Note 15. Stock-Based Compensation

Stock-Based Benefit Plans

Stock Option Plans

As of July 2, 2016, the Company had 12.5 million shares of stock options and Full Value Awards issued and outstanding to employees and directors under the Restated 2005 Acquisition Equity Incentive Plan (“the 2005 Plan”), Restated 2003 Equity Incentive Plan (“the 2003 Plan”), inducement grants in connection with the appointment of our new CEO in fiscal 2016 and various other plans the Company assumed through acquisitions. The exercise price for stock options is equal to the fair value of the underlying stock at the date of grant. The Company issues new shares of common stock upon exercise of stock options. Options generally become exercisable over a three-year or four-year period and, if not exercised, expire from five to ten years after the date of grant.

On November 14, 2012, the Company’s shareholders approved two amendments to the 2003 Plan. The first amendment increased the number of shares that may be issued under this plan by 10,000,000 shares. The second amendment extended the 2003 Plan’s terms for an additional ten year period after the date of approval of the amendment. On December 5, 2014, the Company’s shareholders approved another amendment to the 2003 Plan to increase the number of shares that may be issued under the plan by 9,000,000 shares. On August 1, 2015, following the Separation, the number of shares available for grant and all outstanding awards were automatically adjusted pursuant to the terms of the 2003 Plan and 2005 Plan.

As of July 2, 2016, 19.4 million shares of common stock, primarily under the 2003 Plan and the 2005 Plan, were available for grant.

Employee Stock Purchase Plans

In June 1998, the Company adopted the 1998 Employee Stock Purchase Plan, as amended (the “1998 Purchase Plan”). The 1998 Purchase Plan, which became effective August 1, 1998, provides eligible employees with the opportunity to acquire an ownership interest in the Company through periodic payroll deductions and provides a discounted purchase price as well as a look-back period. The 1998 Purchase Plan is structured as a qualified employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986. However, the 1998 Purchase Plan is not intended to be a qualified pension, profit sharing or stock bonus plan under Section 401(a) of the Internal Revenue Code of 1986 and is not subject to the provisions of the Employee Retirement Income Security Act of 1974. The 1998 Purchase Plan will terminate upon the earlier of August 1, 2018 or the date on which all shares available for issuance have been sold. On August 1, 2015, following the Separation, the number of shares available for issuance was automatically adjusted pursuant to the terms of the 1998 Purchase Plan. As of July 2, 2016, 5.5 million shares remained available for issuance. The 1998 Purchase Plan provides a 5% discount and a six month look-back period.

Full Value Awards

Full Value Awards refer to RSUs (time-based, Non-Performance Shares) and MSUs (Market-based, Performance Shares) that are granted with the exercise price equal to zero and are converted to shares immediately upon vesting. These Full Value Awards are performance-based with market conditions, time-based or a combination of both and expected to vest over one to four years. The fair value of the time-based Full Value Awards is based on the closing market price of the Company’s common stock on the date of award.

Stock-Based Compensation

The impact on the Company’s results of operations of recording stock-based compensation expense by function for fiscal 2016, 2015 and 2014 was as follows (in millions):



	Years Ended
	July 2, 2016		June 27, 2015		June 28, 2014
Cost of sales	$	4.8	$	4.2	$	4.3
Research and development	8.4		8.1		8.4
Selling, general and administrative	29.2		35.2		32.0
Total stock-based compensation expense	$	42.4	$	47.5	$	44.7

Approximately $0.8 million of stock-based compensation expense was capitalized to inventory at July 2, 2016.

Impact on Stock-based Compensation Due to Separation

In connection with the separation of the Lumentum business on August 1, 2015 and in accordance with the Employee Matters Agreement, the Company made certain adjustments to the exercise price and number of shares underlying stock-based compensation awards with the intention of preserving the economic value of the awards for Viavi employees. These adjustments resulted in a modification of equity awards with total incremental stock-based compensation of $13.6 million, to be amortized over the remaining service periods of the underlying awards.

Unless otherwise noted, share amounts and grant-date fair values for periods prior to the Separation Date represent the Company’s historical information and have not been adjusted to remove grants made to employees who transferred to Lumentum as part of the Separation. Refer to “Note 3. Discontinued Operations” for more information on the Separation.

