NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. 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.”

On August 5, 2014, we entered into a separation agreement to sell our industrial and consumer business of Oclaro Japan located at our Komoro, Japan facility to Ushio Opto Semiconductors, Inc. ("Ushio Opto"). On October 27, 2014, the sale was completed. The assets and liabilities to be transferred to Ushio Opto within the next 12 months are classified as assets held for sale and liabilities in connection with the sale within current assets and current liabilities, respectively, on the condensed consolidated balance sheet at September 27, 2014. The transaction is more fully discussed in Note 5, Business Combinations and Dispositions .

On November 1, 2013, we sold our optical amplifier and micro-optics business (the “Amplifier Business”) to II-VI Incorporated (II-VI). The sale is more fully discussed in Note 5, Business Combinations and Dispositions . On September 12, 2013, we sold our Oclaro Switzerland GmbH subsidiary and associated laser diodes and pump business (the “Zurich Business”) to II-VI. The sale is more fully discussed in Note 5, Business Combinations and Dispositions . These sales are reported as discontinued operations, which require retrospective restatement of prior periods to classify the results of operations as discontinued operations. The notes to our condensed consolidated financial statements relate to our continuing operations only, unless otherwise indicated.

The accompanying unaudited condensed consolidated financial statements of Oclaro as of September 27, 2014 and for the three months ended September 27, 2014 and September 28, 2013 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 27, 2014 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 27, 2015 .

The condensed consolidated balance sheet as of June 28, 2014 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 28, 2014 (" 2014 Form 10-K").

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 fair value of other intangible assets and long-lived assets, valuation allowances for deferred tax assets, the fair value of stock-based compensation, estimates used to determine facility lease loss 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 2014 Form 10-K.

Out-of-Period Adjustment

In the first quarter of fiscal 2015, we recorded out-of-period adjustments of approximately $2.0 million in cost of goods sold in our condensed consolidated statements of operations. The adjustments, which increased cost of goods sold, also increased accrued liabilities and decreased inventory, and were made to correct our inventory valuation and the value of our purchase commitment accrual.  We determined that the adjustments did not have a material impact to our current or prior period consolidated financial statements.

Fiscal Years

We operate on a 52/53 week year ending on the Saturday closest to June 30. Our fiscal year ending June 27, 2015 will be a 52 week year, with the quarter ended September 27, 2014 being a 13 week quarterly period. Our fiscal year ended June 28, 2014 was a 52 week year, with the quarter ended September 28, 2013 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. These reclassifications did not affect our consolidated revenues, net income (loss), cash flows, cash and cash equivalents or stockholders’ equity as previously reported.

NOTE 2. RECENT ACCOUNTING STANDARDS

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-15, Presentation of Financial Statements—Going Concern. The update provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. This guidance is effective for us beginning with our annual financial statements for the fiscal year ended July 1, 2017, and interim periods thereafter. We are currently evaluating the impact that the implementation of this standard will have on our condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09,  Revenue from Contracts with Customers.  This update clarifies the principles for recognizing revenue and develops a common revenue standard for GAAP and International Financial Reporting Standards. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. This guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2016. This guidance is effective for us prospectively in the first quarter of fiscal year 2018. We are currently evaluating the impact that the implementation of this standard will have on our condensed consolidated financial statements.

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity . This update requires that a disposal representing a strategic shift that has (or will have) a major effect on an entity's financial results be reported as discontinued operations. The standard also expands the disclosures for discontinued operations and requires new disclosures related to individually material disposals that do not meet the definition of a discontinued operation. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2014. We have elected to early adopt this guidance in our first quarter of fiscal year 2015. In accordance with this guidance, our sale of the Komoro Business does not meet the definition of a discontinued operation. We consider this sale as an individually material disposal and have expanded our disclosures related to this transaction, including presenting the pre-tax profit (loss) of the Komoro Business for the three months ended September 27, 2014 and September 28, 2013, respectively.

As of September 27, 2014 , we had restricted cash of $4.7 million , consisting of collateral for the performance of our obligations under certain lease facility agreements and $2.4 million (equivalent to RMB 15 million ) of cash held in Oclaro Shenzhen’s bank account in China that was frozen by the Xi'an Court in connection with our litigation with Xi’an Raysung Photonics Inc. (see Note 8, Commitments and Contingencies , for additional details regarding this litigation.)

The following table provides details regarding our inventories at the dates indicated:

	September 27, 2014				June 28, 2014
	(Thousands)
Inventories:
Raw materials	$	21,630			$	20,036
Work-in-process	22,942				20,505
Finished goods	30,841				30,558
	$	75,413			$	71,099

In connection with our sale of the Komoro Business, we reclassified $4.3 million of the $75.4 million in inventories as assets held for sale in our condensed consolidated balance sheet at September 27, 2014 .

