10-Q 1 lumentumfy18q3-10q.htm 10-Q Document

 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
 
 
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
 OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
 
to
 
 
 Commission File Number 001-36861
Lumentum Holdings Inc.
(Exact name of Registrant as specified in its charter)
Delaware
 
47-3108385
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
400 North McCarthy Boulevard, Milpitas, California 95035
(Address of principal executive offices including Zip code)
 
(408) 546-5483
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x        No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
(Do not check if a smaller reporting company)
o
Smaller reporting company
o
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x
As of April 27, 2018, the Registrant had 62.6 million shares of common stock outstanding.
 
 
 
 
 




TABLE OF CONTENTS
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1


PART I - FINANCIAL INFORMATION
Item1. Financial Statements (Unaudited)
LUMENTUM HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2018

April 1, 2017
 
March 31, 2018

April 1, 2017
Net revenue
$
298.8

 
$
255.8

 
$
946.6

 
$
778.9

Cost of sales
201.0

 
172.0

 
607.6

 
523.0

Amortization of acquired developed technologies
0.8

 
1.7

 
2.4

 
5.1

Gross profit
97.0

 
82.1

 
336.6

 
250.8

Operating expenses:
 
 
 
 
 
 
 
    Research and development
38.2

 
37.3

 
118.3

 
112.9

    Selling, general and administrative
33.2

 
28.1

 
95.5

 
84.2

    Restructuring and related charges
0.1

 
3.1

 
3.8

 
10.0

Total operating expenses
71.5

 
68.5

 
217.6

 
207.1

Income from operations
25.5

 
13.6

 
119.0

 
43.7

Unrealized loss on derivative liabilities
(20.7
)
 
(56.6
)
 
(8.6
)
 
(74.5
)
Interest and other income (expense), net
(2.1
)
 
(1.4
)
 
(8.7
)
 
(1.4
)
Income (loss) before income taxes
2.7

 
(44.4
)
 
101.7

 
(32.2
)
Provision for (benefit from) income taxes


11.6


(112.9
)

15.4

Net income (loss)
2.7

 
(56.0
)
 
214.6

 
(47.6
)
Cumulative dividends on Series A Preferred Stock
(0.2
)
 
(0.2
)
 
(0.7
)
 
(0.6
)
Earnings allocated to Series A Preferred Stock
(0.1
)
 

 
(4.9
)
 

Net income (loss) attributable to common stockholders
$
2.4

 
$
(56.2
)
 
$
209.0

 
$
(48.2
)
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to common stockholders:
 
 
 
 
 
 
 
    Basic
$
0.04

 
$
(0.92
)
 
$
3.37

 
$
(0.80
)
    Diluted
$
0.04

 
$
(0.92
)
 
$
3.31

 
$
(0.80
)
Shares used in per share calculation attributable to common stockholders

 
 
 
 
 
 
    Basic
62.4

 
61.0

 
62.1

 
60.4

    Diluted
63.3

 
61.0

 
63.2

 
60.4


See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

2

LUMENTUM HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(Unaudited)


 
Three Months Ended

Nine Months Ended
 
March 31, 2018

April 1, 2017

March 31, 2018

April 1, 2017
Net income (loss)
$
2.7

 
$
(56.0
)
 
$
214.6

 
$
(47.6
)
Other comprehensive income (loss):

 
 
 
 
 
 
Net change in cumulative translation adjustment, net of tax
(0.1
)
 
1.9

 
1.9

 
(2.7
)
Net change in unrealized loss on available-for-sale securities, net of tax
(1.3
)
 

 
(2.0
)
 

Net change in accumulated other comprehensive income (loss)
(1.4
)
 
1.9

 
(0.1
)
 
(2.7
)
Comprehensive income (loss)
$
1.3

 
$
(54.1
)
 
$
214.5

 
$
(50.3
)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.


3

LUMENTUM HOLDINGS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share data)
(Unaudited)


March 31, 2018

July 1, 2017
ASSETS
 


 

Current assets:
 


 

Cash and cash equivalents
$
176.8

 
$
272.9

Short-term investments
516.0

 
282.4

Accounts receivable, net
164.7

 
166.3

Inventories
144.2

 
145.2

Prepayments and other current assets
63.0

 
63.5

Total current assets
1,064.7

 
930.3

Property, plant and equipment, net
301.8

 
273.5

Goodwill and intangibles, net
19.9

 
21.5

Deferred income taxes
128.2

 
3.9

Other non-current assets
3.6

 
3.7

Total assets
$
1,518.2

 
$
1,232.9

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
100.9

 
$
114.8

Accrued payroll and related expenses
33.2

 
27.5

Income taxes payable
0.1

 
0.7

Accrued expenses
36.3

 
19.3

Other current liabilities
21.0

 
21.9

Total current liabilities
191.5

 
184.2

Convertible notes
329.9


317.5

Derivative liability
60.2


51.6

Other non-current liabilities
24.2

 
25.0

Total liabilities
605.8

 
578.3

Commitments and contingencies (Note 16)

