Summary of OCLARO, INC. - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, about our future expectations, plans or prospects and our business. These forward-looking statements include statements concerning (i) the impact of the acquisition of Avanex Corporation and the exchange of assets with Newport Corporation (Newport) on the combined entity's gross margin, (ii) sources for improvement of gross margin and operating expenses, including supply chain synergies, optimizing mix of product offerings, transition to higher margin product offerings, benefits of combined research and development and sales organizations and single public company costs, (iii) the expected financial opportunities after the Avanex merger, including becoming profitable in twelve months, expected synergies per quarter by the end of the fourth full quarter after the merger and restructuring costs, (iv) opportunities to grow in adjacent markets, (v) statements containing the words "target," "believe," "plan," "anticipate," "expect," "estimate," "will," "should," "ongoing," and similar expressions and (vi) the assumptions underlying such statements. There are a number of important factors that could cause our actual results or events to differ materially from those indicated by such forward-looking statements, including the impact of continued uncertainty in world financial markets and the resulting reduction in demand for our products, the future performance of Oclaro, Inc. following the closing of the merger with Avanex Corporation and the exchange of assets with Newport, the inability to realize the expected benefits and synergies as a result of the of the merger with Avanex Corporation and the exchange of assets with Newport, increased costs related to downsizing and compliance with regulatory requirements in connection with such downsizing, and the limited availability of credit or opportunity for equity based financing. You should not place undue reliance on forward-looking statements. We cannot guarantee any future results, levels of activity, performance or achievements. Moreover, we assume no obligation to update forward-looking statements or update the reasons actual results could differ materially from those anticipated in forward-looking statements. The factors discussed in the sections captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" in this Quarterly Report on Form 10-Q also identify important factors that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Overview
We are a provider of high performance optical components, modules and subsystems to the telecommunications (telecom) market, and believe we are one of the largest providers into metro and long haul network applications. We leverage proprietary core technologies and vertically integrated product development to provide our telecommunications customers with cost-effective and innovative optical solutions through the transmission products and regeneration and optical routing products of our telecom segment. We also have an advanced photonics solutions division that is chartered with diversification and growth into new markets, leveraging our brand, chip design and manufacturing expertise. We are a global company with chip fabrication facilities in the United Kingdom (U.K.), Switzerland and Italy, as well as in Arizona on a temporary basis during the transition of manufacturing related activities acquired from Newport Corporation (Newport) on July 4, 2009 to our European facilities over the upcoming quarters; manufacturing sites in the United States, Thailand and China; and research and development teams in the United States, U.K., Switzerland, Italy and China. We are the result of the April 27, 2009 merger of Bookham, Inc. (Bookham) and Avanex, with Bookham becoming the parent company and changing its name to Oclaro, Inc. (Oclaro) upon the close of the merger. Subsequent to the merger, Avanex Corporation changed its name to Oclaro (North America), Inc. All references in this Quarterly Report on Form 10-Q to Bookham refer to Oclaro, Inc, and all references to Avanex related to time periods after the merger refer to Oclaro (North America), Inc. We issued approximately 85,152,000 shares of Oclaro common stock for all of the shares of Avanex outstanding on April 27, 2009. Under the terms of the merger, Avanex stockholders received 5.426 shares of Oclaro common stock for every share of Avanex common stock they owned. The combination is intended to qualify as a tax-free reorganization for federal income tax purposes. All financial information herein prior to April 27, 2009 relates to the consolidated financial position and results of operations of the former Bookham, and all financial information subsequent to April 27, 2009 herein relates to the consolidated financial position and results of operations of Oclaro, which includes the consolidated financial information of Avanex since April 27, 2009.
On July 4, 2009, we closed a transaction with Newport Corporation (Newport), under which we sold Newport the assets and liabilities of the New Focus business of Oclaro Photonics, Inc., which was in our advanced photonics solutions division, and in exchange we received the assets of the high power laser diodes business of Newport, which is now part of our advanced photonics solutions division. We also received $3.0 million in cash proceeds in the transaction, which is expected to fund the substantial portion of related transition and integration costs. For accounting purposes, during the three months ended September 26, 2009 we recorded a $1.3 million gain on the sale of the New Focus business and a preliminary $0.7 million gain on bargain purchase on the acquisition of Newport's high power laser diodes business. We intend to finalize our purchase accounting in the second quarter of fiscal 2010. Any adjustments recorded in the second quarter of fiscal 2010 will