The following table provides details regarding our property and equipment, net at the dates indicated:

In connection with our sale of the Komoro Business, we reclassified $3.4 million of the $47.7 million in property and equipment as assets held for sale in our condensed consolidated balance sheet at September 27, 2014 .

Property and equipment includes assets under capital leases of $7.8 million (excluding $0.5 million in capital leases classified as assets held for sale) at September 27, 2014 and $9.9 million at June 28, 2014 , respectively. Amortization associated with assets under capital leases is recorded in depreciation expense.

The following table summarizes the activity related to our other intangible assets for the three months ended September 27, 2014 :

In connection with the sale of our Komoro Business, we intend to transfer certain of our other intangible assets to Ushio Opto. We have classified $4.5 million of our other intangible assets as assets held for sale in our condensed consolidated balance sheet at September 27, 2014 .

With the sale of our Komoro Business, we expect the amortization of intangible assets to be $0.9 million for fiscal year 2015, $0.8 million for each fiscal year 2016 through 2017, $0.7 million for fiscal year 2018, $0.1 million for fiscal year 2019 and $0.1 million thereafter, based on the current level of our other intangible assets as of September 27, 2014 .

The following table presents details regarding our accrued expenses and other liabilities at the dates indicated:

In connection with our sale of the Komoro Business, we reclassified $2.0 million of the $63.4 million in accrued expenses and other liabilities as liabilities in connection with the sale in our condensed consolidated balance sheet at September 27, 2014 .

The following table summarizes the activity related to our accrued restructuring charges for the three months ended September 27, 2014 :

The current portion of accrued restructuring liabilities is included in the caption accrued expenses and other liabilities in the condensed consolidated balance sheet.

During the first quarter of fiscal year 2014, we initiated a restructuring plan to simplify our operating footprint, reduce our cost structure and focus our research and development investment in the optical communications market where we can leverage our core competencies. During the three months ended September 27, 2014 and September 28, 2013 , we recorded restructuring charges of $0.8 million and $0.2 million , respectively, in connection with this restructuring plan. The restructuring charges for the three months ended September 27, 2014 included $0.2 million related to workforce reductions and $0.6 million related to revised estimates related to lease cancellations and commitments. The restructuring charges for the three months ended September 28, 2013 related to workforce reductions in our research and development facility in Israel. During the three months ended September 27, 2014 and September 28, 2013 , we made scheduled payments of $1.4 million and $2.0 million , respectively, to settle a portion of these restructuring liabilities. As of September 27, 2014 , we had $1.4 million in accrued restructuring liabilities related to this restructuring plan.

In connection with the acquisition of Opnext, we initiated a restructuring plan to integrate our acquisition of Opnext. During the three months ended September 27, 2014 and September 28, 2013 , we recorded restructuring charges of zero and $0.9 million , respectively, in connection with this restructuring plan. The restructuring charges recorded in fiscal year 2014 included $0.9 million in external consulting charges and professional fees associated with reorganizing the infrastructure. During the three months ended September 28, 2013 , we made scheduled payments of $2.0 million to settle these restructuring liabilities. As of September 27, 2014 , we had no further accrued restructuring liabilities related to this restructuring plan.

During fiscal year 2012, we initiated a restructuring plan in connection with the transfer of a portion of our Shenzhen, China manufacturing operations to Venture Corporation Limited ("Venture"). This transition is scheduled to occur in a phased and gradual transfer of certain products, which is scheduled to be completed in fiscal year 2015. In connection with this transition, during the three months ended September 27, 2014 and September 28, 2013 , we recorded restructuring charges related to employee separation charges of $0.9 million and $1.0 million , respectively. During the three months ended September 27, 2014

and September 28, 2013 , we made scheduled payments of $1.3 million and $0.5 million ,, respectively, to settle a portion of these restructuring liabilities. As of September 27, 2014 , we had $0.2 million in accrued restructuring liabilities related to this restructuring plan.

We expect to incur an additional $3.0 million to $9.0 million , in aggregate, in restructuring charges over the course of the next year in connection with these restructuring plans.

The following table presents the components of accumulated other comprehensive income at the dates indicated:

In connection with the sale of the Zurich Business in the first quarter of fiscal year 2014, II-VI assumed the pension plan covering employees of the Swiss subsidiary.

NOTE 4. FAIR VALUE

We define fair value as the estimated price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk. We apply the following fair value hierarchy, which ranks the quality and reliability of the information used to determine fair values:

Our cash equivalents and marketable securities are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include most marketable securities and money market securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.