 

Redeemable convertible preferred stock:
 
 
 
Non-controlling interest redeemable convertible Series A Preferred Stock, $0.001 par value, 10,000,000 authorized shares; 35,805 shares issued and outstanding as of March 31, 2018 and July 1, 2017
35.8

 
35.8

Total redeemable convertible preferred stock
35.8

 
35.8

Stockholders’ equity:
 
 
 
Common stock, $0.001 par value, 990,000,000 authorized shares, 62,588,096 and 61,476,103 shares issued and outstanding as of March 31, 2018 and July 1, 2017, respectively
0.1

 
0.1

Additional paid-in capital
736.0

 
694.5

Retained earnings
133.2

 
(83.2
)
Accumulated other comprehensive income
7.3

 
7.4

Total stockholders’ equity
876.6

 
618.8

Total liabilities, redeemable convertible preferred stock, and stockholders’ equity
$
1,518.2

 
$
1,232.9

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.


4

LUMENTUM HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)

 
Nine Months Ended
 
March 31, 2018
 
April 1, 2017
OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
214.6

 
$
(47.6
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation expense
53.3

 
39.1

Stock-based compensation
35.1

 
24.7

Unrealized loss on derivative liabilities
8.6

 
74.5

Amortization of acquired developed technologies and other intangibles
2.4

 
5.4

Loss on retirement of equipment
0.5

 

Excess tax benefit associated with stock-based compensation

 
(5.2
)
Amortization of discount on 0.25% Convertible Senior Notes due 2024
12.4

 
1.0

Release of valuation allowance, net
(124.0
)
 

Other non-cash (income) expenses
0.3

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
1.6

 
(14.9
)
Inventories
1.1

 
(14.0
)
Prepayments and other current and non-currents assets
1.9

 
(7.9
)
Income taxes, net
(0.5
)
 
15.4

Accounts payable
(15.9
)
 
(18.2
)
Accrued payroll and related expenses
5.6

 
4.5

Accrued expenses and other current and non-current liabilities
12.9

 
15.1

Net cash provided by operating activities
209.9

 
71.9

INVESTING ACTIVITIES:
 
 
 
Purchase of property, plant and equipment
(72.9
)
 
(100.0
)
Purchases of short-term investments
(585.1
)
 

Proceeds from maturities and sales of short-term investments
349.3

 

Acquisition of business, net of cash acquired

 
(5.1
)
Net cash used in investing activities
(308.7
)
 
(105.1
)
FINANCING ACTIVITIES:
 
 
 
Proceeds from the issuance of 0.25% Convertible Senior Notes due 2024, net of issuance costs

 
443.2

Excess tax benefit associated with stock-based compensation

 
5.2

    Payment of dividends - preferred stock
(0.7
)
 
(0.6
)
    Proceeds from employee stock plans
4.4

 
3.7

    Repayment of capital lease obligation
(3.5
)
 

    Proceeds from the exercise of stock options
1.7

 
3.2

Net cash provided by financing activities
1.9

 
454.7

Effect of exchange rates on cash and cash equivalents
0.8

 
(0.7
)
Increase (decrease) in cash and cash equivalents
(96.1
)
 
420.8

Cash and cash equivalents at beginning of period
272.9

 
157.1

Cash and cash equivalents at end of period
$
176.8

 
$
577.9

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for taxes
$
11.5

 
$
8.3

Cash paid for interest
1.2

 

Unpaid property, plant and equipment in accounts payable and accrued expenses
10.5

 
15.2

Equipment acquired under capital lease
15.6

 

