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. See Litigation - Oyster Optics Litigation below for additional details.

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
	June 30, 2018			July 1, 2017			July 2, 2016
	(Thousands)
Warranty provision—beginning of period	$	4,124		$	3,827		$	2,932
Warranties issued	414			2,225			2,477
Warranties utilized or expired	(714		)	(1,878		)	(1,520		)
Currency translation and other adjustments	55			(50		)	(62		)
Warranty provision—end of period	$	3,879		$	4,124		$	3,827

Capital Leases

In October 2015 we entered into a capital lease agreement for certain capital equipment with Hitachi High-Technologies Corporation. 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 on July 23, 2012, we assumed capital leases with Hitachi Capital Corporation 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. For certain of these capital leases, we have entered into one year extensions.

The following table shows the future minimum lease payments due under non-cancelable capital leases at June 30, 2018:



	Capital Leases
	(Thousands)
Fiscal Year Ending:
2019	$	2,444
2020	613
2021	265
2022	—
Thereafter	—
Total minimum lease payments	3,322
Less amount representing interest	(79		)
Present value of capitalized payments	3,243
Less: current portion	(2,386		)
Long-term portion	$	857

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:
2019	$	9,071	$	(248	)
2020	9,787		(133		)
2021	9,981		(10		)
2022	10,290		—
2023	10,159		—
Thereafter	37,734		—
	$	87,022	$	(391	)

Rent expense for these leases was $8.9 million, $8.8 million and $7.8 million during the fiscal years ended June 30, 2018, July 1, 2017 and July 2, 2016, respectively. We evaluate 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 2018, 2017 and 2016, we recognized an immaterial amount of interest and penalties related to unrecognized tax benefits. As of June 30, 2018 and July 1, 2017, 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.

Our total amount of unrecognized tax benefits as of June 30, 2018 was approximately $3.1 million. While it is often difficult to predict the final outcome of any particular uncertain tax position, management believes that unrecognized tax benefits could decrease by $1.1 million in the next twelve months.

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. While these purchase commitments are legally binding, the terms generally allow us the option to adjust, reschedule or cancel orders based on our business needs. As of June 30, 2018, we had total purchase commitments of $78.8 million, which we expect to be fulfilled within one year.

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 June 30, 2018, the liability for these purchase commitments was $6.3 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 June 30, 2018, 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 outcomes of these items, an adverse determination in one or more of these items currently pending could have a material adverse effect on our results of operations, financial position or cash flows, and even if we are ultimately successful in defending these claims, such claims may be expensive to defend and could distract our management team from other important business matters.

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. 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 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. After discovery, Oyster’s infringement case against Cisco involved claims of only one patent and did not involve Oclaro components that were the subject of our commercial agreements with Cisco. In June of 2018, Cisco communicated its determination that the Oyster litigation against it did not involve Oclaro. Trial proceedings are set to begin November 5, 2018. Between June and September of 2017, Cisco and Oclaro filed eleven Petitions for inter partes review with the U.S. Patent Office of claims in six of the patents that Oyster originally asserted against Cisco. The Patent Office eventually instituted inter partes review for eight of the eleven Petitions involving claims of five of the six patents. Trials for the instituted Petitions are ongoing.

On November 24, 2016, Oyster also filed a civil suit against Coriant America Inc. (“Coriant”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-cv-01302. In the complaint against Coriant, Oyster alleges that Coriant has infringed the same seven patents that were asserted against Cisco. On May 18, 2017, Oyster’s case against Coriant was consolidated with cases that Oyster brought against other parties, including Cisco. On December 21, 2017, Coriant requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Coriant. Oclaro has refused this request for reasons including that Oyster’s claims against Coriant do not clearly implicate Oclaro products and that Coriant’s request was not timely made. Coriant has stated their disagreement with this position. As a result, Oclaro remains in discussions with Coriant regarding Coriant’s request for defense and indemnification. Oyster and Coriant informed the Court on April 12, 2018, that “all matters in controversy between the parties have been settled, in principle.” On July 3, 2018, the Court granted a joint motion from Oyster and Coriant to dismiss their case with prejudice.

Oyster also filed a civil suit on November 24, 2016 against Ciena Corporation (“Ciena”) in the U.S. District Court for the Eastern District of Texas, Marshall Division, Case No. 2:16-CV-01300. In the complaint against Ciena, Oyster alleges that Ciena has infringed the same seven patents that were asserted against Cisco. Oyster’s case against Ciena was later transferred to the Northern District of California which granted a motion that Ciena filed to stay the case pending inter partes review of the Oyster patents. On June 1, 2018, the parties filed a joint status report reporting on the status of the inter partes review proceedings. Also on June 1, 2018, counsel for Oyster wrote the Court a letter indicating that because there are no further proceedings in the PTAB concerning one of the asserted patents, that Oyster requested that the litigation move forward as to the asserted claims of that patent only and that the Court set a scheduling conference. On June 4, 2018, the Court indicated that Oyster should file a noticed motion for any such relief and the case currently remains stayed. On October 16, 2017, Ciena requested that Oclaro indemnify and defend it in this litigation, pursuant to our commercial agreements with Ciena. Oclaro refused this request for reasons including that Oyster's claims against Ciena do not clearly implicate Oclaro products and that Ciena's request was not timely made. Ciena has stated its disagreement with this position. As a result, discussions with Ciena regarding Ciena’s request for defense and indemnification have not completed.

