Note 16. Stock-Based Compensation

Stock-Based Benefit Plans

Amendment and Restatement of Amended and Restated 2003 Equity Incentive Plan

On November 15, 2017, the Company's stockholders approved the amendment and restatement of the Company’s Amended and Restated 2003 Equity Incentive Plan (the 2003 Plan, as most recently amended and restated, the “Amended and Restated 2003 Plan”), under which:

(1) the number of shares of the Company’s Common Stock reserved under the 2003 Plan increased by the sum of (i) 4,000,000 new shares, (ii) the number of shares remaining for issuance under the Company’s 2005 Acquisition Equity Incentive Plan (“Acquisition Plan”) as of November 15, 2017, the date such Acquisition Plan was terminated (the “Restatement Date”), and (iii) the number of shares subject to outstanding stock awards granted under the Acquisition Plan that on or after Restatement Date would have otherwise been available for re-issuance under the Acquisition Plan;

(2) the 2003 Plan’s fungible share provision was eliminated;

(3) a limit on the total value of equity and cash compensation that may be paid to each of the Company's non-employee directors during each fiscal year was set; and

(4) the material terms of the 2003 Plan for purposes of Section 162(m) of the Internal Revenue Code were re-approved, including, but not limited to the performance goals and share limitations set forth in the 2003 Plan.

As such, an additional 5.5 million shares were authorized under the re-approved 2003 plan and the 2005 Acquisition plan was terminated effective as of November 15, 2017.

Amendment and Restatement of Amended and Restated 1998 Employee Stock Purchase Plan

On November 15, 2017, the Company's stockholders approved the amendment and restatement of the Company’s Amended and Restated 1998 Employee Stock Purchase Plan (the “ESPP”, as most recently amended and restated, the “Amended and Restated ESPP”), to extend the termination date from August 1, 2018 to November 15, 2027.

Stock Option Plans

As of June 30, 2018, the Company had 7.7 million shares of stock options and Full Value Awards issued and outstanding to employees and directors under the Amended and Restated 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- or four-year period and, if not exercised, expire from five to ten years after the date of grant.

As of June 30, 2018, 14.8 million shares of common stock, primarily under the re-approved 2003 Plan, were available for grant.

Employee Stock Purchase Plans

In June 1998, the Company adopted the ESPP, which became effective August 1, 1998 and 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 November 15, 2027 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 June 30, 2018, 4.3 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, MSUs and PSUs that are granted without an the exercise price and are converted to shares immediately upon vesting. PSUs are performance-based with market conditions, performance conditions, time-based or a combination and expected to vest over one to four years. The fair value of the time-based RSUs 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 2018, 2017 and 2016 was as follows (in millions):



	Years Ended
	June 30, 2018		July 1, 2017		July 2, 2016
Cost of revenue	$	3.3	$	3.6	$	4.8
Research and development	4.9		5.7		8.4
Selling, general and administrative	22.3		23.9		29.2
Total stock-based compensation expense	$	30.5	$	33.2	$	42.4

Approximately $0.8 million of stock-based compensation expense was capitalized to inventory at June 30, 2018.

Impact on Stock-based Compensation Due to Separation

In connection with the separation of the Lumentum business on August 1, 2015 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 prior periods have not been adjusted to remove grants made to employees who transferred to Lumentum as part of the separation. Refer to “Note 4. Discontinued Operations” for further information.

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 (in millions, except per share amounts):



	Options Outstanding
	Number of Shares		Weighted-Average Exercise Price (1)
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
Exercised	(1.6	)	5.66
Balance as of July 1, 2017	1.5		6.16
Exercised	(0.2	)	4.53
Balance as of June 30, 2018	1.3		$	6.42

Expected to vest	1.3		$	6.45

(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 June 30, 2018 was $1.2 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 June 30, 2018, $1.0 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 1.6 years.

The following table summarizes outstanding and exercisable options as of June 30, 2018, adjusted to reflect the impact of the Lumentum separation.