Issuance costs in current liabilities

 
0.9

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

5

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Lumentum (we, us, our or the Company) is an industry-leading provider of optical and photonic products defined by revenue and market share addressing a range of end market applications including Optical Communications (“OpComms”) and Commercial Lasers (“Lasers”) for manufacturing, inspection and life-science applications. We seek to use our core optical and photonic technology and our volume manufacturing capability to expand into attractive emerging markets that benefit from advantages that optical or photonics-based solutions provide, including 3D sensing for consumer electronics and diode light sources for a variety of consumer and industrial applications. The majority of our customers tend to be original equipment manufacturers (“OEMs”) that incorporate our products into their products which then address end-market applications. For example, we sell fiber optic components that our network equipment manufacturer (“NEM”) customers assemble into communications networking systems, which they sell to network service providers or enterprises with their own networks. Similarly, many of our customers for our Lasers products incorporate our products into tools they produce, which are used for manufacturing processes by their customers. For 3D sensing, we sell diode lasers to manufacturers of consumer electronics products for mobile, personal computing, gaming, and other applications, who then integrate our devices within their products, for eventual resale to consumers.
Basis of Presentation
The preparation of the condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact the Company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, inventory valuation, derivative liability valuation, long-lived asset valuation, warranty and accounting for income taxes.
On March 11, 2018, Lumentum and Oclaro, Inc. ("Oclaro") entered into a Merger Agreement (the “Merger Agreement”), unanimously approved by the boards of directors of both companies, under which Lumentum will acquire all outstanding shares of Oclaro common stock. Each share of Oclaro common stock will be exchanged for $5.60 in cash and 0.0636 shares of Lumentum common stock, subject to the terms of the Merger Agreement. The total transaction consideration was approximately $1.8 billion as of the date of the Merger Agreement. Oclaro stockholders will own approximately 16% of the combined company at closing. The Merger Agreement contains certain termination rights for both Lumentum and Oclaro. The Merger Agreement further provides that upon termination of the Merger Agreement under specified circumstances relating to failure to obtain regulatory approvals, Lumentum may be required to pay Oclaro a termination fee of $80 million.
The total transaction consideration will be funded by a combination of cash from the combined company of approximately $416 million, $550 million in new debt, and $859 million in Lumentum common stock.
Lumentum entered into a commitment letter with Deutsche Bank Securities Inc. and Deutsche Bank AG New York, New York Branch (“Deutsche Bank”), pursuant to which, subject to the terms and conditions set forth therein, Deutsche Bank has committed to provide a senior secured term loan facility in an aggregate principal amount of $550 million, with a provision for additional senior secured term loans in an aggregate principal amount not to exceed $250 million.
The transaction is subject to customary closing conditions, including the approval of Oclaro stockholders and antitrust regulatory approval in the United States and China. Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), Lumentum and Oclaro are required to make pre-merger notification filings and to await the expiration or early termination of the statutory waiting period prior to completing the Merger. Lumentum and Oclaro submitted pre-merger notification filings under the HSR Act on March 23, 2018 and received early termination of the waiting period on April 4, 2018. The transaction is not subject to any financing condition. The transaction is expected to be completed in the second half of calendar 2018.
Fiscal Years
We utilize a 52-53 week fiscal year ending on the Saturday closest to June 30th. Our fiscal 2018 is a 52-week year ending on June 30, 2018. Our fiscal 2017 was a 52-week year and ended on July 1, 2017.

6

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Principles of Consolidation
These interim unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated in consolidation.
Accounting Policies
The accompanying interim unaudited condensed consolidated financial statements and accompanying related notes should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended July 1, 2017.
Effective July 2, 2017, we adopted Accounting Standards Update (“ASU”) 2016-09, Stock Compensation ASU 718 - Improvements to Employee Share-Based Payment Accounting. As a result of the adoption, in the first quarter of fiscal year 2018, we recorded on a modified retrospective basis a $2.6 million cumulative-effect adjustment to retained earnings for the recognition of excess tax benefits generated by the settlement of share-based awards in prior periods. We elected to account for forfeitures of equity awards when they occur. The change was applied on a modified retrospective basis with a cumulative-effect adjustment of approximately $0.2 million to retained earnings in the fiscal first quarter of 2018.
All excess tax benefits and deficiencies are recognized in the income tax provision in the condensed consolidated statements of operations prospectively, rather than in additional paid-in-capital in the condensed consolidated balance sheets. In addition, the standard eliminates the requirement to defer recognition of excess tax benefits until they are realized through a reduction to income taxes payable. We present excess tax benefits as an operating activity in the condensed consolidated statements of cash flows on a prospective basis.
Note 2. Recently Issued Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-01, Business Combinations (Topic 805), which clarifies the definition of a business. For accounting and financial reporting purposes, businesses are generally comprised of three elements; inputs, processes, and outputs. Integrated sets of assets and activities capable of providing these three elements may not always be considered a business, and the lack of one of the three elements does not always disqualify the set from being a business. The issuance of ASU 2017-01 provides a clarifying screen to determine when a set of assets and activities is not a business. Primarily, the screen requires that when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. The amendments contained in ASU 2017-01 are effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The accounting standard update will be effective for us beginning in the first quarter of fiscal 2019 and should be applied prospectively. We do not believe the implementation of ASU 2017-01 will have a material impact on our condensed consolidated financial statements.
In January 2017, FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. ASU 2017-04 removes the requirement to perform a hypothetical purchase price allocation to measure goodwill impairment. A goodwill impairment charge will be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The amendments contained in ASU 2017-04 are effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted, which should be applied prospectively. We plan to adopt the accounting standard update in our first quarter of fiscal 2019. We do not believe the implementation of ASU 2017-04 will have a material impact on our condensed consolidated financial statements.
In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. The amendments contained in ASU 2016-15 are effective for interim and annual periods beginning after December 15, 2017. The accounting standard update will be effective for us in the first quarter of fiscal 2019 and will be applied prospectively. If we elect to settle the principal amounts of our 2024 Notes (refer to “Note 10. Convertible Senior Notes”) in cash, the payment will be bifurcated between (i) cash outflows for operating activities of $137.6 million for the portion related to accreted interest attributable to debt discount, and (ii) financing activities for the remainder of $312.4 million.
In February 2016, FASB issued ASU 2016-02, Leases. The new guidance generally requires an entity to recognize on its balance sheet operating and financing lease liabilities and corresponding right-of-use assets. The new guidance contained in ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those periods, with early adoption permitted. The standard is effective for us in our first quarter of fiscal 2020 and should be applied prospectively.

