to $2.0 million at that time. See Note 10 in Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Report.

Cash flow discussion

The table below sets forth selected cash flow data for the periods presented:


	Three Months Ended
	March 31,
(in thousands)	2017		2016
Net cash provided by (used in) operating activities	$	(18,748)	$	5,184
Net cash provided by (used in) investing activities		18,131		(19,655)
Net cash provided by (used in) financing activities		(806)		919
Effect of exchange rates on cash and cash equivalents		622		203
Net decrease in cash and cash equivalents	$	(801)	$	(13,349)

Operating activities

Net cash used in operating activities was $18.8 million in the three months ended March 31, 2017, compared to $5.2 million provided by operating activities in the same 2016 period. The decrease was primarily attributable to a $22.3 million decrease in cash flows from inventories primarily due to higher inventory balances, a $17.1 million decrease in cash flows related to net loss and non-cash adjustments and a $7.1 million decrease in accounts payable due to vendor payments. The decreases are partially offset by a $13.5 million increase in cash flows from accounts receivable primarily driven by timing of revenue, a $5.2 million increase in prepaid and other assets primarily relating to the transition service agreement with APAT OE and a $3.9 million increase in cash flows from accrued and other liabilities primarily due to higher variable compensation payments in the 2016 period.

Investing activities

Net cash provided by investing activities was $18.1 million in the three months ended March 31, 2017, compared to $19.7 million used in the same 2016 period. Cash from investing activities increased primarily due to a $29.8 million increase in proceeds from sale of marketable securities, a $21.7 million increase due to proceeds from the sale of Low Speed Transceiver Products’ assets in January 2017, a $5.0 million increase due to proceeds from maturity of marketable securities, partially offset by a $12.9 million decrease due to property, plant and equipment purchases to meet our product demand and a $6.8 million decrease due to purchases of marketable securities.

We expect our property, plant and equipment purchases to be in line with our revenue in the second half of 2017 as we are completing our capacity expansion plan.

Financing activities

Net cash used in financing activities was $0.8 million in the three months ended March 31, 2017, compared to $0.9 million provided by financing activities in the same 2016 period. The decrease in cash flows from financing

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activities was largely due to a $2.0 million decrease in issuance of notes payable, a $0.7 million decrease in proceeds from stock option exercises and issuance of stock under our employee stock purchase plan driven by the stock price of our common stock and a $0.2 million decrease in net proceeds from bank loans due to debt issuance costs paid in connection with our new loan with the Mitsubishi Bank, partially offset by a $1.3 million increase in repayment of notes payable.

Contractual obligations and commitments

As of March 31, 2017, our principle commitments consisted of obligations under operating leases, purchase commitments, debt and other contractual obligations. There have been no significant changes to these obligations during the three months ended March 31, 2017 compared to the contractual obligations disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

Off-balance sheet arrangements

As of March 31, 2017, we did not have any significant off-balance sheet arrangements.

Recent accounting pronouncements

See Note 1 “Basis of presentation and significant accounting policies” in the Notes to Condensed Consolidated Financial Statements on this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements and accounting changes.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have entered into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations, related to RMB on our inter-company receivables and payables. Our exposures to other market risk have not changed materially since December 31, 2016 . For quantitative and qualitative disclosures about market risk, see Item 7A Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report on Form 10-K for the year ended December 31, 2016 .

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2017. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

As previously reported in our Annual Report on Form 10-K, as of December 31, 2016, our management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2016, because of the material weakness described in our Annual Report on Form 10-K, specifically our internal controls were not designed and operating effectively to ensure proper cut-off for certain revenue transactions. Our logistics personnel did not have adequate written procedures and training with respect to our shipping and handling policies for sales. As a result of these design and operating effectiveness deficiencies, our policies and controls related to our revenue recognition and

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shipping and handling practices did not operate effectively to provide reasonable assurance that revenue was properly accounted for in accordance with generally accepted accounting principles. No actual material misstatements were identified for the year ended December 31, 2016.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

In the Evaluation of Disclosure Controls and Procedures included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as a result of the material weakness that existed in our internal controls over financial reporting related to revenue recognition and shipping and handling practices.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended) for the quarter ended March 31, 2017 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Remedial Measures

Our management continued significant efforts in 2017 to establish a framework to improve internal controls over financial reporting. We committed considerable resources to the design, implementation, documentation, and testing of our internal controls. Additional efforts are required to remediate and re-test certain internal control deficiencies. Our management believes that these efforts have improved our internal control over financial reporting. With the oversight of senior management and our audit committee, we have taken steps and plan to take additional measures to remediate the underlying causes of our existing material weakness. Our management is in the process of completing the following steps as part of our ongoing remediation efforts to address the material weakness:

(a)

Strengthening our cut-off controls with improved documentation standards, revised segregation of duties and training, and

(b)

Improving logistics operations documentation standards and procedures.

Our goal is to remediate this material weakness by the end of 2017, provided that there are sufficient opportunities to conclude, through testing, that the enhanced controls are operating effectively.

Inherent Limitation on the Effectiveness of Internal Controls

The effectiveness of any system of internal control over financial reporting is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting can only provide reasonable, not absolute assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but cannot assure that such improvements will be sufficient to provide us with effective internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we are involved in litigation that we believe is of the type common to companies engaged in our line of business, including commercial disputes and employment issues. As of the date of this Quarterly Report on Form 10-Q, other than as described below, we are not involved in any pending legal proceedings that we believe could have a material adverse effect on our financial condition, results of operations or cash flows. However, as described below, a certain dispute involves a claim by a third party that our activities infringe their intellectual property rights. This and other types of intellectual property rights claims generally involve the demand by a third party that we cease the manufacture, use or sale of the allegedly infringing products, processes or technologies and/or pay substantial damages or royalties for past, present and future use of the allegedly infringing intellectual property. Claims that our products or processes infringe or misappropriate any third-party intellectual property rights (including claims arising through our contractual indemnification of our customers) often involve highly complex, technical issues, the outcome of which is inherently uncertain. Moreover, from time to time, we may pursue litigation to assert our intellectual property rights. Regardless of the merit or resolution of any such litigation, complex intellectual property litigation is generally costly and diverts the efforts and attention of our management and technical personnel which could adversely affect our business.

For a discussion of our current legal proceedings, please refer to the information set forth under the “Litigation” section in Note 10, Commitments and Contingencies , in Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

ITEM 1A. RISK FACTORS

Except for those risk factors denoted by an asterisk (*), the risk factors facing our company have not changed materially from those set forth in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on March 16, 2017, which risk factors are set forth below.

Risks Related to Our Business

*We are dependent on Huawei Technologies Co., Ltd. and its affiliate HiSilicon Technologies Co., Ltd., Ciena, Nokia and our other key customers for a large portion of our revenue and the loss of, or a significant reduction in orders in any period from any of our major customers may reduce our revenue and adversely impact our results of operations.

We have generated most of our revenue from a limited number of customers. In the three months ended March 31, 2017, Huawei Technologies Co. Ltd., together with its affiliate HiSilicon Technologies Co., Ltd. (collectively “Huawei”), and Ciena Corporation accounted for approximately 41% and 14% of our revenue, respectively, and our top ten customers represented 90% of our revenue. In the year ended December 31, 2016, Huawei Technologies, together with its affiliate HiSilicon (or collectively, Huawei), and Ciena Corporation accounted for approximately 50% and 15% of our revenue, respectively, and our top ten customers represented 91% of our revenue. In the year ended December 31, 2015, Huawei and Ciena accounted for approximately 44% and 21% of our revenue, respectively, and our top ten customers represented 91% of our revenue. The loss of, or a significant reduction in orders from these major customers or any of our other key customers would materially and adversely affect our revenue and results of operations.

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*We are subject to risks and uncertainties related to our revenue growth outlook in China.

Fiber optics telecommunication growth in China is an important contributor to our success. We expect a major portion of our revenue to come from China infrastructure spending in wireline and wireless networks, notably from the three largest China telecom carriers, China Mobile Communications Corporation, China Telecommunications Corporation and China United Network Communications Group Co., Ltd. In part, this infrastructure spending originates from the publicly announced China Broadband 2020 National Initiative. If the anticipated Chinese spending and carrier tender awards do not materialize as anticipated, or if there are unanticipated and/or prolonged delays in the Chinese initiative, our business, financial condition, results of operations and prospects would be adversely affected.

Manufacturing problems could impact manufacturing yields or result in delays in product shipments to customers and could adversely affect our revenue, competitive position and reputation.

We may experience delays, disruptions or quality control problems in our manufacturing operations or supply chain constraints, which could adversely impact manufacturing volumes, yields or delay product shipments. As a result, we could incur additional costs that would adversely affect our gross margin, and product shipments to our customers could be delayed beyond the shipment schedules requested by our customers, which would negatively affect our revenue, competitive position and reputation.

Additionally, manufacturing yields depend on a number of factors, including the stability and manufacturability of the product design, manufacturing improvements gained over cumulative production volumes, the quality and consistency of component parts and the nature and extent of customization requirements by customers. Capacity constraints, raw materials shortages, logistics issues, labor shortages, volatility in utilization of manufacturing operations, supporting utility services and other manufacturing supplies, the introduction of new product lines, rapid increases in production demands and changes in customer requirements, manufacturing facilities or processes, or those of some third party contract manufacturers and suppliers of raw materials and components have historically caused, and may in the future cause, reduced manufacturing yields, negatively impacting the gross margin on, and our production capacity for, those products. Our ability to maintain sufficient manufacturing yields is particularly challenging with respect to PICs due to the complexity and required precision of a large number of unique manufacturing process steps. Manufacturing yields for PICs can also suffer if contaminated materials or materials that do not meet highly precise composition requirements are inadvertently utilized. Because a large portion of our PIC manufacturing costs are fixed, PIC manufacturing yields have a substantial effect on our gross margin. Lower than expected manufacturing yields could also delay product shipments and decrease our revenue.

We may not be able to obtain capital when desired on favorable terms, if at all, or without dilution to our stockholders.

We believe that our existing cash and cash equivalents, and cash flows from our operating activities and funds available under our credit facilities, will be sufficient to meet our anticipated cash needs for at least the next 12 months. We operate in an industry, however, that makes our prospects difficult to evaluate. It is possible that we may not generate sufficient cash flow from operations or otherwise have the capital resources to meet our future capital needs. If this occurs, we may need additional financing to continue operations or execute on our current or future business strategies, including to:

invest in our research and development efforts, including by hiring additional technical and other personnel;

maintain and expand our operating or manufacturing infrastructure;

acquire complementary businesses, products, services or technologies; or

otherwise pursue our strategic plans and respond to competitive pressures.

If we raise additional funds an equity financing, the percentage ownership of our stockholders could be significantly diluted. In addition, a portion of our cash, cash equivalents and restricted cash is held by our subsidiaries outside of the U.S. and we may not be able to repatriate off-shore cash to the U.S. without taxes that may be substantial. In addition, our credit facility with Comerica Bank currently expires on July 31, 2017. Unless this facility is further

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extended or renewed, we will not be able to borrow further amounts under the facility after July 2017.

If we incur additional indebtedness through arrangements such as credit agreements or term loans, such arrangements may impose restrictions and covenants that limit our ability to respond appropriately to market conditions, make capital investments or take advantage of business opportunities. In addition, any additional debt arrangements we may enter into would likely require us to make regular interest payments, which could adversely affect our results of operations.

Customer demand is difficult to accurately forecast and, as a result, we may be unable to optimally match production with customer demand.

We make planning and spending decisions based on our estimates of customer requirements. The short-term nature of commitments by many of our customers, and the possibility of unexpected changes in demand for their products, reduce our ability to accurately estimate future customer requirements. On occasion, customers may require rapid increases in production, which can strain our resources, cause our manufacturing to be negatively impacted by materials shortages, necessitate higher or more restrictive procurement commitments, increase our manufacturing yield loss and scrapping of excess materials, result in delayed shipments and/or reduce our gross margins. We may not have sufficient capacity at any given time to meet the volume demands of our customers, and we may have difficulty expanding our manufacturing operations on a timely basis to meet increasing customer demand. Additionally, one or more of our suppliers may not have sufficient capacity at any given time to meet our volume demands. Because many of our costs and operating expenses are relatively fixed, reduction in customer demand due to market downturns or other reasons would have a material adverse effect on our operating results.

We depend upon outside contract manufacturers for a portion of the manufacturing process for some of our products. Our operations and revenue related to these products could be adversely affected if we encounter problems with a contract manufacturer.

The majority of our products are manufactured internally. However, we also rely upon contract manufacturers in Thailand, China, Japan and other Asia locations to provide back-end manufacturing and produce the finished portion of some of our products. Our reliance on contract manufacturers for these products makes us vulnerable to possible capacity constraints and reduced control over their supply chains, delivery schedules, manufacturing yields, manufacturing quality/controls and costs. If one of our contract manufacturers is unable to meet all of our customer demand in a timely fashion, whether due to their direct operating control or due to their supply chain, this could have a material adverse effect on the revenue from our products.

We are under continuous pressure to reduce the prices of our products, which has adversely affected, and may continue to adversely affect, our gross margins.