Impact on Stock-based Compensation Due to Amendments in the Change of Control Benefits Plan

During the year ended June 27, 2015, the Company amended its Change of Control Benefits Plan (the “Plan”) to add a spin-off of certain Company assets to the circumstances that could trigger benefits under the Plan, as well as other revisions. The Chief Executive Officer of the Company and the Chairman of the Compensation Committee approved the separation of certain executives in the current fiscal year. Pursuant to the Plan, upon termination, all unvested equity awards that have been granted or issued to certain terminated executives become immediately vested and stock options shall become fully exercisable with an extended exercise period of two years from the termination date.

The amendments resulted in a modification of equity awards for six executives and total incremental stock-based compensation of $6.3 million, which was amortized over the period between the modification date and the termination dates of the executives.

Stock Option Activity

The following is a summary of stock option activities (amount in millions except per share amounts):



	Number of Shares		Weighted-Average Exercise Price (1)
Balance as of June 29, 2013	5.6		$	10.56
Exercised	(1.6	)	7.91
Canceled	(0.5	)	22.24
Balance as of June 28, 2014	3.5		10.13
Exercised	(0.9	)	7.58
Canceled	(0.1	)	14.54
Balance as of June 27, 2015	2.5		10.84
Granted	1.2		5.95
Exercised	(0.7	)	4.74
Canceled	(0.4	)	10.52
Net adjustment due to the separation	0.5
Balance as of July 2, 2016	3.1		$	5.91

Expected to vest	2.8		$	5.91

(1) Weighted average exercise price is calculated using exercise prices prior to the Separation and after the Separation.

The total intrinsic value of options exercised during the year ended July 2, 2016 was $1.3 million. In connection with these exercises, the tax benefit realized by the Company was immaterial due to the fact that the Company has no material benefit in foreign jurisdictions and a full valuation allowance on its domestic deferred tax assets. As of July 2, 2016, $2.0 million of unrecognized stock-based compensation expense related to stock options remains to be amortized. That cost is expected to be recognized over an estimated amortization period of 3.6 years.

The following table summarizes significant ranges of outstanding and exercisable options as of July 2, 2016, adjusted to reflect the impact of the Lumentum separation.



	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Remaining Contractual Term (in years)	Weighted Average Exercise Price		Aggregate Intrinsic Value (in millions)		Number of Shares	Weighted Average Remaining Contractual Term (in years)	Weighted Average Exercise Price		Aggregate Intrinsic Value (in millions)
$1.99 - $3.28	564,672	0.99	$	2.96			564,672		$	2.96
$5.74 - $5.74	812,359	1.52	5.74				812,359		5.74
$5.95 - $5.95	1,180,257	7.62	5.95				—		—
$6.52 - $9.93	394,487	1.25	8.75				394,487		8.75
$11.82 - $11.82	107,412	2.87	11.82				107,412		11.82
	3,059,187	3.79	$	5.91	$	3.6	1,878,930	1.4	$	5.88	$	2.8

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $6.61 as of July 2, 2016, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of July 2, 2016 was 1.5 million.

Employee Stock Purchase Plan Activity

The expense related to the plan is recorded on a straight-line basis over the relevant subscription period.

The following summarizes the shares issued and the fair market value at purchase date, pursuant to the Company’s ESPP during the year ended July 2, 2016:



Purchase date	January 29, 2016
Shares issued	253,885
Fair market value at purchase date	$	4.75

As of July 2, 2016, there was $0.1 million of unrecognized stock-based compensation cost related to ESPP remains to be amortized. The cost will be recognized in the first quarter of fiscal 2017.