7

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Based on our current lease portfolio, we estimate the value of leased assets and liabilities that may be recognized will be material. We are continuing to evaluate the impact of ASU 2016-02 and is subject to change.
In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which amended the existing accounting standards for revenue recognition. ASU 2014-09 establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the consideration expected to be received in exchange for those goods or services. The new standard requires that reporting companies disclose the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. On July 9, 2015, FASB agreed to delay the effective date by one year, and accordingly, the new standard is effective for us at the beginning of the first quarter of fiscal 2019.
The guidance to ASU 2014-09 permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). We selected the modified retrospective method. We do not anticipate that the adoption of ASU 2014-09 will have a material impact on our consolidated financial statements including the potential impact of the additional disclosure requirement, primarily because we will continue to recognize most revenue at a point-in-time when control transfers. This is similar to the current revenue recognition model.
We currently recognize revenue when all four revenue recognition criteria have been met: (i) persuasive evidence of an arrangement exists, (ii) the product has been delivered or the service has been rendered, (iii) the price is fixed or determinable and (iv) collection is reasonably assured. Revenue from product sales is recorded when all of the foregoing conditions are met and risk of loss and title passes to the customer. Our products typically include a warranty and the estimated cost of product warranty claims, based on historical experience, is recorded at the time the sale is recognized. Sales to customers are generally not subject to price protection or return rights. The majority of our sales are made to OEMs, distributors, resellers and end-users.
We are implementing changes to our accounting policies, internal controls, and disclosures to support the new standard; however, these changes will not be material.

8

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 3. Earnings Per Share
The following table sets forth the computation of basic and diluted net income (loss) attributable to common stockholders per share (in millions, except per share data):
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2018
 
April 1, 2017
 
March 31, 2018
 
April 1, 2017
Basic Earnings per Common Share
 

 
 

 
 

 
 
Net income (loss)
$
2.7

 
$
(56.0
)
 
$
214.6

 
$
(47.6
)
Less: Cumulative dividends on Series A Preferred Stock
(0.2
)
 
(0.2
)
 
(0.7
)
 
(0.6
)
Less: Earnings allocated to Series A Preferred Stock
(0.1
)
 

 
(4.9
)
 

Net income (loss) attributable to common stockholders - basic
$
2.4

 
$
(56.2
)
 
$
209.00

 
$
(48.2
)
 
 
 
 
 
 
 
 
Weighted average common shares outstanding including Series A Preferred Stock
63.9

 
62.5

 
63.6

 
61.9

Less: Weighted average Series A Preferred Stock
(1.5
)
 
(1.5
)
 
(1.5
)
 
(1.5
)
Basic weighted average common shares outstanding
62.4

 
61.0

 
62.1

 
60.4

Net income (loss) per share attributable to common stockholders - basic
$
0.04

 
$
(0.92
)
 
$
3.37

 
$
(0.80
)
 
 
 
 
 
 
 
 
Diluted Earnings per Common Share
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders - diluted
$
2.4

 
$
(56.2
)
 
$
209.0

 
$
(48.2
)
Weighted average common shares outstanding for basic earnings per common share
62.4

 
61.0

 
62.1

 
60.4

Effect of dilutive securities from stock-based benefit plans
0.9

 

 
1.1

 

Effect of diluted securities from Series A Preferred Stock

 

 

 

Diluted weighted average common shares outstanding
63.3

 
61.0

 
63.2

 
60.4

Net income (loss) per share attributable to common stockholders - diluted
$
0.04

 
$
(0.92
)
 
$
3.31

 
$
(0.80
)
Our Series A Preferred Stock is considered a participating security, which may participate in undistributed earnings with our common stock. The holders of our Preferred Stock would be entitled to share in dividends, on an as-converted basis, if the holders of our common stock were to receive dividends. We are required to use the two-class method when computing earnings per share as we have a security that qualifies as a participating security. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. In determining the amount of net earnings to allocate to common stockholders, earnings are allocated to both common and participating securities based on their respective weighted-average shares outstanding during the period. Diluted earnings per common share, when applicable, is computed using the more dilutive of the two-class method or the if-converted method. In periods of net loss, no effect is given to participating securities since they do not contractually participate in the losses of the Company.
The dilutive effect of stock-based awards is reflected in diluted earnings per share by application of the treasury stock method, which includes consideration of unamortized share-based compensation expense and the dilutive effect of in-the-money options and non-vested restricted stock units. Under the treasury stock method, the amount the employee must pay for exercising stock options and unamortized share-based compensation expense collectively are assumed proceeds to be used to repurchase hypothetical shares. An increase in the fair value of our common stock can result in a greater dilutive effect from potentially dilutive awards.
In March 2017, we issued $450 million in aggregate principal amount of 0.25% Convertible Senior Notes due in 2024 (the “2024 Notes”). We have the ability and intent to settle the $450 million face value of the 2024 Notes in cash. Therefore, we use the treasury stock method for calculating the dilutive impact of the 2024 Notes. The 2024 Notes will have no impact to diluted earnings per share until the average price of our common stock exceeds the conversion price of $60.62. Refer to “Note 10. Convertible Senior Notes” for further discussion.