During the first quarter of fiscal year 2014, we had a contingent obligation related to the make-whole premium on our convertible notes, which was valued using a valuation model which estimated the value based on the probability and timing of conversion. The contingent obligation was classified within Level 3 of the fair value hierarchy. During the three months ended September 28, 2013, we recorded a $0.6 million fair value adjustment to the the contingent obligation, increasing the value of the contingent obligation to $0.7 million as of September 28, 2013. During the second quarter of fiscal year 2014, the holders of the convertible notes exercised their rights to exchange the convertible notes for common stock, and settled the make-whole premium.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are shown in the table below by their corresponding balance sheet caption and consisted of the following types of instruments at September 27, 2014 :

 

NOTE 5. BUSINESS COMBINATIONS AND DISPOSITIONS

Sale of Komoro, Japan Industrial and Consumer Business ("Komoro Business")

On August 5, 2014, Oclaro Japan, Inc., our wholly-owned subsidiary (“Oclaro Japan”), entered into a Master Separation Agreement (“MSA”) with Ushio Opto and Ushio, Inc. (“Ushio”), whereby Ushio Opto agreed to acquire the industrial and consumer business of Oclaro Japan located at its Komoro, Japan facility (the “Komoro Business”), by means of an absorption-type demerger under the Japanese Companies Act (such transaction, the “Transaction”). On October 27, 2014, the sale was completed. Consideration for the Transaction consisted of 1.85 billion Japanese yen (approximately $17.1 million based on the exchange rate on October 27, 2014) in cash, of which 1.6 billion Japanese yen (approximately $14.8 million based on the exchange rate on October 27, 2014) was paid at the closing and 250 million Japanese yen (approximately $2.3 million ) was paid into escrow and will be released to Oclaro Japan upon the earlier of six months after the closing or the completion by Oclaro Japan of certain transition services, subject to a net asset valuation adjustment post-closing and after deduction for any indemnification amounts determined to be owed to Ushio Opto prior to release of the funds from escrow.

At the closing of the Transaction, Oclaro Japan and Ushio Opto entered into certain transition services and reciprocal services agreements to allow the Komoro Business to continue operations during the ownership transition, as well as an intellectual property agreement. Ushio has guaranteed the performance of Ushio Opto’s obligations under the MSA. Oclaro Japan, Ushio Opto and Ushio each provided customary and reciprocal representations, warranties and covenants in the MSA.

We have recorded the assets and liabilities that we are transferring to Ushio Opto in connection with our sale of the Komoro Business as assets held for sale and liabilities in connection with the sale at September 27, 2014, and consist of the following:

The income from continuing operations before income taxes attributable to the Komoro Business was $1.6 million and $1.7 million for the three months ended September 27, 2014 and September 28, 2013, respectively.

Sale of Amplifier Business

On October 10, 2013, Oclaro Technology Limited entered into an Asset Purchase Agreement with II-VI, whereby Oclaro Technology Limited agreed to sell to II-VI and certain of its affiliates its Amplifier Business for $88.6 million in cash. The transaction closed on November 1, 2013. Consideration, valued at $88.6 million consists of $79.6 million in cash, which was received on November 1, 2013, $4.0 million subject to hold-back by II-VI until December 31, 2014 to address any post-closing claims and $5.0 million related to the exclusive option, which was received on September 12, 2013 and was credited against the purchase price upon closing of the sale.

We classified the sale of our Amplifier Business as a discontinued operation as of September 12, 2013, the date we committed to sell the business. As of September 27, 2014 , we had a $4.0 million receivable in prepaid expenses and other current assets from II-VI related to the hold-back for potential post-closing adjustments or claims.

The following table presents the statements of operations for the discontinued operations of the Amplifier Business:

This acquisition is more fully discussed in Note 3, Business Combinations and Dispositions , to our consolidated financial statements included in our 2014 Form 10-K.

Sale of Zurich Business

On September 12, 2013, we completed a share and asset purchase agreement with II-VI, pursuant to which we sold our Oclaro Switzerland GmbH subsidiary and associated laser diodes and pump business to II-VI. We received proceeds of $90.6 million in cash on September 12, 2013, and $2.9 million in cash during the third quarter of fiscal year 2014 which related to a final settlement of the post-closing working capital adjustment. We will also receive an additional  $6.0 million subject to hold-back by II-VI until December 31, 2014 to address any post-closing adjustments or claims. In addition, we retained approximately $14.7 million in accounts receivable related to the Zurich Business and approximately $9.6 million of supplier and employee related payables related to the Zurich Business which were not included in the Zurich subsidiary.

As part of the agreement, II-VI purchased our Swiss subsidiary, which includes its GaAs fabrication facility, and also the corresponding high power laser diodes, VCSEL and 980 nm pump laser product lines, including intellectual property,

inventory, equipment and a related research and development facility in Tucson, all of which are associated with the business. Also, as part of the agreement, II-VI purchased certain pieces of equipment which are located in our Caswell facility. We continue to operate this equipment on behalf of II-VI, and provide certain wafer processing services in Caswell as part of an ongoing manufacturing services agreement.

We classified the sale of our Zurich Business as a discontinued operation as of September 12, 2013. In connection with this transaction, we transferred $31.4 million in net assets to II-VI and incurred approximately $4.9 million in legal fees, commissions and other administrative costs. During the three months ended September 28, 2013, we initially recognized a gain of $62.8 million . In the third quarter of fiscal year 2014, we recorded an additional $0.4 million primarily related to the final settlement of the post-closing working capital adjustment.

