BASIS OF PREPARATION

Basis of Presentation

Oclaro, Inc., a Delaware corporation, is sometimes referred to in this Quarterly Report on Form 10-Q as “Oclaro,” “we,” “us” or “our.”

The accompanying unaudited condensed consolidated financial statements of Oclaro as of September 29, 2018 and for the three months ended September 29, 2018 and September 30, 2017 have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Article 10 of Securities and Exchange Commission ("SEC") Regulation S-X, and include the accounts of Oclaro and all of our subsidiaries. Accordingly, they do not include all of the information and footnotes required by such accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of our consolidated financial position and results of operations have been included. The condensed consolidated results of operations for the three months ended September 29, 2018 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 29, 2019.

The condensed consolidated balance sheet as of June 30, 2018 has been derived from our audited financial statements as of such date, but does not include all disclosures required by U.S. GAAP. These unaudited condensed consolidated financial statements should be read in conjunction with our audited financial statements included in our Annual Report on Form 10-K for the year ended June 30, 2018 ("2018 Form 10-K").

Merger

On March 11, 2018, Lumentum Holdings Inc., a Delaware corporation (“Lumentum”), Oclaro, Prota Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Lumentum (“Merger Sub”), and Prota Merger, LLC, a Delaware limited liability company and a wholly owned subsidiary of Lumentum (“Merger Sub LLC”), entered into an Agreement and Plan of Merger (the “Merger Agreement”).

Pursuant to the terms of the Merger Agreement, the acquisition of Oclaro will be accomplished through a merger of Merger Sub with and into Oclaro (the “First Step Merger”) with Oclaro surviving the First Step Merger. As soon as reasonably practicable following the First Step Merger, Oclaro will merge with and into Merger Sub LLC with Merger Sub LLC continuing as the surviving entity and a wholly owned subsidiary of Lumentum (the “Second Step Merger,” and taken together with the First Step Merger, the “Merger”).

Pursuant to the terms of the Merger Agreement, and subject to the terms and conditions set forth therein, at the effective time of the First Step Merger (the “Effective Time”), each share of the common stock of Oclaro (the “Oclaro Common Stock”) issued and outstanding immediately prior to the Effective Time (other than (x) shares of Oclaro Common Stock owned by Lumentum, Oclaro, or any direct or indirect wholly owned subsidiary of Lumentum or Oclaro or (y) shares of Oclaro Common Stock owned by stockholders who have properly exercised and perfected appraisal rights under Delaware law, in each case immediately prior to the Effective Time, will be cancelled and extinguished and automatically converted into the right to receive the following consideration (collectively, the “Merger Consideration”):

(A) $5.60 in cash, without interest (the “Cash Consideration”), plus


(B)	0.0636 of a validly issued, fully paid and nonassessable share of the common stock of Lumentum, par value $0.001 per share (“Lumentum Common Stock”) (such ratio, the “Exchange Ratio”).

With regard to the Merger Consideration, if the aggregate number of shares of Lumentum Common Stock to be issued in connection with the Merger (including all Lumentum Common Stock which may be issued in the future pursuant to the conversion of Oclaro Options, Oclaro Restricted Stock Units, or Oclaro Restricted Stock (as defined below) would exceed 19.9 percent of the Lumentum Common Stock issued and outstanding immediately prior to the Effective Time (the “Stock Threshold”), (A) the Exchange Ratio will be reduced to the minimum extent necessary (rounded down to the nearest one thousandth) such that the aggregate number of shares of Lumentum Common Stock to be issued in connection with the Merger (including all shares of Lumentum Common Stock which may be issued after the Effective Time pursuant to company compensatory awards) does not exceed the Stock Threshold and (B) the Cash Consideration for all purposes will be increased on a per share basis by an amount equal to $68.975, multiplied by the difference between the initial Exchange Ratio and the Exchange Ratio.

Each Oclaro restricted stock unit award (an “Oclaro RSU”) that does not become vested at the closing will be converted into a Lumentum restricted stock unit award (a “Lumentum RSU”) with the same terms and conditions, including vesting, that were applicable to such Oclaro RSU, except that the number of Lumentum shares subject to the Lumentum RSU will equal the product of (i) the number of Oclaro shares subject to such Oclaro RSU (with any performance milestones deemed achieved based on the maximum level of achievement) multiplied by (ii) the sum of (A) the Exchange Ratio plus (B) the quotient obtained by dividing the Cash Consideration by Lumentum’s average closing price of the 10 trading days ending on the third trading day prior to the closing (such sum, the “Equity Award Exchange Ratio”), rounded down to the nearest whole share.

