COMMITMENTS AND CONTINGENCIES

Loss Contingencies

We are involved in various lawsuits, claims and proceedings that arise in the ordinary course of business. We record a loss provision when we believe it is both probable that a liability has been incurred and the amount can be reasonably estimated.

Guarantees

We indemnify our directors and certain employees as permitted by law, and have entered into indemnification agreements with our directors and executive officers. We have not recorded a liability associated with these indemnification arrangements, as we historically have not incurred any material costs associated with such indemnification obligations. Costs associated with such indemnification obligations may be mitigated by insurance coverage that we maintain, however, such insurance may not cover any, or may cover only a portion of, the amounts we may be required to pay. In addition, we may not be able to maintain such insurance coverage in the future.

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

Warranty Accrual

We generally provide a warranty for our products for twelve to thirty-six months from the date of sale, although warranties for certain of our products may be longer. We accrue for the estimated costs to provide warranty services at the time revenue is recognized. Our estimate of costs to service our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty costs would increase, resulting in a decrease in gross profit.

The following table summarizes movements in the warranty accrual for the periods indicated:



	Year Ended
	July 1, 2017			July 2, 2016			June 27, 2015
	(Thousands)
Warranty provision—beginning of period	$	3,827		$	2,932		$	4,672
Warranties issued	2,225			2,477			1,430
Warranties utilized or expired	(1,878		)	(1,520		)	(2,709		)
Currency translation and other adjustments	(50		)	(62		)	(461		)
Warranty provision—end of period	$	4,124		$	3,827		$	2,932

Capital Leases

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

In connection with our acquisition of Opnext, we assumed capital leases for certain capital equipment, which had lease terms that ranged from one to five years, and provided us with the option to purchase the equipment at the residual value upon expiration.

The following table shows the future minimum lease payments due under non-cancelable capital leases at July 1, 2017:



	Capital Leases
	(Thousands)
Fiscal Year Ending:
2018	$	2,439
2019	566
2020	604
2021	262
Thereafter	—
Total minimum lease payments	3,871
Less amount representing interest	(124		)
Present value of capitalized payments	3,747
Less: current portion	(2,368		)
Long-term portion	$	1,379

Operating Leases

We lease certain facilities under non-cancelable operating lease agreements that expire at various dates through 2033. Our future fiscal year minimum lease payments under non-cancelable operating leases and related sublease income, including the sale-leaseback of our Caswell facility, are as follows:



	Operating Lease Payments		Sublease Income
	(Thousands)
Fiscal Year:
2018	$	8,748	$	(388	)
2019	8,624		(147		)
2020	7,382		(124		)
2021	7,201		(15		)
2022	6,890		—
Thereafter	40,456		—
	$	79,301	$	(674	)

Rent expense for these leases was $8.8 million, $7.8 million and $9.5 million during the fiscal years ended July 1, 2017, July 2, 2016 and June 27, 2015, respectively. We evaluated our facility capacity on an ongoing basis to meet changing needs in our markets with a goal of minimizing our rent expense.

Taxes

It is our policy to classify accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. For fiscal years 2017, 2016 and 2015, we recognized an immaterial amount of interest and penalties related to unrecognized tax benefits. As of July 1, 2017 and July 2, 2016, we accrued $0.7 million in each year of interest and penalties related to unrecognized tax benefits. At this time, we are unable to reasonably estimate the timing of the long-term payments or the amount by which the liability will increase or decrease over time.

Purchase Commitments

We purchase components from a variety of suppliers and use contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with suppliers and contract manufacturers that either allow them to procure inventory based upon criteria as defined by us or establish the parameters defining our requirements. A significant portion of our reported purchase commitments arising from these agreements consist of firm, non-cancelable and unconditional commitments. As of July 1, 2017, we had total purchase commitments of $142.2 million.

We record a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of July 1, 2017, the liability for these purchase commitments was $4.0 million and was included in accrued expenses and other liabilities.

Malaysian Goods and Services Tax (“GST”)

In February 2016, the Malaysian tax authorities preliminarily denied our Malaysia GST refund claims representing approximately $2.5 million. These claims were made in connection with the export of finished goods from our contract manufacturing partner’s Malaysian facilities. We are currently appealing the denial of these claims, and believe that additional appeal options may be available to us if we do not obtain a favorable resolution. Although we have taken action to minimize the impact of the GST with respect to our ongoing operations, we believe it is reasonably possible that, ultimately, we may not be able to recover some of these GST amounts. Of the $2.5 million in GST claims, we recorded $0.7 million in prepaid expenses and other current assets in our consolidated balance sheet at July 1, 2017, net of reserves and certain offsetting payments from our contract manufacturing partner.

Litigation

Overview

In the ordinary course of business, we are involved in various legal proceedings, and we anticipate that additional actions will be brought against us in the future. The most significant of these proceedings are described below. These legal proceedings, as well as other matters, involve various aspects of our business and a variety of claims in various jurisdictions. Complex legal proceedings frequently extend for several years, and a number of the matters pending against us are at very early stages of the legal process. As a result, some pending matters have not yet progressed sufficiently through discovery and/or development of important factual information and legal issues to enable us to determine whether the proceeding is material to us or to estimate a range of possible loss, if any. Unless otherwise disclosed, we are unable to estimate the possible loss or range of loss for the legal proceedings described below. While it is not possible to accurately predict or determine the eventual outcome of these items, an adverse determination in these items currently pending could have a material adverse effect on our results of operations, financial position or cash flows.