In connection with the sale of our Zurich Business, during the first quarter of fiscal year 2014, we recorded $3.1 million in income from discontinued operations within the condensed consolidated statement of operations related to the cumulative translation adjustment from deconsolidating our Swiss subsidiary. As of September 27, 2014 , we recorded a $6.0 million receivable in prepaid expenses and other current assets from II-VI related to the hold-back for potential post-closing adjustments or claims.

The following table presents the statements of operations for the discontinued operations of the Zurich Business:

	Three Months Ended
	September 27, 2014				September 28, 2013
	(Thousands)
Revenues	$	—			$	13,896
Cost of revenues	163				11,593
Gross profit	(163		)		2,303
Operating expenses	—				3,416
Other income (expense), net	—				61,150
Income (loss) from discontinued operations before   income taxes	(163		)		60,037
Income tax provision	—				163
Income (loss) from discontinued operations	$	(163	)		$	59,874

This acquisition is more fully discussed in Note 3, Business Combinations and Dispositions , to our consolidated financial statements included in our 2014 Annual Report on Form 10-K.

NOTE 6. CREDIT LINE AND NOTES

Silicon Valley Bank Credit Facility

On March 28, 2014, Oclaro, Inc. and its subsidiary, Oclaro Technology Limited (the “Borrower”), entered into a loan and security agreement (the “Loan Agreement”) with Silicon Valley Bank (the “Bank”) pursuant to which the Bank provided the Borrower with a three -year revolving credit facility of up to $40.0 million . Under the Loan Agreement, advances are available based on up to 80 percent of “eligible accounts” as defined in the Loan Agreement. The Loan Agreement has a $10.0 million sub-facility for letters of credit, foreign exchange contracts and cash management services.

Borrowings made under the Loan Agreement bear interest at a rate based on either the London Interbank Offered Rate plus 2.25 percent or Wall Street Journal’s prime rate plus 1.00 percent . If the sum of (a) the Borrower’s unrestricted cash and cash equivalents that are subject to the Bank’s liens less (b) the amount outstanding to the Bank under the Loan Agreement (such sum being “Net Cash”) is less than $15.0 million , then the interest rates are increased by 0.75 percent until Net Cash exceeds $15.0 million for a calendar month. If interest paid under the Loan Agreement is less than $45,000 in any fiscal quarter, the Borrower is required to pay the Bank an additional amount equal to the difference between $45,000 and the actual interest paid during such fiscal quarter. The minimum interest payment is in lieu of a stand-by charge.

If the Loan Agreement terminates prior to its maturity date, the Borrower will pay a termination fee equal to 1.00 percent of the total credit facility if such termination occurs in the first year after closing, 0.75 percent of the total credit facility if such

termination occurs in the second year after closing and 0.50 percent of the total credit facility if such termination occurs in the third year after closing. The maturity date of the Loan Agreement is March 28, 2017. At September 27, 2014 , there were no amounts outstanding under the Loan Agreement.

The Loan Agreement is more fully discussed in Note 7, Credit Line and Notes , to our consolidated financial statements included in our 2014 Form 10-K.

Wells Fargo Credit Line and Term Loan

On August 2, 2006, Oclaro, Inc. ("Parent"), along with Oclaro Technology Limited (“Borrower”), Oclaro Photonics, Inc. and Oclaro Technology, Inc., each a wholly-owned subsidiary, entered into a Credit Agreement with Wells Fargo Capital Finance, Inc. (“Wells Fargo”) and certain other lenders (the “Credit Agreement”).

From time to time, we amended and restated the Credit Agreement, before terminating the agreement on March 14, 2014. The Credit Agreement is more fully discussed in Note 7, Credit Line and Notes , to our consolidated financial statements included in our 2014 Form 10-K.

On May 6, 2013, Wells Fargo and Silicon Valley Bank (collectively, the “Lenders”), Parent, Borrower, Wells Fargo (“Agent”) and PECM Strategic Funding LP and Providence TMT Debt Opportunity Fund II LP (the “Term Lenders”) entered into Amendment Number Two to the Credit Agreement and the associated guaranties and security agreements (the “Amendment”), which amended the Credit Agreement in pertinent part by adding a $25.0 million term loan (the “Term Loan”) to be provided by the Term Lenders; adding an affirmative covenant that Borrower shall have consummated one or more asset sales by July 15, 2013 with a minimum threshold of net proceeds; and providing for payments and proceeds of asset sales to be applied to repay the credit facility and the Term Loan. In connection with the Term Loan, we also issued certain warrants.

On August 21, 2013, Parent, Borrower, Agent, and the Lenders entered into Waiver and Amendment Number Three to the Credit Agreement, which amended the Credit Agreement in pertinent part by extending the date by which the Borrower shall have consummated one or more asset sales with a minimum threshold of net proceeds to September 2, 2013. The Borrower paid the lenders an amendment fee of $650,000 . On September 12, 2013, we completed the sale of the Zurich Business and applied the net proceeds to repay the entire credit line and Term Loan. The event of default resulting from not completing the transaction by September 2, 2013, was waived on September 26, 2013.