Table of Contents

be retrospectively presented as if they had been recorded as of the acquisition date. We expect the acquisition to leverage our existing state-of-the art global manufacturing infrastructure and lower certain of our product costs, including the costs of certain of our transmission products, as a result of operating efficiencies achieved through economies of scale and greater factory utilization.
Recent Accounting Pronouncements
We have adopted Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 105, Generally Accepted Accounting Principles in this Quarterly Report on Form 10-Q for the fiscal quarter ended September 26, 2009. ASC 105 establishes the FASB Accounting Standards Codification(Codification) as the single source of authoritative U.S. GAAP. Under the Codification, all existing accounting standards and pronouncements are superseded and reorganized into a consistent structure arranged by topic, subtopic, section and paragraph. Since the Codification does not change or alter existing U.S. GAAP, it did not have any impact on our condensed consolidated financial statements; however it changes the way references to accounting standards and pronouncements are presented. References made to FASB guidance throughout this Quarterly Report on Form 10-Q have been updated to reflect the Codification.
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-14, Software (Topic 985), Certain Revenue Arrangements that Include Software Elements amending ASC 985. ASU 2009-14 applies to vendors that sell or lease tangible products that contain software that is more than incidental to the tangible product as a whole. ASU 2009-14 removes tangible products from the scope of software revenue guidance and provides direction for measuring and allocating revenue between the deliverables within the arrangement. ASU 2009-14 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We are currently evaluating the impact of ASU 2009-14, but do not expect its adoption to have a material impact on our consolidated financial position or results of operations. In October 2009, the FASB issued ASU 2009-13, Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements amending ASC 605. ASU 2009-13 requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. ASU 2009-13 eliminates the residual method of revenue allocation and requires revenue to be allocated using the relative selling price method. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We are currently evaluating the impact of ASU 2009-13, but do not expect its adoption to have a material impact on our consolidated financial position or results of operations. Application of Critical Accounting Policies The discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements contained elsewhere in this Quarterly Report on Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of our financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses and other financial information. Actual results may differ significantly from those based on our estimates and judgments or could be materially different if we used different assumptions, estimates or conditions. In addition, our financial condition and results of operations could vary due to a change in the application of a particular accounting standard.
We identified our critical accounting policies in our Annual Report on Form 10-K for the year ended June 27, 2009 (or the 2009 Form 10-K) related to revenue recognition and sales returns, inventory valuation, accounting for acquisitions and goodwill, impairment of goodwill and other intangible assets and accounting for share-based payments. It is important that the discussion of our operating results that follows be read in conjunction with the critical accounting policies discussed in our 2009 Form 10-K.

Table of Contents

Results of Operations
The following table sets forth our condensed consolidated results of operations
for the three month periods indicated, along with amounts expressed as a
percentage of net revenues, and comparative information regarding the absolute
and percentage changes in these amounts:

                                                   Three Months Ended                                                     Increase
                                 September 26, 2009                 September 27, 2008                Change             (Decrease)
                             (Thousands)            %           (Thousands)            %            (Thousands)              %
Net revenues                 $     85,110          100.0        $     59,430          100.0        $      25,680                43.2
Cost of revenues                   63,029           74.1              44,777           75.3               18,252                40.8

Gross profit                       22,081           25.9              14,653           24.7                7,428                50.7

Operating expenses:
Research and
development                         9,014           10.6               6,829           11.5                2,185                32.0
Selling, general and
administrative                     13,254           15.5               9,065           15.3                4,189                46.2
Amortization of
intangible assets                      52              -                 197            0.3                 (145 )             (73.6 )
Restructuring and
severance charges                   1,183            1.4               1,486            2.5                 (303 )             (20.4 )
Legal settlements                       -              -                (184 )         (0.3 )                184              (100.0 )
(Gain) loss on sale of
property and equipment               (532 )         (0.6 )                16              -                 (548 )               n/m (1)

Total operating
expenses                           22,971           26.9              17,409           29.3                5,562                31.9


Operating loss                       (890 )         (1.0 )            (2,756 )         (4.6 )              1,866               (67.7 )
Other income (expense):
Interest income                        23              -                 243            0.4                 (220 )             (90.5 )
Interest expense                     (113 )         (0.1 )              (128 )         (0.2 )                 15               (11.7 )
Gain (loss) on foreign
currency translation               (1,276 )         (1.5 )             6,496           10.9               (7,772 )               n/m (1)
Other income (expense)                712            0.8                (600 )         (1.0 )              1,312                 n/m (1)

Total other income
(expense)                            (654 )         (0.8 )             6,011           10.1               (6,665 )               n/m (1)