The communications networks industry has been characterized by declining product prices over time as technological advances increase price and performance and put pressure on existing products. We have reduced the prices of many of our products in the past, most often during annual end-of-year price negotiation. We expect pricing pressure for our products to continue, including from our major customers. To maintain or increase their market share, our competitors also reduce prices of their products each year. In addition, our customers may seek to internally develop and manufacture competing products at a lower cost than we would otherwise charge, which would add additional pressure on us to lower our selling prices. If we are unable to offset any future reductions in our average selling prices by increasing our sales volume, reducing our costs or introducing new products, our gross margin would be adversely affected.

If the Metro and datacenter interconnect market sectors do not grow as rapidly as we expect, or if demand for our products in these sectors is lower than we expect, our revenue growth may be adversely affected.

We expect that our future growth in the market for 100G and beyond coherent products to be driven in large part by the increased adoption of our products in the Metro market segment and in the high-performance datacenter interconnect market. Over the last sever al years, 100G and beyond coherent technology has seen increasing adoption in

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the Long Haul market segment and now is penetrating the much larger Metro sector of the market.

If we fail to achieve or sustain a leadership position in the Long Haul telecom sector and use our position in that market to penetrate t he Metro and datacenter interconnect segments, if these segments fail to grow as expected, or if demand for our products in the Metro and datacenter interconnect market segments fails to materialize, our business, financial condition, results of operations and prospects would suffer.

We face intense competition which could negatively impact our results of operations and market share.

The communications networks industry is highly competitive. Our competitors range from large international companies offering a wide range of products to smaller companies specializing in niche products.

Some of our competitors have substantially greater name recognition, technical, financial, and marketing resources, and greater manufacturing capacity, as well as better-established relationships with customers, than we do. Some of our competitors have more resources to develop or acquire, and more experience in developing or acquiring, new products and technologies. Some of our competitors may be able to develop new products more quickly than us and may be able to develop products that are more reliable or which provide more functionality than ours. In addition, some of our competitors have the financial resources to offer competitive products at below-market pricing levels that could prevent us from competing effectively and result in a loss of sales or market share or cause us to lower prices for our products.

We also face competition from some of our customers who evaluate our capabilities against the merits of manufacturing products internally, including Huawei. Due to the fact that such customers are not seeking to make a comparable profit directly from the manufacture of these products, they may have the ability to provide competitive products at a lower total cost than we would charge such customers. As a result, these customers may purchase less of our products and there would be additional pressure to lower our selling prices which, accordingly, would negatively impact our revenue and gross margin.

If we fail to retain our key personnel or if we fail to attract additional qualified personnel, we may not be able to achieve our anticipated growth and our business could suffer.

Our success and ability to implement our business strategy depends upon the continued contributions of our senior management team and others, including senior management in foreign subsidiaries and our technical and operations employees in all locations. Our future success depends, in part, on our ability to attract and retain key personnel, including our senior management and others. The loss of services of members of our senior management team or key personnel or the inability to continue to attract and retain qualified personnel could have a material adverse effect on our business. Competition for highly skilled technical and operations people where we operate is extremely intense, and we continue to face challenges identifying, hiring and retaining qualified personnel in many areas of our business.

*We have had a history of losses which may recur in the future.

We have had a history of losses and we may incur additional losses in future periods. As of December 31, 2016, our accumulated de ficit was $298.7 million and we incurred a net loss of $11.5 million in the three months ended March 31, 2017. We also expect to continue to make significant expenditures related to the ongoing operation and development of our business. These include expenditures related to the sales, marketing and development of our products and to maintain our manufacturing facilities and research and development operations.

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

Our products are typically sold pursuant to individual purchase orders or by use of a vendor-managed inventory, or VMI, model, which is a process by which we ship agreed quantities of products to a customer-designated location and those products remain our inventory and we retain the title and risk of loss for those products until the customer takes

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possession of the products. Our customers are typically not contractually committed to buy any quantity of products beyond firm purchase orders. Many of our customers may increase, decrease, cancel or delay purchase orders already in place. We have experienced and expect to continue to experience wide fluctuations in demand from customers using VMI, particularly Huawei Technologies Co., Ltd. and their affiliate HiSilicon Technologies Co., Ltd. , even in instances where we have built and shipped products to the customer-designated locations as VMI.

If we fail to adequately manage our growth and expansion, our business and financial results will suffer.

In recent years, we have experienced significant growth through, among other things, internal manufacturing and related expansion programs, product development and acquisitions of other businesses and products. Our business has expanded to numerous locations, including foreign locations, and as a result has become more complex, more demanding of management’s attention and subject to new laws and regulations.

Our success and ability to further scale our business will depend, in part, on our ability to manage changes in a cost-effective and efficient manner. If we cannot manage our growth, we may be unable to take advantage of market opportunities, execute our business strategies or respond to competitive pressures. Any failure to effectively manage growth, maintain our quality and/or or customer satisfaction could adversely affect our business and reputation.

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

Our ability to anticipate and respond to evolving technology, industry standards, customer requirements and product offerings, and to develop and introduce new and enhanced products and technologies, will be critical factors in our ability to succeed. In addition, the introduction of new products by other companies embodying new technologies, or the emergence of new industry standards, could render our existing products uncompetitive from a pricing standpoint, obsolete or otherwise unmarketable.

While we rely on many suppliers, there are a few which, if they stopped, decreased or delayed shipments to us, it could have an adverse effect on our business and financial results.

We depend on a limited number of suppliers for certain components and materials we have qualified to use in the manufacture of certain of our products. Some of these suppliers could disrupt our business if they stop, decrease or delay shipments or if the components they ship have quality, consistency, or business continuity issues. Some of these components and materials are available only from a sole source, or have been qualified only from a single source. We may also face component shortages if we experience increased demand for components beyond what our qualified suppliers can deliver. If we experience component shortages from certain key suppliers, we may be unable to meet customer demand or may have higher purchasing costs, or both. Although we engage in various actions to mitigate the impact of these shortages, any inability on our part to obtain sufficient quantities of critical components at reasonable costs could adversely affect our ability to meet demand for our products, which could cause our revenue, results of operations, or both to suffer.

Our customers generally restrict our ability to change the component parts in our modules without their approval and such changes may require repeating product qualification processes. The reliance on a sole supplier, single qualified vendor or limited number of suppliers could result in delivery and quality problems, reduced control over product pricing, reliability and performance and an inability to identify and qualify another supplier in a timely manner. Any supply deficiencies relating to the quality, quantities or timeliness of delivery of components that we use to manufacture our products could adversely affect our ability to fulfill our customer orders and our results of operations.

We must continually achieve new design wins and enhance existing products or our business and future revenue may be harmed.

The markets for our products are characterized by frequent new product introductions, changes in customer requirements and evolving industry standards, all with an underlying pressure to reduce cost and meet stringent reliability and qualification requirements. Our future performance will depend on our successful development,

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introduction and market acceptance of new and enhanced products that address these challenges. The anticipated or actual introduction of new and enhanced products by us and by our competitors may cause our customers to defer or cancel orders for our existing products, and could result, and in the past, has resulted, in a write-down in the value of inventory. To the extent customers defer or cancel orders for our products for any reason or we fail to achieve new design wins, our competitive position would be adversely affected and our ability to grow revenue would be impaired.

Furthermore, fast time-to-market with new products can be critical to success in our markets. It is difficult to displace an existing supplier for a particular type of product once a network equipment vendor has chosen a supplier, even if a later-to-market product provides superior performance or cost efficiency. If we are unable to make our new or enhanced products commercially available on a timely basis, we may lose existing and potential customers and our financial results would suffer.

We may be exposed to costs or losses from product lines that we intend to exit or may undertake divestiture of portions of our business that require us to continue providing substantial post-divestiture transition services and support, which may cause us to incur unanticipated costs and liabilities and adversely affect our financial condition and results of operations.

In August 2016, we announced our intention to reduce the volume and end the production of certain of our lower-margin laser and PON products within a year of August 2016. In January 2017, we completed the sale of assets and transfer of certain liabilities of our access network and low speed transceiver product lines (the “Low Speed Transceiver Products”). The foregoing actions are part of our strategy to exit products that have been declining in revenue and have lower gross margins than our other higher speed products. We may incur additional costs in connection with the sale or end-of-life of these products, or other products and/or facilities in the future, and our revenues and net income could be negatively affected, particularly in the short term, in connection with the end-of-life or sales of such products and/or facilities. It is also possible that we could incur continued costs or liabilities after the end-of-life process is completed, which could have a material adverse effect on our financial condition or operating results.

We are subject to the cyclical nature of the markets in which we compete and any future downturn may reduce demand for our products and revenue.

The markets in which we compete are tied to the aggregate capital expenditures of telecommunications service providers as they build out and upgrade their network infrastructure. These markets may be cyclical and characterized by rapid technological change, price erosion, evolving standards and wide fluctuations in product supply and demand. In the past, including recently to varying degrees in China, the U.S. and Europe, these markets have experienced significant downturns, often connected with, or in anticipation of, the maturation of product cycles—for both manufacturers’ and their customers’ products—or in response to over or under purchasing of inventory by our customers relative to ultimate carrier demand, and with declining general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices.

Our historical results of operations have been subject to substantial fluctuations, and we may experience substantial period-to-period fluctuations in future results of operations.

If spending for communications networks does not continue to grow as expected, our business and financial results may suffer.

Our future success as a provider of modules and subsystems to leading network equipment vendors depends on continued capital spending on global communications networks. Network traffic has experienced rapid growth driven primarily by bandwidth-intensive content, including cloud services, mobile video and data services, wireless 4G/LTE and 5G services, social networking, video conferencing and other multimedia. This growth is intensified by the proliferation of fixed and wireless devices that are enabling consumers to access content at increasing data rates anytime and anywhere. Our future success depends on continued demand for high-bandwidth, high-speed communications networks and the ability of network equipment vendors and carrier datacenter operators to fulfill this demand.

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We face a variety of risks associated with international sales and operations, which if not adequately managed could adversely affect our business and financial results.

We derive, and expect to continue to derive, a significant portion of our revenue from international sales in various markets. In addition, a major portion of our operations is based in Shenzhen and Dongguan, China and we have additional operations in Japan, Russia and Canada. Our international revenue and operations are subject to a number of material risks, including, but not limited to:

difficulties in staffing, managing and supporting operations in more than one country;

difficulties in enforcing agreements and collecting receivables through foreign legal systems;

fewer legal protections for intellectual property in foreign jurisdictions;

the need for compliance with local laws and regulations;

foreign and U.S. taxation issues and international trade barriers;

general economic and political conditions in the markets in which we operate;

difficulties in obtaining any necessary governmental authorizations for the export of our products to certain foreign jurisdictions;

imposition of export restrictions on sales to any of our major foreign customers;

fluctuations in foreign economies and fluctuations in the value of foreign currencies and interest rates;

trade and travel restrictions;

outbreaks of contagious disease;

domestic and international economic or political changes, hostilities and other disruptions; and

difficulties and increased expenses in complying with a variety of U.S. and foreign laws, regulations and trade standards, including the Foreign Corrupt Practices Act and international labor standards. Negative developments in any of these areas in China, Japan, Russia or other countries could result in a reduction in demand for our products, the cancellation or delay of orders already placed, difficulties in producing and delivering our products, threats to our intellectual property, difficulty in collecting receivables, higher labor costs and a higher cost of doing business.

In addition, although we maintain an anti-corruption compliance program throughout our company, violations of our compliance program may result in criminal or civil sanctions, including material monetary fines, penalties and other costs against us or our employees, and may have a material adverse effect on our business.

Failure to realize the anticipated benefits from our planned expansion in the Russian Federation may affect our future results of operations and financial condition.

In connection with our raising capital in an April 2012 private placement of common stock, we have established a wholly-owned subsidiary and company operations in the Russian Federation. The establishment of successful operations in the Russian Federation requires capital expenditure over several years, and is in part dependent on the cooperation of Russian entities that could include the Russia government and other third parties. If there are delays in our efforts to establish and maintain operations in the Russian Federation, the anticipated benefits of our Russian expansion may not be realized or may take longer to realize than expected. We could be required to pay up to $2.0 million to Joint Stock Company “RUSNANO” (formerly Open Joint Stock Company “RUSNANO”), or Rusnano, at the time if we do not meet certain investment conditions towards our Russian operations by 2019.

Our business operations conducted in Russia are relatively small compared to our overall business . However, we are subject to economic, political, legal, and social events and developments in Russia , including but not limited to actions such as restrictions placed on U.S. companies doing business in Russia.

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Our revenues and costs will fluctuate over time, making it difficult to predict our future results of operations.

Our revenue, gross margin and results of operations have varied significantly and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. For instance, changes in gross margin may result from various factors, such as changes in pricing, changes in our fixed costs, changes in the cost of labor, changes in the mix of our products sold, changes in the amount of product manufactured versus the amount of product sold over time, and charges for excess and obsolete inventory. In addition, our first quarter revenue is generally seasonally lower than the rest of the year primarily due to lower capacity utilization during the holidays in China and the impact of typical price negotiations during the fourth quarter. It is difficult for us to accurately forecast our future revenue and gross margin and plan expenses accordingly and, therefore, it is difficult for us to predict our future results of operations.