Oyster Optics Litigation

On November 23, 2016, Oyster Optics LLC (“Oyster”) filed a civil suit against Cisco Systems, Inc. (“Cisco”) and British Telecommunications PLC (“BT”), in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01301-JRG. In the complaint, Oyster alleges that Cisco and BT infringed seven patents owned by Oyster, which patents allegedly relate to certain Cisco optical platform products, some of which may incorporate Oclaro components. Oyster subsequently dismissed its claim against BT without prejudice. In January 2017, Cisco requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Cisco. In April 2017, Oyster served infringement contentions on Cisco. Those infringement contentions identified certain Cisco products that do implicate Oclaro components that were the subject of those commercial agreements. Accordingly, in May 2017, Oclaro and Cisco preliminarily agreed to an allocation of the responsibilities for the costs of defense associated with Oyster’s claims. However, due to the uncertainty regarding the infringement allegations that Oyster may present at trial and the resultant uncertainty regarding the number of Oclaro components that may be implicated by such infringement allegations, Oclaro and Cisco agreed to defer until the conclusion of the litigation the final determination of whether and to what extent Oclaro will indemnify Cisco for any amounts Cisco may be required to pay Oyster and Cisco’s related defense costs. On May 18, 2017, Oyster’s case against Cisco was consolidated with cases that Oyster brought against other parties. A claim construction hearing is set for October 31, 2017 and trial proceedings are set to begin June 4, 2018 in the consolidated cases. On June 1, 2017, Cisco filed a motion to transfer Oyster’s case against it to the Northern District of California. That motion is fully briefed and awaiting decision. Discovery between Oyster and Cisco is ongoing. Allegedly based on that discovery, Oyster is seeking to amend its infringement contentions to accuse additional Cisco products. To date, no such amendments have been agreed to by Cisco or ordered by the Court. If Oyster were to amend its infringement contentions, they could accuse Cisco products that implicate a different number of Oclaro components that are the subject of commercial agreements between Oclaro and Cisco. On June 30, 2017, Cisco and Oclaro filed Petitions for inter partes review of two of the patents that Oyster is asserting against Cisco with the U.S. Patent Office. On July 27, 2017, Cisco and Oclaro filed Petitions for inter partes review of three other Oyster asserted patents. Oyster has not responded substantively to any of the petitions and the Patent Office has not yet made any Institution Decisions.

Kunst Worker Compensation Matter

On June 18, 2015, Gerald Kunst, or Kunst, filed a civil suit against us and Travelers Property Casualty Company of America, or Travelers, in Massachusetts Superior Court, Civil Action No. SUCV2015-01818F. Travelers is our general liability insurance carrier. The complaint filed by Kunst, an employee of a third party service provider, alleges that he was injured while performing air conditioning repair services on the premises of our Acton, Massachusetts facility and seeks judgment in an amount to be determined by the court or jury, together with interest and costs. On July 24, 2015, we filed an answer to the complaint, which included our affirmative defenses. The case is scheduled for mediation on October 30, 2017. If the mediator is unable to facilitate a resolution, the case is scheduled for trial on February 5, 2018. We intend to vigorously defend against this litigation.

Sale-Leaseback

In March 2006, our Oclaro Technology Ltd. subsidiary entered into multiple agreements with a subsidiary of Scarborough Development (Scarborough) for the sale and leaseback of the land and buildings located at our Caswell, U.K., manufacturing site. The sale transaction, which closed on March 30, 2006, resulted in proceeds to Oclaro Technology Ltd. of £13.75 million (approximately $24.0 million on the date of the transaction). Under these agreements, Oclaro Technology Ltd. leases back the Caswell site for an initial term of 20 years, with options to renew the lease term for 5 years following the initial term and for rolling 2-year terms thereafter.

Based on the exchange rate on July 1, 2017, annual rent for the next 4 years of the lease is approximately £1.4 million, or $1.8 million; and annual rent for the last 5 years of the lease is approximately £1.6 million, or $2.1 million per year. Rent during the optional renewal terms will be determined according to the then market rent for the site. The obligations of Oclaro Technology Ltd under these agreements are guaranteed by us. In addition, Scarborough and us entered into a pre-emption agreement with the buyer under which Oclaro Technology Ltd, within the initial 20-year term, has a right to purchase the Caswell site in whole or in part on terms acceptable to Scarborough if Scarborough agrees to terms with or receives an offer from a third party to purchase the Caswell facility. As a result of these agreements, we deferred a related gain of $20.4 million, which is being amortized ratably against rent expense over the initial 20-year term of the lease. As of July 1, 2017, the unamortized balance of this deferred gain is $6.7 million.

At the inception of the Caswell lease, we determined the total minimum lease payments which were to be paid over the lease term, and we are recognizing the effects of scheduled rent increases, which are included in the total minimum lease payments, on a straight-line basis over the lease term.