7.50% Exchangeable Senior Secured Second Lien Notes ("Convertible Notes")

On December 14, 2012, we and our indirect, wholly owned subsidiary, Oclaro Luxembourg S.A., closed the private placement of $25.0 million aggregate principal amount 7.50 percent Exchangeable Senior Secured Second Lien Notes due 2018 (“Convertible Notes”). The sale of the Convertible Notes resulted in net proceeds of approximately $22.8 million . The private placement was completed pursuant to a purchase agreement, dated December 14, 2012 entered into by us, certain of our domestic and foreign subsidiaries (the "Guarantors") and Morgan Stanley & Co. LLC, which is more fully discussed in Note 7, Credit Line and Notes , to our consolidated financial statements included in our 2014 Form 10-K.

We considered the contingent obligation of having to make a make-whole payment in the event of an early conversion by the holders of the Convertible Notes as an embedded derivative. We estimated the fair value of the make-whole payment by using a valuation model to predict the probability and timing of a conversion. At September 28, 2013 , the fair value of this contingent obligation was estimated at $0.7 million . In connection with the private placement of the Convertible Notes, we incurred approximately $1.3 million in debt discount and $0.9 million in issuance costs. During the three months ended September 28, 2013 , we recorded $0.2 million in debt discount and issuance costs in our condensed consolidated statement of operations.

On December 19, 2013, the holders exercised their rights to exchange the Convertible Notes for our common stock. The exchange rate for the exchanges was 541.7118 shares of common stock per $1,000 in principal amount of Convertible Notes. We issued 13,542,791 shares of common stock in connection with the exchange, with cash payable in lieu of fractional shares. In addition, pursuant to the terms of the indenture governing the Convertible Notes, we made a redemption exchange make-whole payment of $8.3 million during the second quarter of fiscal year 2014.

NOTE 7. POST-RETIREMENT BENEFITS

Switzerland Defined Benefit Plan

During the first quarter of fiscal year 2014, we sold our Zurich Business, and as part of the sale transferred our pension plan covering employees of our Swiss subsidiary (the “Swiss Plan”) to II-VI. At the end of our first quarter of fiscal year 2014, we had no remaining obligations under the Swiss Plan.

Japan Defined Contribution and Benefit Plan

In connection with our acquisition of Opnext, we assumed a defined contribution plan and a defined benefit plan that provides retirement benefits to our employees in Japan.

Under the defined contribution plan, contributions are provided based on grade level and totaled $0.2 million and $0.2 million for the three months ended September 27, 2014 and September 28, 2013 , respectively. Employees can elect to receive the benefit as additional salary or contribute the benefit to the plan on a tax-deferred basis.

Under the defined benefit plan in Japan (the “Japan Plan”), we calculate benefits based on an employee’s individual grade level and years of service. Employees are entitled to a lump sum benefit upon retirement or upon certain instances of termination. As of September 27, 2014 , there were no plan assets. Net periodic pension costs for the Japan Plan included the following:

 

During the three months ended September 27, 2014 , we recorded an adjustment of $0.5 million in accumulated other comprehensive income in connection with revising our methodology for estimating the actuarial present value of accumulated plan benefits under the Japan Plan.

We have $0.2 million in accrued expenses and other liabilities and $7.4 million in other non-current liabilities in our condensed consolidated balance sheet as of September 27, 2014 , to account for the projected benefit obligations under the Japan Plan, of which a portion will be transferred as part of the sale of the Komoro Business.

We made benefit payments under the Japan plan of $0.3 million and $0.1 million during the three months ended September 27, 2014 and September 28, 2013 , respectively.

NOTE 8. 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 months 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:

Capital Leases

In connection with our acquisition of Opnext, we assumed certain capital leases with Hitachi Capital Corporation, a related party, for certain equipment. The terms of the leases generally range from one to five years and the equipment can be purchased at the residual value upon expiration. We can terminate the leases at our discretion in return for a penalty payment as stated in the lease contracts.

The following table shows the future minimum lease payments due under non-cancelable capital leases with Hitachi Capital Corporation, including $0.5 million in capital leases classified as liabilities in connection with the sale in our condensed consolidated balance sheet at September 27, 2014:

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 effect on our results of operations, financial position or cash flows.

Raysung Commercial Litigation

On October 23, 2013, Xi’an Raysung Photonics Inc., or Raysung, filed a civil suit against our wholly-owned subsidiary, Oclaro Technology (Shenzhen) Co., Ltd. (formerly known as Bookham Technology (Shenzhen) Co., Ltd.), or Oclaro Shenzhen, in the Xi’an Intermediate People’s Court in Shaanxi Province of the People’s Republic of China, or the Xi’an Court. The complaint filed by Raysung alleges that Oclaro Shenzhen terminated its purchase order pursuant to which Raysung had supplied certain products and was to supply certain products to Oclaro Shenzhen.