Increasing costs and other factors may adversely impact our gross margins.

We may not be able to maintain or improve our gross margins because of slow introductions of new products, pricing pressure from increased competition, failure to effectively reduce the cost of existing products, failure to improve our product mix, future macroeconomic or market volatility reducing sales volumes, changes in customer demand (including a change in product mix among different areas of our business) or other factors. Our gross margins can also be adversely affected for reasons including, but not limited to, fixed manufacturing costs that would not be expected to decrease in proportion to any decrease in revenues; 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; possible exposure to inventory valuation reserves; and other increases in our costs and expenses, including as a result of rising labor costs in China . Such significant increases in costs without corresponding increases in revenue would materially and adversely affect our business, our results of operations and our financial condition and our gross margins.

If our customers do not qualify our products for use, then our results of operations may suffer.

Prior to placing volume purchase orders with us, most of our customers require us to obtain their approval—called qualification in our industry—of our new and existing products, and our customers often audit our manufacturing facilities and perform other vendor evaluations during this process. The qualification process involves product sampling and reliability testing and collaboration with our product management and engineering teams in the design and manufacturing stages. If we are unable to qualify our products with customers, then our revenue would be lower than expected and we may not be able to recover the costs associated with the qualification process which would have an adverse effect on our results of operations.

In addition, due to evolving technological changes in our markets, a customer may cancel or modify a design project before we have qualified our product or begun volume manufacturing of a qualified product. It is unlikely that we would be able to recover the expenses for cancelled or unutilized custom design projects.

We have pursued and may continue to pursue acquisitions. Acquisitions could be difficult to integrate, divert the attention of key personnel, disrupt our business, dilute stockholder value and impair our financial results.

As part of our business strategy, we have pursued and intend to continue to pursue acquisitions of complementary businesses, products, services or technologies that we believe could accelerate our ability to compete in our existing markets or allow us to enter new markets. Any of these transactions could be material to our financial condition and results of operations. For instance, in October 2011, we completed the acquisition of Santur Corporation, a designer and manufacturer of InP-based PIC products, and in March 2013 we completed the acquisition of the optical semiconductor business unit of LAPIS Semiconductor Co., Ltd., now known as NeoPhotonics Semiconductor. We purchased the tunable laser product lines of EMCORE in January 2015 and the power monitoring products business of EigenLight Corporation, or Eigenlight, in November 2015.

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Acquisitions involve numerous risks. The failure to successfully evaluate and execute acquisitions or otherwise adequately address such risks could result in excess costs and materially harm our business and financial results.

Acquisitions also frequently result in the recording of goodwill and other intangible assets which are subject to potential impairments which have occurred in the past and which, were they to occur in the future, could harm our financial results.

It could be discovered that our products contain defects that may cause us to incur significant costs, divert our attention, result in a loss of customers and result in product liability claims.

Our products are complex and undergo quality testing as well as formal qualification, both by our customers and by us. For various reasons, such as the occurrence of performance problems that are unforeseeable in testing or that are detected only when products age or are operated under peak stress conditions, our products may fail to perform as expected long after customer acceptance. Failures could result from faulty components or design, problems in manufacturing or other unforeseen reasons. As a result, we could incur significant costs to repair or replace defective products under warranty, particularly when such failures occur in installed systems. Any significant product failure could result in lost future sales of the affected product and other products, as well as customer relations problems and litigation, which could harm our business.

The communications networks industry has long product development cycles requiring us to incur product development costs without assurances of an acceptable investment return.

Large volumes of communications equipment and support structures are installed with considerable expenditures of funds and other resources, and long investment return period expectations. At the component supplier level, these cycles create considerable, typically multi-year, gaps between the commencement of new product development and volume purchases. Due to changing industry and customer requirements, we are constantly developing new products, including seeking to further integrate functions on PICs and developing and using new technologies in our products. These development activities necessitate significant investment of capital. Our new products often require a long time to develop because of their complexity and rigorous testing and qualification requirements. Accordingly, we and our competitors often incur significant research and development and sales and marketing costs for products that, initially, will be purchased by our customers long after much of the cost is incurred and, in some cases, may never be purchased due to changes in industry or customer requirements in the interim.

We are subject to global governmental export and import controls that could subject us to liability, impair our ability to compete in international markets, or restrict our sales to certain customers.

We are subject to export and import control laws, trade regulations and other trade requirements that limit which products we sell and where and to whom we sell our products, especially laser-dependent products. In some cases, it is possible that export licenses would be required from the U.S. or other government agencies outside the U.S. such as, but not limited to, Japan, China or Russia for some of our products in accordance with various statutes. In addition, various countries regulate the export or import of certain technologies and have enacted laws that could limit our ability to distribute our products. Failure to comply with these and similar laws on a timely basis, or at all, or any limitation on our ability to export or sell our products or to obtain any required licenses would adversely affect our business, financial condition and results of operations.

If we fail to protect our intellectual property and other proprietary rights, our business and results of operations could be materially harmed.

Our success depends to a significant degree on our ability to protect our intellectual property and other proprietary rights. We rely on a combination of patent, trademark, copyright, trade secret and unfair competition laws, as well as license agreements and other contractual provisions, to establish and protect our intellectual property and other proprietary rights. We have applied for patent registrations in the U.S. and in other foreign countries, some of which have been issued. We cannot guarantee that our pending applications will be approved by the applicable governmental authorities.

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Policing unauthorized use of our technology is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation, unauthorized use or other infringement of our intellectual property rights. Further, we may not be able to effectively protect our intellectual property rights from misappropriation or other infringement in foreign countries where we have not applied for patent protections, and where effective patent, trademark, trade secret and other intellectual property laws may be unavailable, or may not protect our proprietary rights as fully as U.S. or Japan law. Particularly, our U.S. patents do not afford any intellectual property protection in China, Japan, Canada or other Asia locations, including Russia, where we have company operations.

In the future, we may need to take legal actions to prevent third parties from infringing upon or misappropriating our intellectual property or from otherwise gaining access to our technology. Protecting and enforcing our intellectual property rights and determining their validity and scope could result in significant litigation costs and require significant time and attention from our technical and management personnel. If we fail to protect our intellectual property and other proprietary rights, or if such intellectual property and proprietary rights are infringed or misappropriated, our business, results of operations or financial condition could be materially harmed.

We may be involved in intellectual property disputes, which could divert management’s attention, cause us to incur significant costs and prevent us from selling or using the challenged technology.

Participants in the markets in which we sell our products have experienced frequent litigation regarding patent and other intellectual property rights. Numerous patents in these industries are held by others, including our competitors. In addition, from time to time, we have been notified that we may be infringing certain patents or other intellectual property rights of others. Regardless of their merit, responding to such claims can be time consuming, divert management’s attention and resources and may cause us to incur significant expenses. In addition, there can be no assurance that third parties will not assert infringement claims against us. While we believe that our products do not infringe in any material respect upon intellectual property rights of other parties and/or meritorious defense would exist with respect to any assertions to the contrary, we cannot be certain that our products would not be found infringing the intellectual property rights of others.

In January 2010, Finisar Corporation, or Finisar, filed a complaint in the U.S. District Court for the Northern District of California against us and three other co-defendants. In the complaint, Finisar alleged infringement of certain of its U.S. patents arising from the co-defendants’ respective manufacture, importation, use, sale of or offer to sell certain optical transceiver products in the U.S. In March 2010, we filed an answer to the complaint and counterclaims, asserting two claims of patent infringement and additional claims asserting that Finisar has violated state and federal competition laws and violated its obligations to license on reasonable and non-discriminatory terms. In May 2010, the Court dismissed without prejudice all co-defendants (including us) except Source Photonics, Inc., on grounds that such claims should have been asserted in four separate lawsuits, one against each co-defendant. This dismissal without prejudice does not prevent Finisar from bringing a new similar lawsuit against us. In May 2012, we and Finisar agreed to toll our respective claims until the refiling of certain of the previously asserted claims from this dispute. As a result, Finisar is permitted to bring a new lawsuit against us if it chooses to do so, and we may bring new claims against Finisar upon seven days written notice prior to filing such claims.

Although we believe that we would have meritorious defenses to the infringement allegations and intend to defend any new similar lawsuit vigorously, there can be no assurance that we will be successful in our defense. Even if we are successful, we may incur substantial legal fees and other costs in defending the lawsuit. Further, a new lawsuit, if brought by either party, would be likely to divert the efforts and attention of our management and technical personnel, which could harm our business.

If we fail to obtain the right to use the intellectual property rights of others which are necessary to operate our business, and to protect their intellectual property, our business and results of operations will be adversely affected.

From time to time we may choose to or be required to license technology or intellectual property from third parties in connection with the development of our products. Failure to obtain a necessary third-party license required for our product offerings or to develop new products and product enhancements could adversely affect our business.

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Participation in standards setting organizations may subject us to intellectual property licensing requirements or limitations that could adversely affect our business and prospects.

In the course of our participation in the development of emerging standards for some of our present and future products, we may agree to grant to all other participants a license to our patents that are essential to the practice of those standards on reasonable and non-discriminatory, or RAND, terms. If we fail to limit to whom we license our patents, or fail to limit the terms of any such licenses, we may be required to license our patents or other intellectual property to others in the future, which could limit the effectiveness of our patents against competitors.

Any potential dispute involving our products, services or technology could also include our customers using our products, which could trigger our indemnification obligations to them and result in substantial expenses to us.

In any potential dispute involving allegations that our products, services or technology infringe the intellectual property rights of third parties, our customers could also become the target of litigation. Because we often indemnify our customers for intellectual property claims made against them for products incorporating our technology, any claims against our customers could trigger indemnification obligations in some of our supply agreements, which could result in substantial expenses such as increased legal expenses, product recalls, damages for past infringement or royalties for future use.

Natural disasters, terrorist attacks or other catastrophic events could harm our operations and our financial results.

Our worldwide operations could be subject to natural disasters and other business disruptions, which could harm our future revenue and financial condition and increase our costs and expenses. For example, our corporate headquarters and wafer fabrication facility in Silicon Valley, California and our Tokyo, Japan facility are located near major earthquake fault lines, and our manufacturing facilities are located in Shenzhen and Dongguan, China, areas that are susceptible to typhoons. We are not insured against many natural disasters, including earthquakes.

Similarly, our worldwide operations could be subject to secondary effects of natural disasters, terrorist attacks or other catastrophic events. Even if our facilities are not directly affected, any of these types of events could substantially disrupt the business of our suppliers or customers, which could have a material adverse effect on us.

Rapidly changing standards and regulations could make our products obsolete, which would cause our revenue and results of operations to suffer.

We design our products to conform to regulations established by governments and to standards set by industry standards bodies worldwide, such as The American National Standards Institute, the European Telecommunications Standards Institute, the International Telecommunications Union and the Institute of Electrical and Electronics Engineers. Various industry organizations are currently considering whether and to what extent to create standards for elements used in 100Gbps and beyond systems. Because certain of our products are designed to conform to current specific industry standards, if competing or new standards emerge that are preferred by our customers, we would have to make significant expenditures to develop new products and our revenue and results of operations would suffer.

Potential changes in our effective tax rate could negatively affect our future results.

We are subject to income taxes in the U.S., China, Japan and other foreign jurisdictions, and our domestic and international tax liabilities are subject to the allocation of expenses in differing jurisdictions. Our tax rate is affected by changes in the mix of earnings and losses in countries with differing statutory tax rates, certain non-deductible expenses and the valuation of deferred tax assets and liabilities, including our ability to utilize our net operating losses. Increases in our effective tax rate could negatively affect our results of operations.

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Our future results of operations may be subject to volatility as a result of exposure to fluctuations in foreign exchange rates, primarily the Chinese Renminbi (RMB) and Japanese Yen (JPY) exchange rates.

We are exposed to foreign exchange risks. Foreign currency fluctuations may adversely affect our revenue and our costs and expenses, and hence our results of operations. A substantial portion of our business is conducted through our subsidiaries based in China, whose functional currency is the RMB and Japan, whose functional currency is the JPY, and a smaller amount in Russian Rubles (RUB). The value of the RMB against the U.S. dollar and other currencies and the value of the JPY and RUB against the U.S. dollar and other currencies fluctuate and are affected by, among other things, changes in political and economic conditions.

To the extent that transactions by our subsidiaries in China and Japan are denominated in currencies other than the RMB and JPY, we bear the risk that fluctuations in the exchange rates of the RMB and JPY in relation to other currencies could decrease our revenue or increase our costs and expenses, therefore having an adverse effect on our future results of operations.

While we generate a significant portion of our revenue in U.S dollars, a significant portion of our cost of goods sold are in RMB and JPY. Therefore appreciation in RMB and JPY against the U.S. dollar would negatively impact our cost of goods sold upon translation to U.S. dollars.

We have entered into hedging transactions to reduce the short-term impact of foreign currency fluctuations. However, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure. In addition, our currency exchange variations may be magnified by Chinese exchange control regulations that restrict our ability to convert RMB into foreign currency.

We have identified a material weakness in our internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements.