Each Oclaro stock option (an “Oclaro Option”), whether vested or unvested, will be converted into a Lumentum stock option (a “Lumentum Option”) with the same terms and conditions, including vesting, that were applicable to such Oclaro Option, except that (i) the number of shares subject to the Lumentum Option will equal the product of (A) the number of Oclaro shares subject to such Oclaro Option multiplied by (B) the Equity Award Exchange Ratio, rounded down to the nearest whole share and (ii) the exercise price of the Lumentum Option will equal (A) the exercise price per share of the Oclaro Option divided by (B) the Equity Award Exchange Ratio, rounded up to the nearest whole cent. Notwithstanding the foregoing, any Oclaro Option that is held by an individual who is not an Oclaro employee as of immediately prior to the closing will be canceled and converted into the Merger Consideration for each net option share covered by such Oclaro Option, subject to applicable withholding taxes.

In addition, each Oclaro restricted stock award (“Oclaro Restricted Stock Award”) and Oclaro RSU that becomes vested as of immediately prior to the closing (including each Oclaro Restricted Stock Award held by a non-employee director) will be converted into the right to receive the Merger Consideration in respect of each Oclaro share underlying such award, subject to applicable withholding taxes. Each Oclaro stock appreciation right (“Oclaro SAR”) will be canceled and converted into the right to receive a cash amount equal to the product of (i) the number of Oclaro shares subject to the Oclaro SAR multiplied by (ii) the positive difference of (A) the cash equivalent value of the Merger Consideration less (B) the strike price of the Oclaro SAR, subject to applicable withholding taxes.

If Lumentum determines that the treatment of Oclaro equity awards described above would violate, in respect of the holder thereof, the applicable laws of a non-U.S. jurisdiction, Lumentum may treat such Oclaro equity award in a different manner so long as such treatment is no less favorable to the holder of such Oclaro equity award.

The Boards of Directors of Lumentum and Oclaro have unanimously approved the Merger and the Merger Agreement. The transaction is subject to customary closing conditions, including the absence of certain legal impediments, the expiration or termination of the required waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act") and under applicable anti-trust laws in China, the effectiveness of a registration statement on Form S-4 registering the shares of Lumentum common stock to be issued in connection with the Merger, and approval of the Merger Agreement by the holders of a majority of the outstanding shares of Oclaro Common Stock. The transaction is not subject to any financing condition. On April 4, 2018, the U.S. Federal Trade Commission granted early termination of the waiting period under the HSR Act. On July 10, 2018, Oclaro's stockholders approved the Merger Agreement.

The Merger Agreement contains customary representations, warranties and covenants of Lumentum, Oclaro, Merger Sub and Merger Sub LLC, including, (i) covenants by Oclaro concerning the conduct of its business in the ordinary course consistent with past practice during the interim period between the execution of the Merger Agreement and the consummation of the Merger, (ii) covenants by Lumentum concerning the conduct of its business in the ordinary course consistent with past practice during the interim period between the execution of the Merger Agreement and the consummation of the Merger, (iii) a covenant by Oclaro that, subject to certain exceptions, the Board of Directors of Oclaro will recommend to its shareholders adoption of the Merger Agreement, and (iv) a covenant that Oclaro will not solicit, initiate, or knowingly encourage, facilitate or induce the making of inquiry, offer or proposal that would reasonably be expected to lead to any Acquisition Proposal (as defined in the Merger Agreement). Further, the Merger Agreement prohibits us from paying dividends.

The Merger Agreement contains certain termination rights for both Lumentum and Oclaro and further provides that upon termination of the Merger Agreement under specified circumstances (including termination by Oclaro to accept a superior proposal), Oclaro may be required to pay Lumentum a termination fee of $63 million. The Merger Agreement further provides that upon termination of the Merger Agreement under specified circumstances relating to failure to obtain regulatory approvals, Lumentum may be required to pay Oclaro a termination fee of $80 million.

During the three months ended September 29, 2018, we recorded acquisition-related costs of $0.3 million in restructuring and acquisition-related expenses within our condensed consolidated statements of operations. During the three months ended September 30, 2017, we recorded no acquisition-related costs in restructuring and acquisition-related expenses.