	Options Outstanding						Options Exercisable
Exercise Price	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)
$5.74	28,602	0.13	$	5.74	$	0.1	28,602	0.13	$	5.74	$	0.1
$5.95	1,180,257	5.63	5.95		$	5.1	590,129	5.63	5.95		$	2.5
$11.82	107,412	0.87	11.82		$	—	107,412	0.87	11.82		$	—
	1,316,271	5.12	$	6.42	$	5.2	726,143	3.58	$	6.81	$	2.6

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $10.24 as of June 30, 2018, 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 June 30, 2018 was 0.6 million.

Employee Stock Purchase Plan Activity

The expense related to the ESPP 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 June 30, 2018:



Purchase date	July 31, 2017		January 31, 2018
Shares issued	219,586		246,237
Fair market value at purchase date	$	9.29	$	11.20

As of June 30, 2018, 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 2019.

Full Value Awards Activity

A summary of the status of the Company’s non-vested Full Value Awards as of June 30, 2018 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 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
Awards granted	0.6		3.7		4.3		7.86
Awards vested	(0.6	)	(4.5	)	(5.1	)	6.66
Awards forfeited	—		(1.3	)	(1.3	)	6.83
Non-vested at July 1, 2017	1.0		6.3		7.3		7.17
Awards granted	0.8		3.3		4.1		10.01
Awards vested	(0.6	)	(3.6	)	(4.2	)	7.10
Awards forfeited	(0.1	)	(0.7	)	(0.8	)	8.01
Non-vested at June 30, 2018	1.1		5.3		6.4		8.93

(1)

Performance Shares refer to the Company’s MSU and PSU 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 and performance goal achievement. The majority of MSUs vest in equal annual installments over three to four years based on the attainment of certain total shareholder performance measures and the employee’s continued service through the vest date. The aggregate grant-date fair value of MSUs granted during fiscal 2018, 2017 and 2016 were estimated to be $4.7 million, $3.3 million and $3.7 million, respectively, and were calculated using a Monte Carlo simulation. The fair value of the PSUs granted in fiscal 2018 was $1.4 million and vest based on the attainment of certain performance measures and the employee’s continued service through the vest date.

As of June 30, 2018, $38.5 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 1.7 years.

The Company adopted the new authoritative guidance that simplified several aspects of accounting for share-based payment award transactions including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. Under the new guidance, companies can make an accounting policy election to either continue to estimate forfeitures or account for forfeitures as they occur. Upon adoption, the Company elected to account for forfeitures when they occur, on a modified retrospective basis. The Company recognized net cumulative effect of $0.6 million as an increase to accumulated deficit as of the first day of fiscal 2018. Further, the new authoritative guidance required previously unrecognized deferred tax benefits to be recorded as deferred tax assets. Upon adoption, the Company had $117.7 million of net operating loss carryforwards resulting from excess tax benefit deductions. In accordance with the new authoritative guidance, there was no impact to retained earnings resulting from adoption, as the deferred tax assets associated with these net operating loss carryforwards were fully offset by a corresponding valuation allowance. All other aspects of the guidance did not have a material effect on the Company’s consolidated financial statements.

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
	June 30, 2018		July 1, 2017		July 2, 2016
Volatility of common stock	30.1	%	33.2	%	33.8	%
Average volatility of peer companies	32.6	%	36.9	%	52.9	%
Average correlation coefficient of peer companies	.1618		.1856		.1103
Risk-free interest rate	1.4	%	0.7	%	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
	June 30, 2018		June 30, 2018		July 1, 2017		July 2, 2016
Expected term (in years)	5.2		0.5		0.5		0.5
Expected volatility	42.3	%	28.0	%	33.4	%	45.7	%
Risk-free interest rate	1.2	%	1.4	%	0.5	%	0.4	%

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 expected volatility for stock options was based on the historical volatility of the Company's common stock and its peers. The expected volatility for ESPP was based on the historical volatility of its stock price with similar expected term.

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.