As part of our annual evaluation of internal controls for fiscal 2016, our management identified several deficiencies (including inadequate written shipping procedures) in our internal control over financial reporting related to certain revenue cut-off procedures. These deficiencies aggregated to a material weakness in our controls over revenue cut-off procedures, which affected the timing of our revenue recognition. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. While no actual material misstatements were identified for the year ended December 31, 2016, the material weakness had not been remediated as of March 31, 2017.

Over the course of 2017, we intend to develop and implement a remediation plan designed to address this material weakness. However, if our remediation measures are insufficient to address this material weakness, if any of our personnel overrides our controls or if additional material weaknesses in our internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results. For more information see “Item 4. Controls and Procedures”.

If we fail to maintain effective internal control over financial reporting in the future, the accuracy and timing of our financial reporting may be adversely affected.

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended, or the Exchange Act.

Preparing our consolidated financial statements involves a number of complex manual and automated processes, which are dependent upon individual data input or review and require significant management judgment. One or more of these elements may result in errors that may not be detected and could result in a material misstatement of our consolidated financial statements. If we fail to maintain the adequacy of our internal controls over financial reporting, our business and operating results may be harmed and we may fail to meet our financial reporting obligations. If material

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weaknesses in our internal control are discovered or occur, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results.

Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. Any failure of our internal controls could adversely affect the results of the periodic management evaluations and annual independent registered public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting. If we cannot provide reliable financial reports or prevent fraud, our business and results of operations could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock may decline.

We may be subject to disruptions or failures in information technology systems and network infrastructures that could have a material adverse effect on our business and financial condition.

We rely on the efficient and uninterrupted operation of complex information technology systems and network infrastructures to operate our business. A disruption, infiltration or failure of our information technology systems as a result of software or hardware malfunctions, system implementations or upgrades, computer viruses, cyber attacks, third-party security breaches, employee error, theft or misuse, malfeasance, power disruptions, natural disasters or accidents could cause breaches of data security, loss of intellectual property and critical data and the release and misappropriation of sensitive competitive information and partner, customer and employee personal data. Any of these events could harm our competitive position, result in a loss of customer confidence, cause us to incur significant costs to remedy any damages and ultimately materially adversely affect our business and financial condition.

Covenants in our borrowing arrangements may limit our flexibility in responding to business opportunities and competitive developments and increase our vulnerability to adverse economic or industry conditions.

We have lending arrangements with several financial institutions, which generally require us to maintain certain financial covenants and limit our ability to take certain actions such as incurring some kinds of additional debt, paying dividends, or engaging in certain transactions like mergers and acquisitions, investments and asset sales without the lenders’ consent. These restrictions may limit our flexibility in responding to business opportunities, competitive developments and adverse economic or industry conditions. In addition, a breach of any of these covenants, or a failure to pay interest or indebtedness when due under any of our credit facilities, could result in a variety of adverse consequences, including the acceleration of our indebtedness.

We may be unable to utilize our net operating loss carryforwards to reduce our income taxes, which could adversely affect our future financial results.

As of December 31, 2016, we had net operating loss, or NOL, carryforwards for U.S. federal and state tax purposes of $207.3 million and $51.0 million, respectively. As these net operating losses have not been utilized and may not be utilized prior to their expiration in the future. The utilization of the NOL and tax credit carryforwards are subject to a substantial limitation imposed by Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, and similar state provisions. We recorded deferred tax assets, net of valuation allowance, for the NOL carryforwards currently available after considering the existing Section 382 limitation. If we incur an additional limitation under Section 382, then the NOL carryforwards, as disclosed, could be reduced by the impact of any future limitation that would result in existing NOL carryforwards and tax credit carryforwards expiring unutilized and increases in future tax liabilities.

We may utilize conflict minerals in our production or rely on suppliers who utilize conflict minerals in their production, and the use of such conflict minerals may negatively impact our results of operations.

Since 2013, we have been subject to reporting obligations for the use of conflict minerals originating in the Democratic Republic of the Congo and adjoining countries and subsequently have timely filed our conflict minerals reports with the SEC. If we fail to comply with these requirements, our operating results could be harmed.

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In some instances, we rely on third-party sales representatives to assist in selling our products, and the failure of these representatives to perform as expected could reduce our future revenue.

Although we primarily sell our products through direct sales to systems vendors, we also sell our products to some of our customers through third-party sales representatives. Many of our third-party sales representatives also market and sell competing products from our competitors. Our third-party sales representatives may terminate their relationships with us at any time, or with short notice. Our future performance will also depend, in part, on our ability to attract additional third-party sales representatives that will be able to market and support our products effectively, especially in markets in which we have not previously distributed our products. If our third-party sales representatives fail to perform as expected or to operate their businesses effectively, our revenue and results of operations could be harmed.

We are subject to environmental, health and safety laws and regulations, which could subject us to liabilities, increase our costs, or restrict our business or operations in the future.

Our manufacturing operations and our products are subject to a variety of federal, state, local and international environmental, health and safety laws and regulations in each of the jurisdictions in which we operate or sell our products. Our failure to comply with present and future environmental, health or safety requirements, or the identification of contamination, could cause us to incur substantial costs, including cleanup costs, monetary fines, civil or criminal penalties, or curtailment of operations, which could have a material adverse effect on our business, financial condition and results of operations.

Additionally, increasing efforts to control emissions of greenhouse gases, or GHG, may also impact us. Additional climate change or GHG control requirements are under consideration at the federal level in the U.S. and in China. Additional restrictions, limits, taxes, or other controls on GHG emissions could increase our operating costs and, while it is not possible to estimate the specific impact any final GHG regulations will have on our operations, there can be no assurance that these measures will not have significant additional impact on us.

Risks Related to Our Operations in China

Our business operations conducted in China are critical to our success. A significant portion of our revenue was recognized from customers for whom we shipped products to a location in China. Additionally, a substantial portion of our net property, plant and equipment, approximately 32% as of March 31, 2017, was located in China. We expect to make further investments in China in the foreseeable future. Therefore, our business, financial condition, results of operations and prospects are to a significant degree subject to economic, political, legal, and social events and developments in China.

Adverse changes in economic and political policies in China, or Chinese laws or regulations could have a material adverse effect on business conditions and the overall economic growth of China, which could adversely affect our business.

The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate and control of foreign exchange and allocation of resources. The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Despite reforms, the government continues to exercise significant control over China’s economic growth by way of the allocation of resources, control over foreign currency-denominated obligations and monetary policy and provision of preferential treatment to particular industries or companies. Moreover, the laws, regulations and legal requirements in China, including the laws that apply to foreign-invested enterprises are relatively new and are subject to frequent changes. The interpretation and enforcement of such laws is uncertain. Any adverse changes to these laws, regulations and legal requirements, including tax laws, or their interpretation or enforcement, or the creation of new laws or regulations relating to our business, could have a material adverse effect on our business.

Furthermore, any slowdown or economic downturn, whether actual or perceived, in China could have a material adverse effect on our business, financial condition and results of operation.

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The termination, expiration or unavailability of our preferential income tax treatment in China may have a material adverse effect on our operating results.

Effective January 1, 2008, the China Enterprise Income Tax Law, or the EIT law, imposes a single uniform income tax rate of 25% on all Chinese enterprises, including foreign-invested enterprises. Historically, one of our subsidiaries in China qualified for a preferential 15% tax rate that is available for new and high technology enterprises. In June 2016, the State Administration of Taxation issued a notice to adjust the requirements for high technology enterprise status. As a result, we did not meet the requirements for 2016 and became subject to the 25% regular income tax rate, which may impact our operating results for future years.

Our subsidiaries in China may be subject to restrictions on dividend payments, on making other payments to us or any other affiliated company, and on borrowing or allocating tax losses among our subsidiaries.

Current Chinese regulations permit our subsidiaries in China to pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations, which are different than U.S. accounting standards and regulations. In addition, our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund their statutory common reserves until such reserves have reached at least 50% of their respective registered capital, as well as to allocate a discretional portion of their after-tax profits to their staff welfare and bonus fund . As of March 31, 2017 and December 31, 2016, our Chinese subsidiaries’ common reserves had not reached this threshold and, accordingly, these entities are required to continue funding such reserves with accumulated net profits. Accordingly, we may not be able to move our capital easily, which could harm our business.

Restrictions on currency exchange may limit our ability to receive and use our revenue and cash effectively.

Because a portion of our revenue is denominated in RMB, any restrictions on currency exchange may limit our ability to use revenue generated in RMB to fund any business activities we may have outside China or to make dividend payments in U.S. dollars. Under relevant Chinese rules and regulations, the RMB is convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans, without the prior approval of the State Administration of Foreign Exchange, or SAFE. We cannot be certain that Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB, especially with respect to foreign exchange transactions. If such restrictions are imposed, our ability to adjust our capital structure or engage in foreign exchange transactions may be limited.

Uncertainties with respect to China’s legal system could adversely affect the legal protection available to us.

Our operations in China are governed by Chinese laws and regulations. Our subsidiaries in China are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. China’s legal system is a civil law system based on written statutes. Unlike common law systems, it is a legal system where decided legal cases have limited value as precedents. However, China has not developed a fully-integrated legal system, and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. Uncertainties in the Chinese legal system may impede our ability to enforce the contracts we have entered into with our distributors, business partners, customers and suppliers. In addition, protections of intellectual property rights and confidentiality in China may not be as effective as in the U.S. or other countries or regions with more developed legal systems. All of these uncertainties could limit the legal protections available to us and could materially and adversely affect our business and operations.

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If the Chinese government determines that we failed to obtain approvals of, or registrations with, the requisite Chinese regulatory authority with respect to our current and past import and export of technologies, or failed to obtain the necessary licenses to file patent applications outside China for inventions made in China, we could be subject to sanctions, which could adversely affect our business.

China imposes controls on technology import and export. The term “technology import and export” is broadly defined to include, without limitation, the transfer or license of patents, software and know-how, and the provision of services in relation to technology. Depending on the nature of the relevant technology, the import and export of technology to or from China requires either approval by, or registration with, the relevant Chinese governmental authorities. Additionally, the Chinese government requires the patent application for any invention made at least in part in China to be filed first in China, then undergo a government secrecy review and obtain a license before such application is filed in other countries.

If the Chinese government determines that we failed to obtain follow required procedures and obtain the appropriate license before filing a patent application outside China for an invention made at least in part in China, our China patents on such products may be invalidated, which could have a material and adverse effect on our business and operations.

China regulation of loans and direct investment by offshore holding companies to China entities may delay or prevent us from using our cash proceeds to make loans or additional capital contributions to our China subsidiaries.

From time to time, we may make loans or additional capital contributions to our China subsidiaries. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all, with respect to our future loans or capital contributions to our China subsidiaries. If we fail to receive such registrations or approvals, our ability to capitalize our China subsidiaries may be negatively affected, which could materially and adversely affect our liquidity and ability to fund and expand our business.

Dividends paid to us by our Chinese subsidiaries may be subject to Chinese withholding tax.

The EIT Law and the implementation regulations provide that a 10% withholding tax may apply to dividends payable to investors that are “non-resident enterprises,” to the extent such dividends are derived from sources within China and in the absence of any tax treaty that may reduce such withholding tax rate.

Our contractual arrangements with our subsidiaries in China may be subject to audit or challenge by the Chinese tax authorities, and a finding that our subsidiaries in China owe additional taxes could substantially reduce our net income and the value of our stockholders’ investment.

Under the applicable laws and regulations in China, arrangements and transactions among related parties may be subject to audit or challenge by the Chinese tax authorities. We would be subject to adverse tax consequences if the Chinese tax authorities were to determine that the contracts with or between our subsidiaries were not executed on an arm’s length basis, and as a result the Chinese tax authorities could require that our Chinese subsidiaries adjust their taxable income upward for Chinese tax purposes. Such an adjustment could adversely affect us by increasing our tax expenses.

We may have difficulty maintaining adequate management, legal and financial controls in China, which we are required to do in order to comply with Section 404 of the Sarbanes-Oxley Act and securities laws, and which could cause a material adverse impact on our consolidated financial statements, the trading price of our common stock and our business.

Chinese companies have historically not adopted a western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and computer, financial and other control systems. Most of our middle management staff in China are not educated in the western system, and we may have difficulty hiring new employees in China with experience and expertise relating to accounting principles generally accepted in the U.S. and U.S. public-company reporting requirements. These issues could make it more difficult for us to

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establish and maintain adequate internal control over our financial reporting, which could then result in errors that could cause a material misstatement of our consolidated financial statements.

We may be exposed to liabilities under the FCPA and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.

We are subject to the Foreign Corrupt Practices Act of 1977, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties and we make significant sales in China. China also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by our employees, consultants, sales agents or distributors, even though they may not always be subject to our control. Although we have implemented policies and procedures to discourage these practices by our employees, our existing safeguards and any future improvements may prove to be less than effective, and our employees, consultants, sales agents or distributors may engage in conduct for which we might be held responsible. Violations of the FCPA or anti-corruption laws in other countries may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition.

Risks Related to Ownership of Our Common Stock

Our stock price may be volatile due to fluctuation of our financial results from quarter-to-quarter and other factors.