9

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

For the three and nine months ended March 31, 2018 and April 1, 2017, the number of shares related to our stock-based benefit plans that were excluded from the calculation of diluted shares was not material.
Note 4. Accumulated Other Comprehensive Income (Loss)
Our accumulated other comprehensive income (loss) consists of the accumulated net unrealized gains or losses on foreign currency translation adjustments, the defined benefit obligation, and available-for-sale securities.
As of March 31, 2018 and July 1, 2017, balances for the components of accumulated other comprehensive income (loss) were as follows (in millions):
 
Foreign currency translation adjustments, net of tax
 
Defined benefit obligation, net of tax
 
Unrealized gain (loss) on available-for-sale securities, net of tax
 
Total
Beginning balance as of July 1, 2017
$
10.5

 
$
(3.1
)
 
$

 
$
7.4

Other comprehensive income (loss)
1.9

 

 
(2.0
)
 
(0.1
)
Ending balance as of March 31, 2018
$
12.4

 
$
(3.1
)
 
$
(2.0
)
 
$
7.3

We evaluate the assumptions over the fair value of our defined benefit obligation annually and make changes as necessary.
Note 5. Asset Acquisition
On March 30, 2018, we entered into a Transition Services Agreement (“TSA”) with one of our contract manufacturers to wind down the production of our products at their facility in China and to facilitate an orderly transition of manufacturing to our manufacturing facility in Thailand, including the purchase of the manufacturing equipment. Under the terms of the TSA, we are required to pay $5.3 million in cash upon completion of certain milestones related to the purchase of equipment.
We are also required to share cost of retention and severance, and to reimburse for certain other direct and indirect costs incurred by our contract manufacturer for transition services provided. These costs will be expensed as incurred.
Note 6. Balance Sheet Details
Accounts receivable allowances
As of March 31, 2018 and July 1, 2017, our accounts receivable allowance balance was $1.8 million and $1.8 million, respectively.
Inventories
The components of inventories were as follows (in millions):
 
March 31, 2018

July 1, 2017
Finished goods
$
93.2

 
$
71.7

Work in process
30.5

 
49.4

Raw materials and purchased parts
20.5

 
24.1

Inventories
$
144.2

 
$
145.2


10

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Prepayments and other current assets
The components of prepayments and other current assets were as follows (in millions):
 
March 31, 2018

July 1, 2017
Capitalized manufacturing overhead
$
23.9

 
$
30.1

Prepayments
14.8

 
12.3

Advances to contract manufacturers
15.0

 
10.5

Other current assets
9.3

 
10.6

Prepayments and other current assets
$
63.0

 
$
63.5

Property, plant and equipment, net
The components of property, plant and equipment, net were as follows (in millions):
 
March 31, 2018

July 1, 2017
Land
$
10.6

 
$
10.6

Buildings and improvement
49.3

 
37.3

Machinery and equipment (1)
543.2

 
461.1

Computer equipment and software
37.3

 
31.2

Furniture and fixtures
4.9

 
4.6

Leasehold improvements
30.1

 
30.5

Construction in progress
63.2

 
84.6

 
738.6

 
659.9

Less: Accumulated depreciation
(436.8
)
 
(386.4
)
Property, plant and equipment, net
$
301.8

 
$
273.5

(1) In the first quarter of fiscal 2018, we started leasing equipment from a vendor and have accounted for the transaction as a capital lease. Included in the table above is our capital lease asset of $11.9 million, net of depreciation expense of $3.7 million as of March 31, 2018.
During the three and nine months ended March 31, 2018, we recorded depreciation expense of $18.4 million and $53.3 million, respectively. During the three and nine months ended April 1, 2017, we recorded a depreciation expense of $14.1 million and $39.1 million, respectively.
Our construction in progress primarily includes machinery and equipment that were purchased in order to increase our manufacturing capacity. We expect to place these assets in service in the next 12 months.
Other current liabilities
The components of other current liabilities were as follows (in millions):
 
March 31, 2018

July 1, 2017
Warranty accrual (1)
$
7.0

 
$
9.7

Restructuring accrual and related charges (2)