Income (loss) from
continuing operations
before income taxes                (1,544 )         (1.8 )             3,255            5.5               (4,799 )               n/m (1)
Income tax provision
(benefit)                             223            0.3                 (62 )         (0.1 )                285                 n/m (1)

Income (loss) from
continuing operations              (1,767 )         (2.1 )             3,317            5.6               (5,084 )               n/m (1)
Income (loss) from
discontinued
operations, net of tax              1,270            1.5              (1,124 )         (1.9 )              2,394                 n/m (1)

Net income (loss)            $       (497 )         (0.6 )      $      2,193            3.7        $      (2,690 )               n/m (1)

(1) Not meaningful.

Net Revenues
Net revenues for the three months ended September 26, 2009 increased by $25.7 million, or 43.2 percent, compared to the three months ended September 27, 2008. The increase was primarily related to the inclusion of revenues in fiscal year 2010 generated through the merger with Avanex on April 27, 2009, all of which are associated with our telecom segment. For the three months ended September 26, 2009, revenues in the telecom and advanced photonics solution segments increased by $21.2 million and $4.5 million, respectively, compared to the three months ended September 27, 2008. Revenues in our advanced photonics solutions segment increased by $4.5 million in the three months ended September 26, 2009 compared to the three months ended September 27, 2008, primarily as a result of classifying $7.1 million in revenues from our New Focus business within discontinued operations for the three months ended September 27, 2008.
For the three months ended September 26, 2009, Huawei Technologies Co., Ltd. (Huawei) accounted for $11.1 million, or 13 percent, of our net revenues. For the three months ended September 27, 2008, Huawei accounted for $9.0 million, or 15 percent, of our net revenues and Nortel Networks Corporation (Nortel) accounted for $12.2 million, or 20 percent, of our net revenues.

Table of Contents

Cost of Revenues
Our cost of revenues consists of the costs associated with manufacturing our products, and includes the purchase of raw materials, labor costs and related overhead, including stock-based compensation charges, and the costs charged by our contract manufacturers on the products they manufacture. Charges for excess and obsolete inventory, including in regards to inventories procured by contract manufacturers on our behalf, the cost of product returns and warranty costs are also included in cost of revenues. Costs and expenses related to our manufacturing resources which are incurred in connection with the development of new products are included in research and development expense.
Our cost of revenues for the three months ended September 26, 2009 increased $18.3 million, or 40.8 percent, from the three months ended September 27, 2008. The increase was primarily related to the inclusion of cost of revenues in fiscal year 2010 generated through the merger with Avanex on April 27, 2009, which was partially offset by decreases from merger related synergies and realizing the benefits of previous cost reduction efforts described more fully in Note 6 to our condensed consolidated financial statements, appearing elsewhere in this Quarterly Report on Form 10-Q. Cost of revenues for the three months ended September 26, 2009, relative to the three months ended September 27, 2008, were also favorably impacted by a $0.6 million reduction in our U.K. manufacturing costs associated with the weakening of the U.K. pound sterling relative to the U.S. dollar, offset by a $5.1 million impact from classifying the cost of revenues associated with the New Focus business within discontinued operations for the three months ended September 27, 2008. Gross Profit
Gross profit is calculated as revenues less cost of revenues. Gross margin rate is gross profit reflected as a percentage of revenues.
Our gross margin rate increased to 25.9 percent for the three months ended September 26, 2009, compared to 24.7 percent for the three months ended September 27, 2008. The increase in gross margin rate was primarily due to synergies from the merger with Avanex, including related cost reductions and the internal sourcing of Oclaro components into Avanex products, as well as the impact of other cost reduction efforts during fiscal year 2009. Gross margin for the three months ended September 26, 2009, relative to the three months ended September 27, 2008, was also favorably impacted by a $0.6 million reduction in our U.K. manufacturing costs associated with the weakening of the U.K. pound sterling relative to the U.S. dollar. Further synergies from the Avanex merger and the consolidation of the Tucson wafer fabrication facility acquired from Newport into our European facilities, expected to take place during our third fiscal quarter of 2010, are expected to contribute 2.5 to 3.5 percentage points of gross margin improvement over the next three fiscal quarters. Research and Development Expenses
Research and development expenses consist primarily of salaries and related costs of employees engaged in research and design activities, including stock-based compensation charges related to those employees, costs of design tools and computer hardware, costs related to prototyping and facilities costs for certain research and development focused sites.
Research and development expenses increased to $9.0 million for the three months ended September 26, 2009 from $6.8 million for the three months ended September 27, 2008. The increase was primarily due to the increase in research and development activities in connection with the merger with Avanex on April 27, 2009, and $1.1 million in research and development expenses associated with the New Focus business which were classified within discontinued operations for the three months ended September 27, 2008. Personnel-related costs increased to $5.8 million for the three months ended September 26, 2009, compared with $3.9 million for the three months ended September 27, 2008. Other costs, including the costs of design tools and facilities-related costs increased to $3.2 million for the three months ended September 26, 2009, compared with $2.9 million for the three months ended September 27, 2008. Research and development expenses were favorably impacted by approximately $0.7 million as a result of the U.K. pound sterling weakening relative to the U.S. dollar. Research and development expenses were 10.6 percent of net revenues for the three months ended September 26, 2009. Over the coming year, we intend to increase our research and development expenditures towards our target investment level of 13 percent of revenues.
Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of personnel-related expenses, including stock-based compensation charges related to employees engaged in sales, general and administrative functions, legal and professional fees, facilities expenses, insurance expenses and certain information technology costs.