Our quarterly revenue and results of operations have varied in the past and may continue to vary significantly from quarter to quarter. This variability may lead to volatility in our stock price as research analysts and investors respond to these quarterly fluctuations. These fluctuations are due to numerous factors, including:

fluctuations in demand for our products;

the timing, size and product mix of sales of our products;

changes in our pricing and sales policies, particularly in the first quarter of the year, or changes in the pricing and sales policies of our competitors;

our ability to design, manufacture and deliver products to our customers in a timely and cost-effective manner and that meet customer requirements;

quality control or yield problems in our manufacturing operations;

our ability to timely obtain adequate quantities of the components used in our products;

length and variability of the sales cycles of our products;

unanticipated increases in costs or expenses; and

fluctuations in foreign currency exchange rates.

The foregoing factors are difficult to forecast, and these, as well as other factors, could materially adversely affect our quarterly and annual results of operations in the future. In addition, a significant amount of our operating expenses is relatively fixed in nature due to our internal manufacturing, research and development, sales and general administrative efforts. Any failure to adjust spending quickly enough to compensate for a revenue shortfall could magnify the adverse impact of such revenue shortfall on our results of operations. Moreover, our results of operations may not meet our announced financial outlook or the expectations of research analysts or investors, in which case the price of our common stock could decrease significantly. There can be no assurance that we will be able to successfully address these risks.

The market price of our common stock could be subject to wide fluctuations in response to, among other things, the risk factors described in this section of this Quarterly Report on Form 10-Q, and other factors beyond our control, such as fluctuations in the valuation of companies perceived by investors to be comparable to us.

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The stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, such as recessions, sovereign debt or liquidity issues, interest rate changes or international currency fluctuations, may negatively affect the market price of our common stock.

In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

Our failure to prepare and file timely our periodic reports with the SEC may make it more difficult for us to access the public markets to raise debt or equity capital.

In January 2017 we did not file a Current Report on Form 8-K reporting the completion of the sale of the assets of our Low Speed Transceiver Products within the time frame required by the SEC. As a result of our failure to file this Current Report by the filing date required by the SEC, we are not eligible to file or use a Form S-3 registration statement to conduct public offerings until our filings with the SEC have been timely made for a full year. Our ineligibility to use Form S-3 during this time period may have a negative impact on our ability to quickly access the public capital markets because we would be required to file a long-form registration statement and wait for the SEC to declare such registration statement effective. This may limit our ability to access the public markets quickly to raise debt or equity capital. Our limited ability to access the public markets could prevent us from pursuing transactions or implementing business strategies that we believe would be beneficial to our business.

The concentration of our capital stock ownership with our principal stockholders, executive officers and directors and their affiliates may limit other stockholders’ ability to influence corporate matters.

As of December 31, 2016, our executive officers and directors, and entities that are affiliated with them or that have a right to designate a director, beneficially own an aggregate of approximately 39% of our outstanding common stock. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. Also, as a result, these stockholders, acting together, may be able to control our management and affairs and matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions.

Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock.

Our amended and restated certificate of incorporation and our amended and restated bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:

providing for a classified board of directors with staggered, three-year terms;

not providing for cumulative voting in the election of directors;

authorizing our board of directors to issue, without stockholder approval, preferred stock rights senior to those of common stock;

prohibiting stockholder action by written consent;

limiting the persons who may call special meetings of stockholders; and

requiring advance notification of stockholder nominations and proposals.

In addition, we have been governed by the provisions of Section 203 of the Delaware General Corporate Law since the completion of our initial public offering. These provisions may prohibit large stockholders, in particular those

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owning 15% or more of our outstanding common stock, from engaging in certain business combinations without approval of substantially all of our stockholders for a certain period of time.

These and other provisions in our amended and restated certificate of incorporation, our amended and restated bylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

See Index to Exhibits at the end of this report.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		NeoPhotonics Corporation

Date:	May 9, 2017	By:	/S/ CLYDE RAYMOND WALLIN
			Clyde Raymond Wallin
			Chief Financial Officer and Senior Vice President
			(Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit
no.

Description of exhibit

Form

SEC File No.

Exhibit

Filing Date

Filed Herewith

2.1

Asset Purchase Agreement dated December 14, 2016 between APAT Optoelectronics Components Co., Ltd., NeoPhotonics Dongguan Co., Ltd. and NeoPhotonics (China) Co., Ltd.*

Form 8-K

001-35061

2.1

January 23, 2017

2.2

Supplementary Agreement to Asset Purchase Agreement, dated January 12, 2017, between APAT Optoelectronics Components Co., Ltd., NeoPhotonics Dongguan Co., Ltd. and NeoPhotonics (China) Co., Ltd.*

Form 8-K

001-35061

2.2

January 23, 2017

2.3

Second Supplementary Agreement to Asset Purchase Agreement, dated January 14, 2017, between APAT Optoelectronics Components Co., Ltd., NeoPhotonics Dongguan Co., Ltd. and NeoPhotonics (China) Co., Ltd.*

Form 8-K

001-35061

2.3

January 23, 2017

3.1

Amended and Restated Certificate of Incorporation of NeoPhotonics Corporation.

Form 8-K

001-35061

3.1

February 10, 2011

3.2

Amended and Restated Bylaws of NeoPhotonics Corporation.

Form S-1

333-166096

3.4

November 22, 2010

4.1

Specimen Common Stock Certificate of NeoPhotonics Corporation.

Form S-1

333-166096

4.1

May 17, 2010

4.2

2008 Investors’ Rights Agreement by and between NeoPhotonics Corporation and the investors listed on Exhibit A thereto, dated May 14, 2008.

Form S-1

333-166096

4.2

April 15, 2010

4.3

Commitment to File Registration Statement and Related Waiver of Registration Rights by and between NeoPhotonics Corporation and Open Join Stock Company “RUSNANO” dated as of December 18, 2014.

Form S-1

333-201180

4.4

December 19, 2014

10.1

Tenth Amendment dated January 3, 2017 to Revolving Credit and Term Loan Agreement, dated March 21, 2013, by and between NeoPhotonics Corporation and Comerica Bank, as Agent and sole Lender.

Form 10-K

001-35061

10.59

March 16, 2017

10.2

Term Loan Agreement, dated March 29, 2017, by and between NeoPhotonics Semiconductor GK and The Bank of Tokyo-Mitsubishi**.

31.1

Certification pursuant to Rule 13a-14(a)/15d-14(a).

31.2

Certification pursuant to Rule 13a-14(a)/15d-14(a).

32.1

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

XBRL Instance Document.

101.SCH

XBRL Taxonomy Extension Schema Document.

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document.

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Exhibit
no.

Description of exhibit

Form

SEC File No.

Exhibit

Filing Date

Filed Herewith

101.LAB

XBRL Taxonomy Extension Label Linkbase Document.

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document.

+ Management compensatory plan or arrangement.

* Translation to English of an original Chinese document.

** Tranlation to English of an original Japanese document.

Exhibit 10.2

[Translation – For Reference Purposes Only]


	Stamp

Term Loan Agreement with Loan Availability Period

(690,000,000 JPY)


Borrower	NeoPhotonics Semiconductor GK

Lender	The Bank of Tokyo-Mitsubishi UFJ, Ltd.

March 29, 2017

Table of Contents*

Article 1 (Definitions)	2
Article 2 (Lender’s Rights and Obligations)	4
Article 3 (Use of Proceeds)	5
Article 4 (Application for Individual Loans)	5
Article 5 (Conditions Precedents for Individual Loans)	5
Article 6 (Advancement of Individual Loans)	6
Article 7 (Non-advancement of Individual Loans)	6
Article 8 (Termination of Lending Obligation)	6
Article 9 (Integration of Individual Loans)	6
Article 10 (Repayment of Principal)	6
Article 11 (Interest)	6
Article 12 (Repayment before Maturity)	6
Article 13 (Facility Fee)	7
Article 14 (Structuring Fee, Expenses, Tax and Break Funding Cost)	8
Article 15 (Automatic Payment of Borrower’s Obligation)	8
Article 16 (Representations and Warranties of Borrower)	9
Article 17 (Covenants of Borrower)	10
Article 18 (Reports by Borrower)	11
Article 19 (Borrower’s Obligation to Obtain Prior Consents)	12
Article 20 (Financial Covenants)	12
Article 21 (Breach of Financial Covenants)	13
Article 22 (Event of Default)	13
Article 23 (Amendment of Agreement)	14
Article 24 (Notarized Deed)	14
Article 25 (Inconsistencies)	14
Article 26 (Negotiation in Good Faith)	15

*Exhibit 1 – Exhibit 6 Omitted. Per Regulation S-K, Item 601(b)(2), the Registrant hereby agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Commission upon request.

Term Loan Agreement with Loan Availability Period

NeoPhotonics Semiconductor GK (the “ Borrower ”) and The Bank of Tokyo-Mitsubishi UFJ, Ltd. (the “ Lender ”) hereby acknowledge the terms of the Banking Transaction Agreement ( gintori yakujo ) and agree as follows on March 29, 2017 (this “ Agreement ”).

Article 1 (Definitions)

The following terms shall, unless the context otherwise requires, have the meanings set forth below for purposes of this Agreement:

(1)

“ Business Day ” means a day on which banks shall be open for business in accordance with Japanese laws and regulations.

(2)

“ Lending Obligation ” means the obligation of the Lender to lend money to the Borrower as set forth in Article 2.1.

(3)

“ Maximum Loan Amount ” means 690,000,000 JPY (or, if amended in accordance with Article 2.3, such amount as amended).

(4)

“ Lending Impossibility Period ” means a period commencing on the date on which the Borrower receives a notice from the Lender stating that a Lending Impossibility Event has occurred (inclusive) and ending on the date on which the Borrower receives a notice from the Lender stating that the Lending Impossibility Event has been resolved (inclusive).

(5)

“ Lending Impossibility Event ” means natural disaster, war, civil disturbance, acts of terror, arson and other events caused by man, breakdown or fault of electricity supply, communications or various types of settlement system functions, an event occurring at the Tokyo Interbank Market that makes it impossible to make yen lending transactions or an event not attributable to the Lender that makes it impossible or materially difficult to advance Individual Loans.

(6)

“ Loan Request Letter ” means a request letter in the form attached hereto as Exhibit 1 (Loan Request Letter).

(7)

“ Base Rate ” means the Japanese yen rate of the Lender displayed on page 58143 of Reuters Monitor corresponding to the relevant Interest Calculation Period as of 2 Business Days prior to the Advancement Date (in the case of the initial Interest Calculation Period) or 2 Business Days prior to the last day of the Interest Calculation Period immediately preceding the relevant Interest Calculation Period (in the case of the second Interest Calculation Period and after). If there is no such Japanese yen rate corresponding to the relevant Interest Calculation Period, the “ Base Rate ” shall be a rate reasonably determined by the Lender for the relevant period with reference to the lending rate ( dashite kinri ) used in yen loan transactions in the financial market as of 2 Business Days prior to the Advancement Date (in the case of the initial Interest Calculation Period) or 2 Business Days prior to the last day of the Interest Calculation Period immediately preceding the relevant Interest Calculation Period (in the case of the second Interest Calculation Period and after).　If such Japanese yen rate is not displayed for any reason, the “ Base Rate ” shall be a rate displayed on a successor page or an alternative page.

(8)

“ Principal Repayment Date ” means, commencing on April 27, 2018, the last of any calendar month during the period up to the Maturity Date (exclusive). If any such day is not a Business Day, the “ Principal Repayment Date ” shall be the next succeeding Business Day unless such Business Day falls in another calendar month, in which case the “ Principal Repayment Date ” shall be the immediately preceding Business Day.

(9)

“ Banking Transaction Agreement ” means the Banking Transaction Agreement ( ginko torihiki yakujo sho ) separately submitted by the Borrower to the Lender or executed by the Borrower with the Lender.

(10)

“ Financial Documents ” means the documents as specified in (i) to (iv) below:

(i)

Financial statements, business reports and supplementary schedules for each fiscal year as stipulated in Article 435, paragraph 2 of Company Act.

(ii)

Provisional financial statements actually prepared in accordance with Article 441, paragraph 1 of Company Act.

(iii)

Consolidated Financial Statements (which shall collectively refer to a consolidated balance sheet, consolidated profit-and-loss statement, consolidated statement of changes in net assets and notes to consolidated financial statements, the same in this item (iii)) as stipulated in Article 444, paragraph 1 of Company Act for each fiscal year required in accordance with Article 444, paragraph 3 of Company Act and any other Consolidated Financial Statement as stipulated in Article 444, paragraph 1 of Company Act actually prepared.

(iv)

Balance sheet, profit-and-loss statement, statement of changes in net assets and notes to financial statements, whether consolidated or non-consolidated, actually prepared.

(11)

“ Accounting Term ” means a period commencing on the first day of a fiscal year (inclusive) and ending on the last day of the same fiscal year (inclusive).

(12)

“ Tax ” means income tax, corporate tax and any and all other tax and public dues imposed in Japan.

(13)

Each of “ Subsidiaries ” and “ Affiliate Company ” shall have the meanings ascribed to such terms in Article 8 of the Ordinance on Terminology, Forms, and Preparation Methods of Consolidated Financial Statements ( zaimu shohyo tou no yogo, yoshiki oyobi sakusei hoho ni kansuru kisoku ).

(14)

“ Individual Loans ” mean the loans to be advanced in accordance with each Loan Request Letter.