 
3.8

Deferred revenue and customer deposits
2.5

 
6.9

Capital lease obligation (3)
9.2

 

Other current liabilities
2.3

 
1.5

Other current liabilities
$
21.0

 
$
21.9


11

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(1) Refer to “Note 16. Commitments and Contingencies” in the Notes to Unaudited Condensed Consolidated Financial Statements.
(2) Refer to “Note 13. Restructuring and Related Charges” in the Notes to Unaudited Condensed Consolidated Financial Statements.
(3) As of March 31, 2018, an amount of $2.3 million related to a capital lease was recorded in accounts payable on the condensed consolidated balance sheet. Refer to “Note 16. Commitments and Contingencies” in the Notes to Unaudited Condensed Consolidated Financial Statements.
Other non-current liabilities
The components of other non-current liabilities were as follows (in millions):
 
March 31, 2018

July 1, 2017
Asset retirement obligation
$
2.7

 
$
2.5

Pension and related accrual
3.2

 
3.9

Deferred rent
3.1

 
3.3

Unrecognized tax benefit
10.2

 
10.5

Capital lease obligation (1)
0.8

 

Other non-current liabilities
4.2

 
4.8

Other non-current liabilities
$
24.2

 
$
25.0

(1) Refer to “Note 16. Commitments and Contingencies” in the Notes to Unaudited Condensed Consolidated Financial Statements.
Note 7. Cash, Cash Equivalents, and Short-term Investments

12

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Cash, cash equivalents and short-term investments
The following table summarizes our cash, cash equivalents, and short-term investments by category for the periods presented (in millions):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
March 31, 2018:
 
 
 
 
 
 
 
Cash
$
82.6

 
$

 
$

 
$
82.6

Cash equivalents:
 
 
 
 
 
 
 
Commercial paper
29.1

 

 

 
29.1

Corporate debt securities
26.0

 

 

 
26.0

Money market funds
2.5

 

 

 
2.5

Municipal bonds
1.5

 

 

 
1.5

Foreign government bonds
2.0

 
 
 
 
 
2.0

U.S. Treasury
26.7

 

 

 
26.7

Asset-backed securities
6.4

 

 

 
6.4

Total cash and cash equivalents
$
176.8

 
$

 
$

 
$
176.8

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit
$
32.0

 
$

 
$

 
$
32.0

Commercial paper
35.1

 

 

 
35.1

Asset-backed securities
114.3

 

 
(0.3
)
 
114.0

Corporate debt securities
317.6

 
0.1

 
(1.8
)
 
315.9

Municipal bonds
6.2

 

 

 
6.2

Mortgage-backed securities
4.8

 

 

 
4.8

Foreign government bonds
8.0

 

 

 
8.0

Total short-term investments
$
518.0

 
$
0.1

 
$
(2.1
)
 
$
516.0

 
 
 
 
 
 
 
 
July 1, 2017:
 
 
 
 
 
 
 
Cash
$
201.3

 
$

 
$

 
$
201.3

Cash equivalents:
 
 
 
 
 
 
 
Certificates of deposit
52.1

 

 

 
52.1

Commercial paper
14.7

 

 

 
14.7

Money market funds
4.8

 

 

 
4.8

Total cash and cash equivalents
$
272.9

 
$

 
$

 
$
272.9

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit
$
202.1

 
$

 
$

 
$
202.1

Asset-backed securities
26.1

 

 

 
26.1

Corporate debt securities
46.4

 

 

 
46.4

Municipal bonds
4.9

 

 

 
4.9

Foreign government bonds
1.0

 

 

 
1.0

U.S. Treasury
1.9

 

 

 
1.9

Total short-term investments
$
282.4

 
$

 
$

 
$
282.4

We use the specific-identification method to determine any realized gains or losses from the sale of our short-term investments classified as available-for-sale. During the three and nine months ended March 31, 2018, we did not realize significant gains or losses on a gross level from the sale of our short-term investments classified as available-for-sale.

13

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table summarizes unrealized losses on our cash equivalents and short-term investments by category and length of time the investment has been in a continuous unrealized loss position as of the periods presented (in millions):
 
Less than 12 months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
March 31, 2018:
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
25.4

 
$

 
$

 
$

 
$
25.4

 
$

Commercial paper
39.7

 

 

 

 
39.7

 

Asset-backed securities
112.9

 
(0.3
)
 

 

 
112.9

 
(0.3
)
Corporate debt securities
291.8

 
(1.8
)
 

 

 
291.8

 
(1.8
)
Municipal bonds
6.2

 

 

 

 
6.2

 

Mortgage-backed securities
4.5

 

 

 

 
4.5

 

U.S. Treasury
3.0

 

 

 

 
3.0

 

Foreign government bonds
8.8

 

 

 

 
8.8

 

Total
$
492.3

 
$
(2.1
)
 
$

 
$

 
$
492.3

 
$
(2.1
)
 