Table of Contents

Selling, general and administrative expenses increased to $13.3 million for the three months ended September 26, 2009, from $9.1 million for the three months ended September 27, 2008. The increase was primarily due to costs incurred in connection with the merger with Avanex on April 27, 2009, and $1.6 million in selling, general and administrative expenses associated with the New Focus business which were classified within discontinued operations for the three months ended September 27, 2008, and which were offset by merger related synergies. Personnel-related costs increased to $6.7 million for the three months ended September 26, 2009, compared with $4.7 million for the three months ended September 27, 2008. Other costs, including legal and professional fees, facilities expenses and other miscellaneous expenses increased to $6.5 million for the three months ended September 26, 2009, compared with $4.4 million for the three months ended September 27, 2008. Selling, general and administrative expenses were favorably impacted by approximately $0.6 million as a result of the U.K. pound sterling weakening relative to the U.S. dollar. Restructuring and Severance Charges
For the three months ended September 26, 2009 and September 27, 2008, we accrued $1.2 million and $1.5 million, respectively, in expenses for revised estimates related to employee separation charges and costs to exit certain facilities. In the remainder of fiscal year 2010, we expect to accrue an additional $1.0 million to $1.4 million in restructuring and related charges in connection with the Avanex merger. We also expect to incur and pay an additional $0.5 million to $0.8 million in restructuring and related charges during the remainder of fiscal year 2010 associated with our acquisition of Newport's high power laser diodes business and fabrication facility in Tucson and the related move of the fabrication activities to Europe. We accrued approximately $0.2 million of these anticipated costs, which are included in the restructuring and severance charges for the three months ended September 26, 2009. Legal Settlement
For the three months ended September 27, 2008, we recorded a benefit of $0.2 million associated with the settlement of a legal action in connection with our sale of land in Swindon, U.K. to a third party in 2005. (Gain)Loss on Sale of Property and Equipment For the three months ended September 26, 2009, we recorded a gain of $0.5 million related to the sale of certain fixed assets in Villebon, France made surplus in connection with the closing of that facility. Other Income (Expense)
Other income (expense) for the three months ended September 26, 2009 decreased by $6.7 million compared to the three months ended September 27, 2008. This was primarily related to a $7.8 million decrease in gain/(loss) from the re-measurement of short term receivables and payables for fluctuations in the U.S. dollar relative to our other local functional currencies during the corresponding periods between certain of our wholly-owned international subsidiaries. This was partially offset by a preliminary gain of $0.7 million from the bargain purchase of the high power laser diodes business from Newport on July 4, 2009. The three months ended September 27, 2008 also included a $0.6 million expense related to the fair value impairment of our short-term investment in a debt security of Lehman Brothers Holdings, Inc. Income Tax Provision (Benefit)
We have incurred substantial losses to date and accordingly our income tax provision in each period presented is not significant. For the three months ended September 26, 2009, our income tax provision of $0.2 million primarily relates to income taxes on our manufacturing operations in Italy and China. Based upon the weight of available evidence, which includes our historical operating performance and the recorded cumulative net losses in prior periods, we have provided a full valuation allowance against our net deferred tax assets at September 26, 2009 and June 27, 2009. Income (Loss) From Discontinued Operations In the three months ended September 26, 2009, we recorded income of $1.3 million from discontinued operations from the sale of the New Focus business. For the three months ended September 27, 2008, we recorded a loss of $1.1 million related to the operations of the New Focus business during that period.

Table of Contents