Raysung initially requested that the court award damages of RMB 4,796,531 (equivalent to approximately $0.8 million at the exchange rate in effect September 27, 2014), and requested that Oclaro Shenzhen take the finished products that are now stored in Raysung’s warehouse (the value of the finished product is RMB 13,505,162 (equivalent to approximately $2.2 million at the exchange rate in effect September 27, 2014) and requested that Oclaro Shenzhen pay its court fees in connection with this suit.

The Xi’an Court delivered an Asset Preservation Order which was served on Oclaro Shenzhen and the local Customs office. According to the Asset Preservation Order, Oclaro Shenzhen was ordered to maintain RMB 15,000,000 (equivalent to approximately $2.4 million at the exchange rate in effect September 27, 2014) or assets equivalent to the said amount during the litigation process, and the Customs office was ordered to restrict Oclaro Shenzhen's equipment from being exported before the Asset Preservation Order is lifted. On November 11, 2013, Oclaro Shenzhen entered into a settlement agreement. Under the terms of this settlement agreement, Oclaro Shenzhen agreed to pay $500,000 in payment of invoices for certain materials to Raysung and to work with Raysung to requalify it as a vendor for certain Oclaro Shenzhen manufacturing requirements, in consideration of which Raysung agreed to submit the settlement agreement to the Xi’an Court so it could issue a civil mediation agreement, apply for a discharge of the Asset Preservation Order and waive the right to bring any legal actions against Oclaro Shenzhen relating to these matters. Oclaro Shenzhen performed its obligations under the settlement agreement, however, on January 15, 2014, Raysung applied to the Xi’an Court to terminate the settlement agreement and add Oclaro, Inc. as a co-defendant in the original civil suit.

On March 26, 2014, the Xi’an Court froze RMB 15,000,000 (equivalent to approximately $2.4 million at the exchange rate in effect September 27, 2014) of cash held in Oclaro Shenzhen’s bank account in China. On April 30, 2014, Oclaro Shenzhen submitted a challenge to the jurisdiction of the Xi'an Court. On May 26, 2014, the Xi'an Court overruled the jurisdictional challenge. On June 4, 2014, Oclaro Shenzhen filed an appeal with the Shaanxi High Court to revoke the civil order of the Xi'an Court overruling Oclaro Shenzhen's jurisdictional challenge. The Shaanxi High Court held hearings on July 15, 2014 and July 30, 2014, and on August 20, 2014 sustained the Xi'an Court's civil order on jurisdiction and transferred the case back to the Xi'an Court for substantive proceedings. On September 22, 2014, Raysung amended its complaint in the Xi'an Court proceeding by increasing its claims to RMB 36.2 million (equivalent to approximately $5.9 million at the exchange rate in effect on September 27, 2014). On October 22, 2014, the Xi'an Court conducted a hearing on the substantive elements of Raysung's claims. At the same hearing, Oclaro Shenzhen filed counterclaims against Raysung for RMB 7.4 million (equivalent to approximately $1.2 million at the exchange rate in effect on September 27, 2014) of losses resulting from supply of products with unqualified materials. The Xi'an Court has not yet established the next hearing date. Oclaro, Inc. and Oclaro Shenzhen believe that they have meritorious defenses to the claims made by Raysung and intend to defend this litigation vigorously.

Class Action and Derivative Litigation

On May 19, 2011, Curtis and Charlotte Westley filed a purported class action complaint in the United States District Court for the Northern District of California, against us and certain of our officers and directors. The Court subsequently appointed the Connecticut Laborers’ Pension Fund (“Pension Fund”) as lead plaintiff for the putative class. On April 26, 2012, the Pension Fund filed a second amended complaint, captioned as Westley v. Oclaro, Inc., No. 11 Civ. 2448 EMC, allegedly on behalf of persons who purchased our common stock between May 6 and October 28, 2010, alleging that we and certain of our officers and directors issued materially false and misleading statements during this time period regarding our current business and financial condition, including projections for demand for our products, as well as our revenues, earnings, and gross margins, for the first quarter of fiscal year 2011 as well as the full fiscal year. The complaint alleged violations of section 10(b) of the

Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, as well as section 20(a) of the Securities Exchange Act. The complaint sought damages and costs of an unspecified amount. On September 21, 2012, the Court dismissed the second amended complaint with leave to amend. After the Pension Fund moved for reconsideration, on January 10, 2013, the Court allowed plaintiffs to take discovery regarding statements made in May and June 2010. On March 1, 2013 the Pension Fund filed a third amended complaint, attempting to cure pleading deficiencies with regard to statements allegedly made in July and August 2010. On April 1, 2013, defendants moved to dismiss the third amended complaint with respect to the statements made in July and August 2010. On May 30, 2013, the Court granted Defendants’ motion to dismiss the complaint’s claims based on statements made in July and August 2010. Although discovery has commenced, no trial was ever scheduled in this action.