(15)

“ Individual Loan Proceeds ” means the proceeds of Individual Loans advanced to the Borrower by the Lender. “ Individual Loan Amount ” means the amount of Individual Loan Proceeds.

(16)

“ Individual Loans Integration Date ” means the first Payment Date falling after the Commitment Termination Date (inclusive).

(17)

“ Individual Loan Obligations ” means principal, interest, default interest, the Break Funding Cost and any other obligations owed by the Borrower in relation to each Individual Loan under this Agreement.

(18)

“ Commitment Period ” means a period commencing on the Effectuation Date (inclusive) and ending on the date on which the Lender’s Lending Obligation shall terminate (inclusive).

(19)

“ Commitment Termination Date ” means March 30, 2018. If such day is not a Business Day, the “ Commitment Termination Date ” shall be the immediately preceding Business Day.

(20)

“ Desired Advancement Date ” means a Business Day during the Commitment Period specified by the Borrower in the Loan Request Letter as the date the Borrower desires an Individual Loan to be advanced.

(21)

“ Advancement Date ” means a date on which an Individual Loan is advanced.

(22)

“ Spread ” means 1.000% per annum.

(23)

“ Break Funding Cost ” means an amount calculated in accordance with the calculation formula below; provided, however, that no Break Funding Cost shall arise if the amount calculated falls below zero.

Amount to be repaid x (the market rate of the Loan (#1) – the market rate at the time of the repayment (#2)) x the number of days in the remaining period (#3) at the time of the repayment / 365 days

#1 The interest rate applicable when the Lender raises the fund from the market.

#2 The interest rate applicable in the market if the Lender make investments during the remaining period.

#3 The period commencing on the date of repayment and ending on the next succeeding interest rate renewable date (if there is no next succeeding interest rate renewable date, the Maturity Date).

(24)

“ Applicable Rate ” means a rate calculated as the Base Rate added by the Spread; provided, however, that the “ Applicable Rate ” may be changed in accordance with provisions in this Agreement.

(25)

“ Effectuation Date ” means March 31, 2017.

(26)

“ Facility Fee ” means a fee payable by the Borrower to the Lender as consideration for the Lending Obligation.

(27)

“ Facility Fee Calculation Period ” means a period commencing on the Effectuation Date

(inclusive) and ending on the Commitment Termination Date (inclusive).

(28)

“ Facility Fee Calculation Rate ” means 1.000% per annum.

(29)

“ Due Date ” means the Principal Repayment Date and the Maturity Date (in the case of the principal), the Payment Date (in the case of the interest), the date specified in Article 13, paragraph 1 (in the case of the Facility Fee) and such other date specified as the date on which certain payment shall be made under this Agreement.

(30)

“ Collection Account ” means a bank account held by the Borrower at Hachioji Branch of The Bank of Tokyo-Mitsubishi UFJ, Ltd. (Account Number: 0494084, Account Name: NeoPhotonics Semiconductor GK) or certain other bank account to be opened by the Borrower and acknowledged by the Lender at the head office or any other branch of The Bank of Tokyo-Mitsubishi UFJ, Ltd.

(31)

“ Reports ” means securities report, semiannual report, quarterly report, extraordinary report, reissued report and certain other reports.

(32)

“ Governmental Rules ” means treaties, laws, rules, codes, ordinances, decisions, regulations, judicial or administrative order, arbitral award, judgment, releases, guidelines and other public policies of relevant government authority.

(33)

“ Loan ” means each of the Individual Loans before the Individual Loans are integrated into one in accordance with Article 9 and such single loan after the Individual Loans are integrated into one in accordance with Article 9.

(34)

“ Loan Obligation ” means principal, interest, default interest, the Break Funding Cost and any other obligations owed by the Borrower in relation to the Loan under this Agreement.

(35)

“ Maturity Date ” means March 29, 2024. If such day is not a Business Day, the “ Maturity Date ” shall be the next succeeding Business Day unless such Business Day falls in another calendar month, in which case the “ Maturity Date ” shall be the immediately preceding Business Day.

(36)

“ Unused Maximum Loan Amount ” means the amount of Maximum Loan Amount deducted by the sum of the principals of advanced Individual Loans (including the repaid Individual Loans).

(37)

“ Interest Calculation Period ” means, for each Loan, a period commencing on the Advancement Date of such Loan and ending on the initial Payment Date and, after that, a period commencing on the next day of the immediately preceding Payment Date and ending on the next Payment Date.

(38)

“ Payment Date ” means a date on which interest shall be paid and means the last day of each calendar month falling in the period commencing on the Advancement Date of the first Individual Loan and ending on the Maturity Date (exclusive) and the Maturity Date. If such day is not a Business Day, the “ Payment Date ” shall be the next succeeding Business Day unless such Business Day falls in another calendar month, in which case the “ Payment Date ” shall be the immediately preceding Business Day.

Article 2 (Lender’s Rights and Obligations)

The Lender shall lend, in accordance with this Agreement, money up to the Maximum Loan Amount to the Borrower if the requirements provided for in each item of Article 5 are satisfied.

If the Lender, on any Desired Advancement Date, fails to advance an Individual Loan relating to the relevant Desired Advancement Date in breach of the Lending Obligation, the Lender shall, upon request by the Borrower, immediately compensate the Borrower for all damages, losses and expenses incurred by the Borrower as a result of such breach; provided, however, that the maximum amount of such compensation to the Borrower shall be the remaining amount after deducting (i) the interest and other expenses that would have been required by the Borrower to be paid during the period from such Desired Advancement Date to the Payment Date that arrives on or immediately after the day following such Desired Advancement Date if such Individual Loan were made on such Desired Drawdown Date, from (ii) the interest and other expenses that is required or would be required by the Borrower to be paid during such period if the Borrower separately borrows money as a result of such failure to advance the Individual Loan on such Desired Advancement Date.

During the Commitment Period, the Borrower may reduce all or any part of the Maximum Loan

Amount by the amount equal to the Unused Maximum Loan Amount or less by notifying in the form attached hereto as Exhibit 3 (Maximum Loan Amount Reduction Notice) to the Lender at least 10 Business Days in advance. The Borrower may not cancel such notice and the reduction of all or any part of the Maximum Loan Amount shall take effect on the date specified in the notice that such reduction of amount is desired.

Article 3 (Use of Proceeds)

The Borrower shall use the proceeds of the Individual Loans solely for (i) acquisition of equipment for the manufacturing line of the main products described in attached Exhibit 2 (Specifications of Equipment) (the “ Equipment ”) and (ii) payment of related costs. The projects in which the Borrower purchases and operates equipment for the manufacturing line of the main products, including the Equipment, shall collectively be referred to as the “ Project. ”

Article 4 (Application for Individual Loans)

If the Borrower desires to drawdown an Individual Loan, the Borrower shall indicate to the Lender its intention to request the Individual Loan by sending the Loan Request Letter to the Lender by facsimile and confirming the receipt of the Loan Request Letter by the Lender by noon of the third Business Day prior to the Desired Advancement Date; provided, however, that in the case where the Effectuation Date is the Desired Advancement Date, the Borrower shall do so by 2 PM on the execution date of this Agreement. Such indication of intention to request such Individual Loan shall be effective at the time that such confirmation is made by the Borrower. If such confirmation is not made, the Lender may deem that the request for the Individual Loan has not been made. After the Lender receives the Loan Request Letter, the Borrower may not, for any reason, cancel or change the request for the Individual Loan.

The amount of the Individual Loan to be specified in the Loan Request Letter shall be no less than 1,000,000 yen and in increments of 100,000 yen, and at the same time, shall be an amount that does not exceed the Unused Maximum Loan Amount to be specified in the Loan Request Letter on the Desired Advancement Date.

The number of times for drawdown of Individual Loans shall be up to 1 time on the same Desired Advancement Date.

Article 5 (Conditions Precedents for Individual Loans)

During the Commitment Period, the Lender shall make an Individual Loan for the relevant Desired Advancement Date provided that the conditions in each of the following items are satisfied on each Desired Advancement Date. The satisfaction of such conditions shall be determined by the Lender.

(1)

The request for an Individual Loan satisfies the requirements provided for in Article 4.

(2)

The relevant Desired Advancement Date does not fall on any date during Lending Impossibility Period.

(3)

All the facts that the Borrower represents and warrants in each item of Section 16 are true and correct.

(4)

No matter provided for in Article 22, paragraph 1 and Article 22, paragraph 2 and in Article 5, paragraph 1 and Article 5, paragraph 2 of Banking Transaction Agreement has occurred or is likely to occur.

(5)

The Borrower has not breached any provision of this Agreement and any other agreements entered into with the Lender, and there is no threat that the Borrower may breach such provisions on or after the Desired Advancement Date.

(6)

The Lender has received the following documents from the Borrower on the execution date of this Agreement, and the Lender is satisfied with the details thereof:

(i) The business plan for the Project (including, without limitation, progress schedule chart and financial plan; the “ Business Plan ”)

(ii) Documents supporting the amount to be paid for the Equipment.

(7)

The Lending Obligation of the Lender has not been terminated pursuant to the provisions of this Agreement.

(8)

The Borrower has submitted documents supporting the use of proceeds (including, without limitation, invoices and quotations) to the Lender, and the desired drawdown amount of the Individual Loan described in the Loan Request Letter is equal to or less than the amount described in such documents supporting the use of proceeds.

Article 6 (Advancement of Individual Loans)

If the Lender receives a request for an Individual Loan in accordance with Article 4 and all conditions provided for in each item of Article 5 are satisfied on the Desired Advancement Date, the Lender shall remit the Individual Loan Amount relating to such Desired Advancement Date to the Collection Account on such Desired Advancement Date.

Article 7 (Non-advancement of Individual Loans)

Except for in the case of Article 2, paragraph 2, the Borrower shall be responsible for any damages, losses or expenses incurred by the Lender as a result of the failure to make the Individual Loan by the Lender.

Article 8 (Termination of Lending Obligation)

If any of the events described in the items below occurs, the Lender’s Lending Obligation shall terminate. Until the Borrower completely pays all of its debts under this Agreement, the relevant provisions of this Agreement shall survive in full force and effect.

(1)

The Commitment Termination Date expires.

(2)

The debts of the Borrower are accelerated pursuant to Article 22.

(3)

The Unused Maximum Loan Amount becomes zero.

Article 9 (Integration of Individual Loans)

All of the Individual Loans shall be integrated to one loan on the Individual Loans Integration Date.

Article 10 (Repayment of Principal)

The Borrower, with respect to the principal of the Loan, shall repay the amount obtained by dividing the principal amount of the Loan upon the integration of all of the Loans on the Individual Loans Integration Date by 72 (provided, however, that if fractions less than 1,000 yen arise, they shall be rounded down, and the repayment amount on the Maturity Date shall be the amount obtained by deducting the total amount of the principal repayment amount on each Principal Repayment Date from the principal amount of the Loan) on each Principal Repayment Date and the Maturity Date to the Lender in accordance with the provisions of Article 15.

Article 11 (Interest)

The Borrower shall pay in arrears the total amount of interest calculated as the outstanding principal amount of the Loan for each Interest Calculation Period (minimum denomination on which interest is calculated is 100 yen), multiplied by (i) the Applicable Rate for such Interest Calculation Period and (ii) the actual number of days of such Interest Calculation Period, on the Payment Date that falls on the last day of such Interest Calculation Period, in accordance with the provisions of Article 15.

The calculation method for interest in the preceding paragraph shall be on a per diem basis, inclusive of first and last day, assuming that there are 365 days per year, wherein divisions shall be done at the end of the calculation, and fractions less than one yen shall be rounded down.

Article 12 (Repayment before Maturity)

If the Borrower makes an early repayment, the Borrower shall give a written notice in the form of attached Exhibit 4 (Planned Early Repayment Notice) to the Lender by 5 Business Days prior to the date the Borrower plans to make the early repayment (the “ Planned Early Repayment Date ”), stating

(a) the early repayment principal amount, (b) that the Borrower will pay in full on the Planned Early Repayment Date, the interest on the early repayment principal amount that has accrued during the period up to the Planned Early Repayment Date (inclusive), and (c) the Planned Early Repayment Date.

The Borrower shall pay, in the way prescribed by the Lender, the total amount of (i) the principal of the Loan to be repaid early, (ii) the interest provided for in (b) of the preceding paragraph and (iii) the Break Funding Cost on the Planned Early Repayment Date.

If the Borrower sells, transfers or otherwise disposes of all or any part of the Equipment to a third party after the Borrower obtains the Lender’s prior consent pursuant to Article 19, item (4), the Borrower shall pay on the Payment Date immediately following the date of such disposition (the “ Mandatory Repayment Date ”) the total amount of (i) the principal amount of the Loan equivalent to such disposition price, (ii) the interest on such principal amount that has accrued during the period up to the Mandatory Repayment Date (inclusive) and (iii) the Break Funding Cost.

In the case where early repayment is made in accordance with paragraph 1 and paragraph 2, if the Break Funding Cost arises, the Lender shall notify the Borrower of the amount of the Break Funding Cost by 2 Business Days prior to the Planned Early Repayment Date or the Mandatory Repayment Date.