 
 
 
 
 
 
 
 
 
 
 
July 1, 2017:
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
21.5

 
$

 
$

 
$

 
$
21.5

 
$

Corporate debt securities
29.8

 

 

 

 
29.8

 

Municipal bonds
2.9

 

 

 

 
2.9

 

Foreign government bonds
1.0

 

 

 

 
1.0

 

U.S. Treasury
1.9

 

 

 

 
1.9

 

Total
$
57.1

 
$

 
$

 
$

 
$
57.1

 
$

The following table classifies our investments in debt securities by contractual maturities (in millions): 
 
As of March 31, 2018

 
Amortized Cost
 
Fair Value
Due in 1 year
$
252.1

 
$
251.5

Due in 1 year through 5 years
252.7

 
251.3

Due in 5 years through 10 years
7.2

 
7.2

Due after 10 years
6.0

 
6.0

 
$
518.0

 
$
516.0

All available-for-sale securities have been classified as current, based on management’s intent and ability to use the funds in current operations.
Note 8. Fair Value Measurements
We determine fair value based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value assumes that the transaction to sell the asset or transfer the liability occurs in the principal or most advantageous market for the asset or liability and establishes that the fair value of an asset or liability shall be determined based on the assumptions that market participants would use in pricing the asset or liability. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value: 

14

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Level 1:
Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2:
Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3:
Inputs are unobservable inputs based on our assumptions.
The fair value of the Company’s Level 1 financial instruments, such as money market funds, which are traded in active markets, is based on quoted market prices for identical instruments. The fair value of the Company’s Level 2 fixed income securities is obtained from an independent pricing service, which may use quoted market prices for identical or comparable instruments or model driven valuations using observable market data or inputs corroborated by observable market data. Our marketable securities are held by custodians who obtain investment prices from a third-party pricing provider that incorporates standard inputs in various asset price models. The Company’s procedures include controls to ensure that appropriate fair values are recorded, including comparing the fair values obtained from the Company’s pricing service against fair values obtained from another independent source.
We estimate the fair value of the embedded derivative for the Series A Preferred Stock using the binomial lattice model. The lattice model requires the various assumptions to be made to determine the fair value of the embedded derivatives. These assumptions represent Level 3 inputs. Refer to “Note 11. Derivative Liability” in the Notes to Unaudited Condensed Consolidated Financial Statements.
In February 2017, we completed the acquisition of a privately held company to enhance our manufacturing and vertical integration capabilities for a total purchase consideration of $8.7 million. We estimated the fair value of our Level 3 contingent consideration related to this acquisition at the present value of the expected contingent payments, determined using a probabilistic approach. We are required to reassess the fair value of contingent payments on a periodic basis. During the three months ended April 1, 2017, we estimated the likelihood of meeting the production targets at 90 percent. There was no change in the fair value of our contingent consideration during the three and nine months ended March 31, 2018. The fair value of such contingent consideration is recorded in accrued liabilities on the condensed consolidated balance sheet as of March 31, 2018. This contingent consideration will result in a cash payment of $3.0 million, if and when the production targets are achieved, which we expect to occur within 36 months following the acquisition date.
Our pension assets consist of multiple institutional funds (“pension funds”) of which the fair values are based on the quoted prices of the underlying funds. Pension funds are classified as Level 2 assets since such funds are not directly traded in active markets.
Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in millions): 

15

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2018:
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 

Cash equivalents:

 

 

 

Commercial paper
$

 
$
29.1

 
$

 
$
29.1

Corporate debt securities

 
26.0

 

 
26.0

Money market funds
2.5

 

 

 
2.5

Municipal bonds

 
1.5

 

 
1.5

Foreign government bonds

 
2.0

 

 
2.0

U.S. Treasury
26.7

 

 

 
26.7

Asset-backed securities

 
6.4

 

 
6.4

Short-term investments:


 

 

 

Certificates of deposit

 
32.0

 

 
32.0

Commercial paper

 
35.1

 

 
35.1

Asset-backed securities

 
114.0

 

 
114.0

Corporate debt securities

 
315.9

 

 
315.9

Municipal bonds

 
6.2

 

 
6.2

Mortgage-backed securities

 
4.8

 

 
4.8

Foreign government bonds

 
8.0

 

 
8.0

Total assets
$
29.2

 
$
581.0

 
$

 
$
610.2

Other accrued liabilities:
 
 
 
 
 
 
 
Derivative liability
$

 
$

 
$
60.2

 
$
60.2

Acquisition contingencies

 

 
2.7

 
2.7

Total other accrued liabilities
$

 
$

 
$
62.9

 
$
62.9


16

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Level 1
 
Level 2
 
Level 3
 
Total
July 1, 2017:
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Certificates of deposit
$

 
$
52.1

 
$

 
$
52.1

Commercial paper

 
14.7

 

 
14.7

Money market funds
4.8

 

 