On June 10, 2011, a purported shareholder, Stanley Moskal, filed a purported derivative action in the Superior Court for the State of California, County of Santa Clara, against us, as nominal defendant, and certain of our current and former officers and directors, as defendants. The case is styled Moskal v. Couder, No. 1:11 CV 202880 (Santa Clara County Super. Ct., filed June 10, 2011). Four other purported shareholders, Matteo Guindani, Jermaine Coney, Jefferson Braman and Toby Aguilar, separately filed substantially similar lawsuits in the United States District Court for the Northern District of California on June 27, June 28, July 7 and July 26, 2011, respectively. By Order dated September 14, 2011, the Guindani, Coney, and Braman actions were consolidated under In re Oclaro, Inc. Derivative Litigation, Lead Case No. 11 Civ. 3176 EMC. On October 5, 2011, the Aguilar action was voluntarily dismissed. Each remaining purported derivative complaint alleged that Oclaro has been, or will be, damaged by the actions alleged in the Westley complaint, and the litigation of the Westley action, and any damages or settlement paid in the Westley action. Each purported derivative complaint alleged counts for breaches of fiduciary duty, waste, and unjust enrichment. Each purported derivative complaint sought damages and costs of an unspecified amount, as well as injunctive relief. By Order dated March 6, 2012, the parties in the Moskal action agreed that defendants shall not be required to respond to the original complaint. By Order dated February 27, 2013, the parties in the Moskal action agreed that plaintiff would serve an amended complaint no later than 30 days after the Court in the Westley action rules on defendants’ motion to dismiss the third amended complaint in the Westley action and the stay of discovery would remain in effect until further order of the Court or agreement by the parties, provided, however, that they obtain discovery produced in the Westley Action. By Order dated March 12, 2013, the parties to In re Oclaro, Inc. Derivative Litigation agreed to stay all proceedings until such time as (a) the defendants file an answer to any complaint in the Westley action; or (b) the Westley action is dismissed in its entirety with prejudice, provided, however, that they obtain discovery produced in the Westley Action. No trial has been scheduled in any of these actions.

On September 3, 2013, the parties agreed to settle the Westley, Moskal, and In re Oclaro Derivative matters for a total of $3.95 million , plus certain corporate governance changes. The money will be paid entirely by our directors and officers liability insurance carriers. Any fees awarded to the plaintiffs in these actions, or their respective counsel, are included in this amount. By Order dated August 13, 2014, the Court in the Westley matter gave its final approval to the settlement. By Order dated September 19, 2014, the Court in the In re Oclaro, Inc. Derivative Litigation gave its final approval to the settlement. By Order dated October 1, 2014, the Court approved the voluntary dismissal of the Moskal matter, terminating the state court derivative matters.

 

NOTE 9. EMPLOYEE STOCK PLANS

Stock Incentive Plans

In connection with our acquisition of Opnext, we assumed Opnext’s Third Amended and Restated 2001 Long-Term Stock Incentive Plan and the shares reserved for issuance thereunder. After giving effect to the exchange ratio, the unused and converted share reserve thereunder consisted of 6.3 million shares of common stock as of the acquisition date. Subject to compliance with applicable NASDAQ rules, we can only make grants to legacy Opnext employees and employees hired after the close of the merger unless stockholder approval was obtained to permit awards to all our employees. On July 23, 2013, our board of directors approved the Fourth Amended and Restated 2001 Long-Term Stock Incentive Plan (the "Plan") and on January 14, 2014, our shareholders ratified this plan, establishing it as our primary equity incentive plan. The Plan (i) revises the eligibility section to allow us to make grants to all our employees, non-employee directors and consultants, (ii) allows us to grant incentive stock options and awards which may be able to qualify as qualified performance-based compensation under Section 162(m) of the Internal Revenue Code, (iii) extends the term of the Plan to ten years from the effective date of the Plan (the Plan expires in July 2023), and (iv) conforms the share counting provisions of the Plan to provide that full value awards count as 1.25 shares for purposes of the Plan.

We also maintain the Amended and Restated 2004 Stock Incentive Plan (“2004 Plan”). Under the 2004 Plan, there are a total of 7.8 million shares of common stock authorized for issuance, with full value awards being counted as 1.25 shares of common stock for purposes of the share limit. The 2004 Plan expires in October 2020 .

As of September 27, 2014 , there were 2.7 million shares of our common stock available for grant under both plans.

We generally grant stock options that vest over a two to four year service period, and restricted stock awards and units that vest over a one to four year service period, and in certain cases each may vest earlier based upon the achievement of specific performance-based objectives as set by our board of directors or the compensation committee of our board of directors.