If the Loan after the integration on the Individual Loans Integration Date is repaid early in accordance with this Article, the repayment shall be applied to the principal of the Loan in reverse chronological order of the Due Date.

If there is loss, damage or dysfunction of the Equipment due to fire or earthquake, etc. or any other event occurs that makes it obviously difficult to continue the Project, the Borrower shall make an early repayment, concurrently with the occurrence of such event, for the total amount of (i) full principal amount of the Loan (ii) the interest on such principal amount that has accrued during the period up to the early repayment date (inclusive) and (iii) the Break Funding Cost.

Article 13 (Facility Fee)

The Borrower shall pay to the Lender in the way prescribed by the Lender on the Effectuation Date a Facility Fee in the amount calculated as the Maximum Loan Amount multiplied by (i) the Facility Fee Calculation Rate and (ii) the actual number of the days of the Facility Fee Calculation Period, and divided by 365 days. Except for in the cases of paragraphs 2 through 4, the Lender shall not be required to return the Facility Fee that it receives.

If a Lending Impossibility Event occurs, the Borrower shall not be required to pay to the Lender, with respect to the Facility Fee in relation to the Lending Impossibility Period, the amount calculated as the total amount of the Maximum Loan Amount on each day during the Lending Impossibility Period, multiplied by the Facility Fee Calculation Rate, and divided by 365. If the Lender has already received an equivalent amount of such money, the Lender shall return such amount to the Borrower immediately after the termination of the Lending Impossibility Period.

If the Lending Obligation is terminated pursuant to the provisions of Article 8, item (2), the Borrower shall not be required to pay to the Lender, with respect to the Facility Fee in relation to the period after the termination of the Lending Obligation, the amount calculated as the total amount of the Unused Maximum Loan Amount on each day during the period from the day (inclusive) of termination of the Lending Obligation and ending on the Commitment Termination Date (inclusive), multiplied by the Facility Fee Calculation Rate, and divided by 365. If the Lender has already received the amount equivalent to such money, the Lender shall return such amount to the Borrower immediately after the day when all obligations of the Borrower under this Agreement are repaid.

If the Borrower reduces all or any part of the Maximum Loan Amount pursuant to the provisions of Article 2, paragraph 3, the Borrower shall not be required to pay to the Lender, with respect to the Facility Fee in relation to the period after the reduction of the Maximum Loan Amount, the amount calculated as the actual number of the days of the period from the day (inclusive) of reduction of the Maximum Loan Amount and ending on the Commitment Termination Date (inclusive), multiplied by

the amount reduced and Facility Fee Calculation Rate, and divided by 365. If the Lender has already received the amount equivalent to such money, the Lender shall return such amount to the Borrower immediately after the reduction of the Maximum Loan Amount.

The method for calculating the Facility Fee pursuant to each preceding paragraph shall be on a per diem basis, inclusive of first and last day, assuming that there are 365 days per year, wherein divisions shall be done at the end of the calculation, and fractions less than one yen shall be rounded down. Further, if an advancement of an Individual Loan by the Lender or a change of the Maximum Loan Amount in accordance with the provisions of Article 2, paragraph 3 is made, in the calculation of the Facility Fee, the principal amount of the Lender’s Individual Loan Obligation and the Maximum Loan Amount as of the date that such advancement or change is made shall be the principal amount of the Lender’s Individual Loan Obligation and the Maximum Loan Amount which has been increased or reduced by such advancement or change.

Article 14 (Structuring Fee, Expenses, Tax and Break Funding Cost)

The Borrower shall pay 14,904,000 yen (including consumption tax and local consumption tax) in the way prescribed by the Lender as the fee regarding the structuring of the loan under this Agreement (the “ Structuring Fee ”) to the Lender on the Advancement Date for the initial Individual Loan.

The Lender shall not be required to return the Structuring Fee that it receives. Provided, however, that the Lender may return all or any part of the Structuring Fee if it so determines.

In addition to the cases provided for in each preceding paragraph, all reasonable expenses (including, without limitation, Tax such as stamp duties, attorney’s fees and judicial scrivener’s fees) incurred in connection with the preparation and any revision or amendment of this Agreement and advancement of the Loan under this Agreement, and all reasonable expenses (including, without limitation, attorney’s fees, judicial scrivener’s fees and expenses for investigation pursuant to Article 17, item (14) (expenses arising on or after the execution of this Agreement shall be borne by the Borrower; the Lender shall claim the expenses for the investigation by submitting the document in the form of Exhibit 6 (Investigation Expense Claim) to the Borrower)) incurred in relation to the preservation, maintenance and exercise of the rights by the Lender pursuant to this Agreement shall be borne by the Borrower. If the Lender has paid these expenses in the place of the Borrower, the Borrower shall, immediately upon the Lender’s request, pay the same to the Lender.

If the principal of the Loan is repaid or set off for any reason not attributable to the Lender, the Borrower shall pay to the Lender in the way prescribed by the Lender, on the same date of such repayment or set off, the total amount of the interest on principal of the Loan repaid or set off that has accrued during the period up to such repaid date or set off date (inclusive) and the Break Funding Cost. In the case of set off, “early repayment” shall be read as “set off” in the formula described in the definition of “Bread Funding Cost” provided for in Article 1.

In the cases where the early repayment is made pursuant to Article 12, the principal of the Loan is repaid or set off for any reason not attributable to the Lender, and all of the Borrower’s debts owed to the Lender under this Agreement are accelerated due to the occurrence of any event provided for in this Agreement or Banking Transaction Agreement, the Borrower shall pay immediately to the Lender in the way prescribed by the Lender the Breaking Funding Costs and other expenses relating to such early repayment, repayment, set off or acceleration, etc. that the Lender deems necessary. In the case of acceleration, “early repayment” shall be read as “acceleration” in the formula described in the definition of “Bread Funding Cost” provided for in Article 1.

Article 15 (Automatic Payment of Borrower’s Obligation)

The Borrower shall request to the Lender that the Lender withdraw funds from the Collection Account, on each Due Date of the Borrower’s obligations provided for in this Agreement, for the payment amount of the Borrower’s obligations provided for in this Agreement and apply the funds for each payment amount. With respect to this payment procedure, submission by the Borrower of any passbook, payment request or check shall not be required.

In the case where the balance of the Collection Account is not sufficient for the payment amount, the Borrower shall not object if the Lender, at its discretion, applies the balance for any part of the payment amount or does not apply the balance for any payment amount at all.

If the Borrower is unable to perform its obligations on each Due Date and will make a payment at a later date, the Lender may, with respect to the amount equivalent to the payment amount and damages, withdraw from the Collection Account and apply funds pursuant to paragraph 1.

If an Event of Default has occurred to the Borrower, notwithstanding any terms and conditions for deposit accounts in relation to the Collection Account, the Borrower shall grant to the Lender the authority to withdraw any amount of funds from the Collection Account. The Lender may apply, at its discretion, the funds withdrawn by using such authority for the repayment of the Loan and all of the Borrower’s debts owed to the Lender.

Article 16 (Representations and Warranties of Borrower)

The Borrower represents and warrants to Lender as of the date hereof and each Advancement Date that each of the following matters are true and accurate. If any representation or warranty set forth below is found to be incorrect or inaccurate, the Borrower shall indemnify the Lender for any damages and expenses suffered or borne by the Lender.

(1)

The execution and performance of this Agreement and the transaction contemplated herein do not violate (i) the Governmental Rules applicable to the Borrower, (b) the Borrower’s articles of incorporation and other internal rules and (c) agreements or contracts to which the Borrower is a party by which the Borrower or its assets are bound.

(2)

The Agreement is legal, valid and binding upon the Borrower and enforceable against the Borrower in accordance with the provisions thereof.

(3)

The Financial Documents (which shall mean the audited Financial Documents if the Borrower is required to conduct an audit under the Governmental Rules or the Borrower otherwise conducted an audit. Further, if the Borrower prepared the Reports, the Financial Documents shall include such Report; hereinafter the same) prepared by the Borrower are prepared accurately and lawfully in accordance with generally accepted accounting principles in Japan.

(4)

No events have occurred after the end of the Accounting Term of the Borrower which ended in December 2016, that will, or that is likely to, materially and adversely affect the ability of the Borrower to perform its obligations hereunder (such as the degradation or deterioration of business, assets or financial status of the Borrower, its Subsidiaries and its Affiliate Companies as shown in the Financial Documents or other finance documents prepared by the Borrower as of the said Accounting Term).

(5)

No litigation, preservative proceeding, compulsory execution proceeding, conciliation, arbitration, administrative proceeding or any other kind of dispute that will, or that is likely to, materially and adversely affect the ability of the Borrower to perform its obligations hereunder have been instituted or commenced and there is no threat of the institution or commencement of any of the above-mentioned proceedings.

(6)

The Borrower is not liable for any indebtedness that will, or that is likely to, materially and adversely affect the ability of the Borrower to perform its obligations hereunder.

(7)

All of the documents submitted by the Borrower to the Lender are true and accurate in material respects, do not contain any misleading statements and include every statement required for the Lender to unmistakenly judge whether to execute this Agreement and advance the Individual Loans. Any future projections contained therein have been made using a reasonable methodology. No facts adversely affecting, or which are likely to adversely affect, such projection have occurred after the submission date of such documents.

(8)

The Borrower is maintaining all permits necessary to engage in its main business and is running its business in compliance with all of the Governmental Rules.

(9)

The Business Plan is planned reasonably to the level satisfactory to the Lender and there is no threat that the Business Plan will be delayed or terminated.

(10)

There are no obstacles, or the threat thereof, to the accomplishment of the Project.

(11)

That certain purchase and sale agreement (the “ Purchase and Sale Agreement ”) by and between the Borrower and the seller of the Equipment is legally and validly executed and maintained and enforceable against parties.

(12)

The Equipment are free from material defects, and to the best knowledge of the Borrower, there is no threat thereof.

(13)

The seller of the Equipment and any other party to the Project do not fall under any of the following:

(i) an organization that is likely to promote the collective or habitual commission of violent, unlawful or other similar acts, a person belonging to such organization or his affiliate.

(ii) an organization sanctioned under the Act on the Control of Organizations Which Committed Indiscriminate Mass Murder, a person belonging to such organization or his affiliate.

(iii) a person conducting an entertainment and amusement business ( fuzoku eigyo ) as defined in Article 2 of the Act on Control and Improvement of Amusement Business, etc. (Law No. 122 of 1948, as amended) or the money lending business operator ( kashikin gyosha ) as defined in Article 2, paragraph 2 of the Money Lending Business Act.

(iv) a person who conducts or is suspected of conducting concealment of criminal proceeds ( hanzai shueki tou intoku ) and/or receipt of criminal proceeds ( hanzai shueki tou shuju ) as defined in the Act for Punishment of Organized Crimes, Control of Crime Proceeds, or any person who has business with these people.

(vi) a person who is likely to perplex people by intimidating or otherwise threatening by action or by word other people’s personal life or their business, a person who is planning to use the Equipment for such purpose, a person who materially lacks social credibility.

Article 17 (Covenants of Borrower)

The Borrower shall comply with the following matters until all of the obligations to the Lender are paid in full.

(1)

The Borrower shall not change its main business.

(2)

The Borrower shall maintain the Collection Account at its cost.

(3)

The Borrower shall prepare its Financial Documents accurately and lawfully in accordance with generally accepted accounting principles in Japan.

(4)

The Borrower shall not (i) offer as security all or part of the Borrower’s mechanical equipment and inventory to, or (ii) enter into any lending transaction for purposes of fundraising with, any person other than the Lender on its behalf or on behalf of a third party. In this Article, “offer as security” means either creating a security (tanpo ken ) (including revolving security, the same in this Article) or promising to create a security ( tanpo ken settei no yoyaku ), and does not include a statutory lien ( sakidori tokken ), a retention right or any other charges created under Governmental Rules.

(5)

The Borrower shall not take any action which destroys or damages the value of the Equipment. The Borrower shall use efforts to maintain its value with the care of a good manager.

(6)

The Borrower shall not enter into an agreement with a third party that will, or that is likely to, materially and adversely affect the Project.

(7)

In the case if the Borrower wishes to change the Business Plan, such Business Plan is planned reasonably to the level satisfactory to the Lender and there is no threat that the Business Plan shall be delayed or aborted.

(8)

The Borrower shall implement the Project continuously and shall not impair the accomplishment of the Project.

(9)

The Borrower shall make sure that none of the parties to the Project falls under (i) to (v) of Article 16, item (13).

(10)

The Borrower shall not bear a guarantee obligation to a third party.

(11)

The Borrower shall commence the operation of the manufacturing line of the main parts to be installed by the Project by the last day of September 2018.

(12)

The Borrower shall enter into a security agreement with the Lender and offer all of the mechanical equipment owned by the Borrower as security to the Lender within 2 months from the date of the confirmation of operation of the mechanical equipment regarding the manufacturing line of the main products to be installed by the Project. The Borrower shall then immediately complete the registration of such collateral assignment of movables ( dosan joto touki ) in accordance with the Law Prescribing Exceptions etc. to the Civil Code Requirements for Setting Up Against a Third Party to an Assignment of Movables and Claims ( dosan oyobi saiken no joto no taikoyoken ni kansuru minpo no tokurei tou ni kansuru horitsu , Law No. 104 of 1998, as amended)(registration is only required for the equipment owned by the Borrower in Japan).