Full Value Awards Activity

A summary of the status of the Company’s non-vested Full Value Awards as of July 2, 2016 and changes during the same period is presented below (amount in millions, except per share amounts):



	Full Value Awards
	Performance Shares (1)		Non-Performance Shares		Total Number of Shares		Weighted-average grant-dated fair value
Non-vested at June 29, 2013	1.0		8.0		9.0		$	12.61
Awards granted	0.6		5.4		6.0		13.42
Awards vested	(0.4	)	(4.1	)	(4.5	)	12.26
Awards forfeited	(0.1	)	(1.0	)	(1.1	)	12.94
Non-vested at June 28, 2014	1.1		8.3		9.4		13.19
Awards granted	0.7		5.3		6.0		11.78
Awards vested	(0.8	)	(4.4	)	(5.2	)	12.96
Awards forfeited	—		(1.4	)	(1.4	)	13.10
Non-vested at June 27, 2015	1.0		7.8		8.8		12.36
Awards granted	0.7		6.1		6.8		5.75
Awards vested	(0.7	)	(4.8	)	(5.5	)	6.01
Awards forfeited	(0.4	)	(1.8	)	(2.2	)	7.89
Net adjustment due to the separation	0.4		1.1		1.5
Non-vested at July 2, 2016	1.0		8.4		9.4		$	6.55

(1)

Performance Shares refer to the Company’s MSU awards, where the actual number of shares awarded upon vesting may be higher or lower than the target amount depending on the achievement of the relevant market conditions. The majority of MSUs vest in equal annual installments over three to four years based on the attainment of certain total shareholder return performance measures and the employee’s continued service through the vest date. The aggregate grant-date fair value of MSUs granted during fiscal 2016, 2015 and 2014 was estimated to be $3.7 million, $9.4 million and $9.2 million respectively, and was calculated using a Monte Carlo simulation.

As of July 2, 2016, $39.1 million of unrecognized stock-based compensation cost related to Full Value Awards remains to be amortized. That cost is expected to be recognized over an estimated amortization period of 2.0 years.

Full Value Awards are converted into shares upon vesting. Shares equivalent in value to the minimum withholding taxes liability on the vested shares are withheld by the Company for the payment of such taxes. During fiscal 2016, 2015 and 2014, the Company paid $11.4 million, $22.1 million and $21.4 million, respectively, and classified the payments as operating cash outflows in the Consolidated Statements of Cash Flows.

Valuation Assumptions

The Company estimates the fair value of the MSUs on the date of grant using a Monte Carlo simulation with the following assumptions:



	Years Ended
	July 2, 2016		June 27, 2015		June 28, 2014
Volatility of common stock	33.8	%	40.8	%	53.9	%
Average volatility of peer companies	52.9	%	53.4	%	58.6	%
Average correlation coefficient of peer companies	0.1103		0.2156		0.2920
Risk-free interest rate	0.8	%	0.6	%	0.8	%

The Company estimates the fair value of Stock Options and ESPP using a BSM valuation model. The fair value is estimated on the date of grant using the BSM option valuation model with the following weighted-average assumptions:



	Stock Options		Employee Stock Purchase Plans
	July 2, 2016		July 2, 2016		June 27, 2015		June 28, 2014
Expected term (in years)	5.2		0.5		0.5		0.5
Expected volatility	42.3	%	45.7	%	37.9	%	39.5	%
Risk-free interest rate	1.2	%	0.4	%	0.1	%	0.1	%

Expected Term: The Company's expected term for stock options was calculated utilizing the simplified method in accordance with the authoritative guidance. The Company used the simplified method as the Company does not have sufficient historical share option exercise data due to the limited number of shares granted as well as changes in the Company's business following the Separation, rendering existing historical experience less reliable in formulating expectations for current grants. The Company’s expected term for ESPP is in line with the six month look-back period of its ESPP.

Expected Volatility: The Company has limited trading history following the Separation; therefore, the expected volatility for stock options was based on the historical volatility of the Company's common stock and its peers. For grants prior to the Separation and for ESPP grants, the Company determined that a combination of the implied volatility of its traded options and historical volatility of its stock price based on the expected term of the equity instrument most appropriately reflects market expectation of future volatility. Implied volatility is based on traded options of the Company’s common stock with a remaining maturity of four and a half months or greater.

Risk-Free Interest Rate: The Company bases the risk-free interest rate used in the BSM valuation method on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

Expected Dividend: The BSM valuation model calls for a single expected dividend yield as an input. The Company has not paid and does not anticipate paying any dividends in the near future.