In July 2011, our board of directors approved the grant of 0.2 million performance stock units (“PSUs”) to certain executive officers with an aggregate estimated grant date fair value of $0.9 million . In October 2013, the board of directors determined that achievement of the performance conditions was reached at the 100 percent target level. Approximately 0.1 million of the grants outstanding, or 50 percent , vested on October 22, 2013, with the remaining 50 percent scheduled to vest upon a two -year service condition through August 2015. As of September 27, 2014 , there were less than 0.1 million PSUs outstanding, after adjustments for forfeitures due to terminations, related to this grant, with an aggregate estimated grant date fair value of less than $0.1 million .

In July 2012, our board of directors approved a grant of 0.6 million PSUs to certain executive officers, subject to shareholder approval of an amendment to our Plan. Prior to shareholder approval, approximately 0.4 million of the PSUs were forfeited as a result of certain executive officer departures. On January 14, 2014, shareholder approval was obtained at our annual general meeting of stockholders. These PSUs were scheduled to vest upon the achievement of certain adjusted earnings before interest, taxes, depreciation and amortization targets through June 30, 2014. During the three months ended September 27, 2014, it was determined that the performance conditions were not achieved, and the corresponding PSUs were forfeited.

In February 2014, our board of directors granted our chief executive officer 0.8 million restricted stock units ("RSUs") in satisfaction of the terms set forth in his employment agreement dated September 11, 2013. The RSUs vested in full on the date of grant, and settled on August 15, 2014. The RSUs have an aggregate grant date fair value of $2.0 million , which was recorded in the third quarter of fiscal year 2014.

In March 2014, our board of directors approved a grant of 0.2 million PSUs to certain executive officers with an aggregate estimated grant date fair value of $0.5 million . These PSUs vest upon the achievement of non-GAAP operating income break-even for calendar year 2015. Vesting is also contingent upon service conditions being met through February 2018. If the performance condition is not achieved, then the corresponding PSUs will be forfeited in the third quarter of fiscal year 2016. As of September 27, 2014, there were 0.1 million PSUs outstanding, after adjustments for forfeitures due to terminations, related to this grant, with an aggregate estimated grant date fair value of $0.4 million .

In August 2014, our board of directors approved a grant of 0.5 million PSUs to certain executive officers with an aggregate estimated grant date fair value of $0.9 million . These PSUs will vest at 100 percent upon the achievement of two consecutive quarters with positive earnings before interest, taxes, depreciation and amortization on or before the end of our fiscal year 2017. If the performance condition is not achieved, then the corresponding PSUs will be forfeited in the first quarter of fiscal year 2018.

In August 2014, our board of directors approved a retention grant of 0.4 million RSUs to certain of our executives, which vest annually over three years . In September 2014, our board of directors also approved a retention grant of 1.4 million RSUs to other employees, which vest over two years .

The following table summarizes the combined activity under all of our equity incentive plans for the three months ended September 27, 2014 :

Supplemental disclosure information about our stock options and SARs outstanding as of September 27, 2014 is as follows:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the closing price of our common stock of $1.51 on September 26, 2014, which would have been received by the option holders had all option holders exercised their options as of that date. There were less than 0.1 million shares of common stock subject to in-the-money options which were exercisable as of September 27, 2014 . We settle employee stock option exercises with newly issued shares of common stock.

The amounts included in cost of revenues and operating expenses for stock-based compensation were as follows:

As of September 27, 2014 and June 28, 2014 , we had capitalized approximately $0.4 million and $0.4 million , respectively, of stock-based compensation as inventory.

As of September 27, 2014 , we had $1.0 million in unrecognized stock-based compensation expense related to unvested stock options and SARs, net of estimated forfeitures, that will be recognized over a weighted-average period of 2.2 years , and $10.2 million in unrecognized stock-based compensation expense related to unvested restricted stock awards, net of estimated forfeitures, that will be recognized over a weighted-average period of 1.9 years .

The amount of stock-based compensation expense recognized in any one period related to PSUs can vary based on the achievement or anticipated achievement of the performance conditions. If the performance conditions are not met or not expected be met, no compensation cost would be recognized on the underlying PSUs, and any previously recognized compensation expense related to those PSUs would be reversed. During the three months ended September 27, 2014 and September 28, 2013 , we recorded minimal stock-based compensation expense in connection with the issuance of the PSUs from July 2011, March 2014 and August 2014.

NOTE 11. INCOME TAXES

The income tax provision of $1.0 million and $0.3 million for the three months ended September 27, 2014 and September 28, 2013 , respectively, relates primarily to our foreign operations.

The total amount of our unrecognized tax benefits as of September 27, 2014 and June 28, 2014 were approximately $4.1 million and $4.2 million , respectively. As of September 27, 2014 , we had $3.6 million of unrecognized tax benefits that, if recognized, would affect our effective tax rate. While it is often difficult to predict the final outcome of any particular uncertain tax position, we believe that unrecognized tax benefits could decrease by approximately $0.5 million in the next twelve months.