(13)

The Borrower shall maintain 100 % ownership by Parent Company A (Name: Neo Photonics (China) Co. Ltd./ Address: 37 Queen's Road, Central, Hong Kong).

(14)

The Borrower shall accept the inspection described below:

[Purpose of Inspection] To investigate the actual presence of inventory, the management system, business flow and internal management system of the Borrower by obtaining information from the Borrower about its inventory.

[Method of Inspection] Method chosen by the Lender (including, without limitation, a site inspection to be conducted by a third party inspection company) as follows:

(a) Regular Inspection

The first inspection shall be conducted by the end of March 2018. The site inspection is not necessary for the fiscal year in which the Maturity Date falls.

(b) Inspection as Required

When demanded by the Lender.

Article 18 (Reports by Borrower)

The Borrower shall report to the Lender the following matters at its own cost until the obligation to the Lender hereunder is paid in full.

(1)

The Borrower shall immediately notify the Lender in writing if any Event of Default has occurred or is likely to occur.

(2)

If asked by the Lender, the Borrower shall immediately report to the Lender in writing the financial, management and business situation of the Borrower, its Subsidiaries and its Affiliate Companies and provide necessary assistance to the Lender to conduct an investigation.

(3)

The Borrower shall immediately notify the Lender in writing if there occurred any material changes or threat of material changes occur with respect to the financial, management and business situation of the Borrower, its Subsidiaries and its Affiliate Companies.

(4)

The Borrower shall submit a report (the “ Covenants Compliance Report ”) describing the status of compliance with provisions in this Agreement in a form attached hereto as Exhibit 5 (Covenants Compliance Report) within 3 months from the end of each Accounting Term, commencing on the Accounting Term ending in December 2017.

(5)

The Borrower shall submit the copies of Financial Documents or the Reports and the tax returns within 3 months from the end of each Accounting Term, commencing on the Accounting Term ending in December 2017. The Borrower shall immediately report to the Lender in writing if any changes or threat of changes occur to Financial Documents or the Reports and the tax returns submitted to the Lender in accordance with this item (5). If the Borrower made the Reports available online through EDINET, copies thereof shall be deemed to be submitted to the Lender at the time of such online disclosure.

(6)

Commencing in April 2017, the Borrower shall submit a business projection chart ( shisan hyo ) and an indebtedness balance chart ( kariire zandaka hyo ) created for each financial institution separately, both prepared as of the last day of each calendar month, to the Lender in forms satisfactory to the Lender by the last day of the next succeeding calendar month. The Borrower

may change the reference date by obtaining a consent from the Lender if the last day of the Accounting Term is changed.

(7)

Commencing in March 2017, the Borrower shall prepare a report detailing the inventory and the progress of the installation of the Equipment as of the last day of each March, June, September and December in a form satisfactory to the Lender and submit it to the Lender in writing no later than the last day of the month that falls two months from the dates on which the respective reports were prepared.

(8)

The Borrower shall immediately report to the Lender if the Business Plan has to be changed.

(9)

Other than above, the Borrower shall immediately report to the Lender if any event which has a material effect on the Project occurs.

(10)

Immediately after the Advancement Date of each Individual Loan, the Borrower shall submit to the Lender a supporting written document (such as a receipt) evidencing the actual payment of the loan proceeds of such Individual Loan advanced on the relevant Advancement Date (such as a receipt).

Article 19 (Borrower’s Obligation to Obtain Prior Consents)

Until the obligation to the Lender hereunder is paid in full, the Borrower shall obtain prior consent from the Lender if it intends to conduct any of the following matters.

(1)

Materially change the articles of incorporations ( teikan ) of the Borrower.

(2)

Conduct consolidation or merger, corporate split, exchange of shares or equity transfer, organizational change under the Company Act, business transfer or acquisition, transfer or acquisition of material assets, leasing of business to a third party, delegation of the company management to a third party, decrease of capital or capital reserve which has, or may cause, material adverse effects on the ability of the Borrower to perform the obligations hereunder.

(3)

Execute, change or terminate any agreement which may which have, or may cause, material adverse effects on the ability of the Borrower to perform the obligations hereunder.　

(4)

Sell, transfer or otherwise dispose of all or part of the Equipment to a third party.

(5)

Materially change the Business Plan.

Article 20 (Financial Covenants)

Until the obligation to the Lender hereunder is paid in full, the Borrower shall maintain and comply with the financial covenants set out below. Compliance with each financial covenant shall be tested on the last day of the calendar month that is 3 months from the last day of each Accounting Term of the Borrower (the “ Net Asset Covenants Reference Date ”)(in the case of items (i) and (ii) below) and on the last day of the calendar month that is 2 months from the Inventory Rotation Reference Date (defined in item (iii) below) occurs (in the case of items (iii) below) (the “ Inventory Rotation Testing Date ”).

(1)

Commencing on the Accounting Term ending in December 2017, the Borrower shall maintain its net asset on its non-consolidated balance sheet as of the end of each Accounting Term to be (i) 100,000,000 yen or more and (ii) 70% or more of the amount of net asset as of the end of the immediately preceding Accounting Term; provided, however, that, if the amount of non-consolidated net asset of the Borrower is 250,000,000 yen or more as of the Net Asset Covenants Reference Date, the Borrower does not have to meet the 70% criteria.

(2)

Commencing on the Accounting Term ending in December 2017, the Borrower shall maintain the result of the following calculation formula to be 325,000,000 yen or above on its non-consolidated profit and loss statement as of the last day of each Accounting Term:

Ordinary profit and loss + depreciation cost - corporate taxes - dividend

(3)

Commencing in March 2017, the Borrower shall cause the inventory rotation period (to be calculation by the calculation formula set out below) to be 4 months or less as of the last day of each March, June, September and December (the “ Inventory Rotation Reference Date ”) on the Borrower’s non-consolidated balance sheet:

Inventory rotation period (months) = Remaining value of the inventory / (amount of sale proceeds in the relevant subject period / number of months in the relevant subject period)

The subject period and the number of months in the relevant subject period shall be determined in accordance with below:


Inventory Rotation Reference Date	Subject Period	Number of Months in the Relevant Subject Period
The last day of March	January 1 to the last day of March	3
The last day of June	January 1 to the last day of June	6
The last day of September	January 1 to the last day of September	9
The last day of December	January 1 to the last day of December	12

Article 21 (Breach of Financial Covenants)

The Borrower shall conduct the following matters if the Borrower breaches the financial covenants set out in Article 20.

(1)

In case of breach of items (i) or (ii) of Article 20: All obligations of the Borrower to the Lender hereunder shall be accelerated on demand by the Lender and the Borrower shall henceforth immediately pay all such obligations to the Lender; provided, however, that the obligations hereunder may not be accelerated so long as the Borrower conducts the Corrective Action within 90 days from the date on which the Borrower becomes aware of the breach of any of items (i) and (ii) of Article 20 and the Borrower continues to make payments of the interest and principals of the Loan without delay during such 90-day period; provided, further, that the Lender may accelerate the obligations hereunder if the Lender is not satisfied with the Corrective Action. The term “ Corrective Action ” means such actions as determined by the agreement between the Lender and the Borrower through discussion in order to improve the financial situation of the Borrower in case if the Borrower breaches any of items (i) and (ii) of Article 20. The Lender shall negotiate in good faith with the Borrower to determine the Corrective Action if asked by the Borrower to conduct such negotiation.

(2)

In case of breach of items (iii) of Article 20: Applicable Rate shall be increased as follows for all of the Interest Calculation Period whose commencement date falls within the period commencing on the next day (inclusive) of the Inventory Rotation Testing Date and ending on the next Inventory Rotation Testing Date (inclusive).

New Applicable Rate = Original Applicable Rate + 0.300%

Article 22 (Event of Default)

If any of the events set out in Article 5, paragraph 1 of the Banking Transaction Agreement occurs, any and all obligations owed by the Borrower to the Lender hereunder shall be automatically accelerated without any notice or demand by the Lender and the Borrower shall immediately pay to the Lender any and all Loan principals, interests, the Break Funding Cost and any other amount owed by it to the Lender hereunder in a manner specified by the Lender.

If any of the events set out in Article 5, paragraph 2 of the Banking Transaction Agreement or other events set out below occurs, upon the Lender’s notice to the Borrower, any and all obligations owed by the Borrower to the Lender hereunder shall be automatically accelerated without any notice or demand by the Lender and the Borrower shall immediately pay to the Lender any and all Loan principals, interests, the Break Funding Cost and any other amount owed by it to the Lender hereunder in a manner specified by the Lender.

(1)

Any representation and warranty made by Borrower under Article 16 is found to be untrue or inaccurate as of the time when such representation and warranty was made.

(2)

The Borrower breaches any provision of this Agreement; provided, however, that this item (2) shall not be applicable so long as the Borrower is in compliance with Article 21, items (1) and (2).

(3)

Any of the collaterals on which the Borrower created security interests in favor of the Lender becomes subject to the issuance of an order or a notice of provisional attachment ( kari sashiosae ), temporary attachment order ( hozen sashiosae ), permanent attachment ( sashiosae ), provisional disposition or collection order regarding taxes and public dues ( taino shobun ) (including similar proceedings in foreign jurisdictions), or public auction process is commenced with respect to the collaterals.

(4)

Any monetary indebtedness (including guaranty obligations) of the Borrower other than the obligations hereunder result in a breach of the relevant agreement ( saimu furiko ) or is accelerated.

(5)

The Borrower fails to honor the bill ( fuwatari ) for the first time, the Borrower is recorded as unable to pay its debts as they become due ( shiharai funo ) by densai.net Co. Ltd. with respect to any of its electronically recorded monetary obligations or the Borrower becomes subject to similar actions by other electronic monetary claim recording institutions ( denshi saiken kiroku kikan ).

(6)

The Borrower violates Governmental Rules and suspends its business or receives an order of suspension or prohibition of business from government or other authorities, or Lender reasonably determines that such order may be forthcoming.

(7)

The Borrower resolves to dissolve or receives an order of dissolution (excluding where the Borrower is dissolved due to absorption type merger ( kyushu gappei ) or consolidation type merger ( shinsetsu gappei )).

(8)

The Borrower is found to have abandoned the Project or equivalently neglected the Project over a long period of time.

(9)

The Lender is unsatisfied with the “Corrective Action” under item (1) of Article 21.

(10)

Excluding the preceding items, preservative attachment is deemed necessary due to deterioration of the Borrower’s business or financial conditions or risk thereof.

In regard to the preceding items, where the Lender’s notices or mailed documents arrive late or do not arrive at all due to Borrower’s failure to submit a notice of change of address or failure to accept notices from the Lender, or for other causes attributable to the Borrower, the Borrower’s obligations shall be accelerated as if such mailings of Lender had arrived as would normally be expected.

Break Funding Costs shall arise even where the Borrower’s obligations are accelerated as set forth in paragraphs 1, 2 or 3, and in such case, the Borrower shall pay such Break Funding Costs to the Lender. Where Borrower’s obligations are accelerated, the Borrower shall immediately pay to the Lender any and all Loan principals, interests, the Break Funding Cost and any other amount owed by it to the Lender hereunder in a manner specified by the Lender and Lending Obligations of the Lender shall be extinguished.

Article 23 (Amendment of Agreement)

This Agreement shall not be amended without written agreement by and between the Borrower and the Lender.

Article 24 (Notarized Deed)

The Borrower shall cooperate upon request by the Lender with procedures required for notarized deeds including acknowledgements of obligations and compulsory execution pursuant to this Agreement. The Borrower shall bear costs required for such procedures.

Article 25 (Inconsistencies)

The relationship between this Agreement and the provisions of the Banking Transaction Agreement and other comprehensive agreements related to financial transactions (hereunder, the “ Transaction Rules ”).

(1)

Where the provisions of this Agreement are inconsistent or conflict with the provisions of the Transaction Rules, the provisions of this Agreement shall prevail.

(2)

Matters not prescribed by this Agreement shall be construed in accordance with the provisions of the Transaction Rules.

(3)

Matters not prescribed by this Agreement and not prescribed by the Transaction Rules shall be determined upon negotiation between the Borrower and the Lender.

Article 26 (Negotiation in Good Faith)

If any dispute arises with respect to any matters not specifically set forth in this Agreement or the interpretation hereof, the Borrower and the Lender shall negotiate in good faith and agree on how to resolve the issue.

[THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, one original of this Agreement has been prepared, and upon execution by the affixing of name or inscription and seal by representatives of the Borrower and the Lender, the Lender shall retain the original and Borrower shall retain one copy hereof.

March 29, 2017


	Borrower:
	/s/ Authorized Signatory
	(NeoPhotonics Semiconductor GK)

Registered Loan Repayment Bank Account Seal		Imprint of the registered loan account seal if different from the registered loan repayment bank account seal




	Lender:
	/s/ Takashi Takahashi
	Takashi Takahashi
	Branch Manager
	(The Bank of Tokyo-Mitsubishi UFJ, Ltd.)

(For Bank Use)


Inspected	Seal Verified	Executed