Oclaro Merger Litigation

Following announcement of the execution of the Merger Agreement on March 12, 2018, seven lawsuits were filed by purported stockholders of Oclaro challenging its proposed acquisition by Lumentum, Inc. The first suit, a putative class action styled as Nicholas Neinast v. Oclaro, Inc., et al., No. 3:18-cv-03112-VC, was filed in the United States District Court for the Northern District of California on May 24, 2018, and was against Oclaro, its directors, Lumentum, Merger Sub, and Merger Sub LLC (the “Neinast Lawsuit”). Five additional suits, styled as Gerald F. Wordehoff v. Oclaro, Inc., et al., No. 5:18-cv-03148-NC (the “Wordehoff Lawsuit”), Walter Ryan v. Oclaro, Inc., et al., No. 3:18-cv-03174-VC (the “Ryan Lawsuit”), and Jayme Walker v. Oclaro, Inc., et al., No. 3:18-cv-03203 (the “Walker Lawsuit”), Kevin Garcia v. Oclaro, Inc., et al., No. 5:18-cv-03262-VKD (the “Garcia Lawsuit”), and Saisravan Bharadwaj Karri v. Oclaro, Inc., et al., No. 3:18-cv-03435-JD (the “Karri Lawsuit”) were also filed in the United States District Court for the Northern District of California on, respectively, May 25, 2018, May 29, 2018, May 30, 2018, May 31, 2018 and June 9, 2018. Each of the lawsuits name Oclaro and its directors as defendants. The Ryan Lawsuit and the Karri Lawsuit, like the Neinast Lawsuit, were putative class actions. A seventh suit, a putative class action styled as Adam Franchi v. Oclaro, Inc., et al., Case 1:18-cv-00817-GMS, was filed in the United States District Court for the District of Delaware on May 30, 2018, and was against Oclaro, its directors, Lumentum, Merger Sub, and Merger Sub LLC (the “Franchi Lawsuit” and, with the Neinast Lawsuit, the Wordehoff Lawsuit, the Ryan Lawsuit, the Walker Lawsuit, the Garcia Lawsuit, and the Karri Lawsuit, the “Lawsuits”).

The Lawsuits alleged that Oclaro and its directors violated Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder because the Proxy Statement/Prospectus was incomplete and misleading. The Lawsuits further alleged that Oclaro’s directors violated Section 20(a) of the Exchange Act by failing to exercise proper control over the person(s) who violated Section 14(a) of the Exchange Act. The Neinast Lawsuit additionally alleged that Oclaro’s directors breached fiduciary duties by entering into the Merger, and also names Lumentum, Merger Sub, and Merger Sub LLC as violators of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Franchi Lawsuit additionally named Lumentum, Merger Sub, and Merger Sub LLC as violators of Section 20(a) of the Exchange Act.

The Lawsuits sought, among other things, injunctive relief preventing the parties from consummating the merger, rescission of the transactions contemplated by the Merger Agreement should they be consummated, and litigation costs, including attorneys’ fees. The Lawsuits also sought damages to be awarded to the plaintiff and any class if the Merger were consummated. In addition, the Wordehoff Lawsuit sought injunctive relief directing defendants to disseminate a true and complete proxy statement/prospectus and declaratory relief that defendants violated Sections 14(a) and/or 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder.

To avoid the risk of the Lawsuits delaying or adversely affecting the Merger and to minimize the costs, risks and uncertainties inherent in litigation, and without admitting any liability or wrongdoing and believing that the initial Proxy Statement/Prospectus disclosed all material information concerning the Merger and no supplemental disclosure was required under applicable law, Oclaro voluntarily filed with the SEC a supplement to the Proxy Statement/Prospectus on June 29, 2018.

Thereafter, on July 25, 2018, the plaintiff in the Garcia Lawsuit dismissed his action, with prejudice as to the individual plaintiff. The plaintiffs in the Neinast, Franchi, Wordehoff, and Ryan Lawsuits dismissed these actions, with prejudice as to the respective individual plaintiffs, on July 27, 2018. The plaintiff in the Walker Lawsuit dismissed her action, with prejudice as to the individual plaintiff, on August 14, 2018. Counsel for plaintiff in the remaining lawsuit, the Karri Lawsuit, has stated his intention to file an amended complaint. If the Karri Lawsuit proceeds, Oclaro intends to defend the action vigorously.

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 June 30, 2018, annual rent for the next 3 years of the lease is approximately £1.4 million, or $1.9 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 June 30, 2018, the unamortized balance of this deferred gain is $6.0 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.