Termination of Denial Order and Reinstitution of ZTE's Export Privileges

On April 16, 2018, the U.S. Department of Commerce ("DOC") changed and reactivated its previously suspended denial order and suspended the export privileges of Zhongxing Telecommunications Equipment Corporation ("ZTE Corporation") and its subsidiary, ZTE Kangxun Telecommunications Ltd. ("ZTE Kangxun") (collectively, "ZTE") after determining that ZTE made false statements to the DOC related to senior employee disciplinary actions ("Denial Order"). On July 13, 2018, following approval of a settlement agreement between the DOC and ZTE and ZTE's payment of certain amounts to the DOC, the Denial Order was terminated and ZTE was removed from the DOC's Denied Persons List. During the pendency of the Denial Order, ZTE was prohibited from participating in any way in any transaction subject to the Export Administration Regulations ("EAR") and U.S. companies were restricted from exporting or re-exporting to or on behalf of ZTE any item subject to the EAR or engaging in any transaction to service any item subject to the EAR that has been or will be exported from the U.S. and which was owned, possessed or controlled by ZTE. During the pendency of the Denial Order, we ceased shipment of products to ZTE, which has been one of our significant customers. During the first quarter of our fiscal 2019, we resumed shipments of products to ZTE.

During the three months ended September 29, 2018, we recorded a $0.5 million net benefit related to inventory that was sold in the quarter that had previously been written-down because of the uncertainty of whether it would be sold to ZTE or re-allocated to other customers.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reported periods. Examples of significant estimates and assumptions made by management involve the valuation allowances for deferred tax assets, the fair value of stock-based compensation, the fair value of pension liabilities, estimates for allowances for doubtful accounts and valuation of excess and obsolete inventories. These judgments can be subjective and complex and consequently actual results could differ materially from those estimates and assumptions. Descriptions of the key estimates and assumptions are included in our 2018 Form 10-K.

Fiscal Years

We operate on a 52/53 week year ending on the Saturday closest to June 30. Our fiscal year ending June 29, 2019 will be a 52 week year, with the quarter ended September 29, 2018 being a 13 week quarterly period. Our fiscal year ended June 30, 2018 was a 52 week year, with the quarter ended September 30, 2017 being a 13 week quarterly period.

Reclassifications

For presentation purposes, we have reclassified certain prior period amounts to conform to the current period financial statement presentation, including an adjustment relating to an immaterial error of approximately $10.4 million, increasing cash flows from operations associated with changes in accounts payable and increasing cash flows used in investing activities associated with purchases of property and equipment, in our condensed consolidated statement of cash flows for the three months ended September 30, 2017. We determined that the adjustment did not have a material impact to our prior period condensed consolidated financial statements.

In connection with our adoption of Accounting Standards Update ("ASU") 2016-18, Statement of Cash Flows: Restricted Cash, we adjusted the beginning-of-period and end-of-period cash and cash equivalent balances within the condensed consolidated statement of cash flows for the three months ended September 30, 2017 to include restricted cash. The impact of this adoption was an increase of $0.4 million in net cash used in investing activities, an increase of $0.7 million to the beginning-of-period cash, cash equivalents and restricted cash balance and an increase of $0.3 million to the end-of-period cash, cash equivalents and restricted cash balance for the three months ended September 30, 2017.

None of these reclassifications affect our consolidated revenues, net income, cash and cash equivalents or stockholders’ equity as previously reported.

Functional Currency

Effective October 1, 2017, the functional currency for our worldwide operations is the U.S. dollar. Prior to October 1, 2017, the functional currency for each of our foreign subsidiaries was the respective local currency for that subsidiary. The change in our functional currency is a result of significant changes in economic facts and circumstances, including (i) a re-organization of our operating environment, which includes consolidating and integrating our sales, supply chain and manufacturing organizations; (ii) a transition to centrally negotiating worldwide supplier contracts and capital expenditures in U.S. dollars; and (iii) a shift to recording all intercompany transactions in U.S. dollars.

Translation adjustments reported prior to October 1, 2017, remain as a component of accumulated other comprehensive income in our condensed consolidated balance sheet. The translated values for any non-monetary assets and liabilities as of October 1, 2017 became the new accounting basis for those assets.

Effective October 1, 2017, monetary assets and liabilities denominated in currencies other than the U.S. dollar functional currency are re-measured each reporting period into U.S. dollars, with the resulting exchange gains and losses reported in (loss) gain on foreign currency transactions, net within our condensed consolidated statement of operations.