 
4.8

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit

 
202.1

 

 
202.1

Asset-backed securities

 
26.1

 

 
26.1

Corporate debt securities

 
46.4

 

 
46.4

Municipal bonds

 
4.9

 

 
4.9

Foreign government bonds

 
1.0

 

 
1.0

U.S. Treasury
1.9

 

 

 
1.9

Total assets
$
6.7

 
$
347.3

 
$

 
$
354.0

Other accrued liabilities:
 
 
 
 
 
 
 
Derivative liability
$

 
$

 
$
51.6

 
$
51.6

Acquisition contingencies


 

 
2.7

 
2.7

Total other accrued liabilities
$

 
$

 
$
54.3

 
$
54.3

Assets Measured at Fair Value on a Non-Recurring Basis
We periodically review our intangible and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on the lowest level of identifiable estimated undiscounted cash flows resulting from use of the asset and its eventual disposition. If not recoverable, an impairment loss would be calculated based on the excess of the carrying amount over the fair value.
Management utilizes various valuation methods, including an income approach, a market approach and a cost approach, to estimate the fair value of intangible and other long-lived assets. During the annual impairment testing performed in fiscal 2017, all our intangible and other long-lived assets passed Step 1. No impairment charges were recorded in fiscal 2017 or during the three and nine months ended March 31, 2018. Refer to “Note 12. Goodwill and Other Intangible Assets”.
Note 9. Non-Controlling Interest Redeemable Convertible Preferred Stock
On July 31, 2015, our wholly-owned subsidiary, Lumentum Inc., issued 40,000 shares of its Series A Preferred Stock to Viavi Solutions Inc. (“Viavi”). Pursuant to a securities purchase agreement between the Company, Viavi and Amada Holdings Co., Ltd. (“Amada”), 35,805 shares of Series A Preferred Stock were sold by Viavi to Amada in August 2015. The remaining 4,195 shares of the Series A Preferred Stock were canceled. The Series A Preferred Stock is referred to as our Non-Controlling Interest Redeemable Convertible Preferred Stock within these condensed consolidated financial statements.
The Series A Preferred Stock is redeemable at the option of Amada after five years and classified as non-controlling interest redeemable convertible preferred stock in our condensed consolidated balance sheet. The Series A Preferred Stock is measured at its redemption value. The Series A Preferred Stock value of $35.8 million as of March 31, 2018 has not changed from the prior year.
The Series A Preferred Stock conversion feature is bifurcated from the Series A Preferred Stock and accounted for separately as a derivative liability. The derivative liability is measured at fair value each reporting period with the change in fair value recorded in the condensed consolidated statements of operations. Refer to “Note 11. Derivative Liability”.
 
The following paragraphs describe the terms and conditions of the Series A Preferred Stock:
Conversion

17

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Series A Preferred Stock is convertible, at the option of the holder, into shares of our common stock commencing on the second anniversary of the closing of the securities purchase (absent a change of control of us or similar event) using a conversion price of $24.63, which is equal to 125% of the volume weighted average price per share of our common stock in the five “regular-way” trading days following our separation from JDS Uniphase Corporation (“JDSU” and now, Viavi) in August 2015 (the “Separation”).
Liquidation
Upon any liquidation, dissolution, or winding up of our business, whether voluntary or involuntary, holders of Series A Preferred Stock will be entitled to receive, in preference to holders of common stock or any other class or series of our outstanding capital stock ranking in any such event junior to the Series A Preferred Stock, an amount per share equal to the greater of (i) the Issuance Value of $1,000 per share for Series A Preferred Stock plus all accrued and unpaid dividends thereon (whether or not authorized or declared) through the date of payment and (ii) the amount as would have been payable had all Series A Preferred Stock been converted into common stock immediately prior to such liquidation event.
If upon occurrence of any such event, our assets legally available for distribution are insufficient to permit payment of the aforementioned preferential amounts, then all of our assets legally available for distribution will be distributed ratably to the holders of the Series A Preferred Stock and to the holders of any other class or series of our capital stock ranking on parity with the Series A Preferred Stock.
Voting Rights
The shares of Series A Preferred Stock have no voting rights except as follows:
Authorize, approve, or make any change to the powers, preferences, privileges or rights of the Series A Preferred Stock;
Authorize or issue any additional shares of Series A Preferred Stock or reduce the number of shares of Series A Preferred Stock; or
Create, or hold capital stock in, any subsidiary that is not wholly-owned by the Company.
Dividends
Holders of Series A Preferred Stock, in preference to holders of common stock or any other class or series of our outstanding capital stock ranking in any such event junior to the Series A Preferred Stock, are entitled to receive, when and as declared by the board of directors, quarterly cumulative cash dividends at the annual rate of 2.5% of the Issuance Value per share on each outstanding share of Series A Preferred Stock. The accrued dividends are payable on March 31, June 30, September 30 and December 31 of each year commencing on September 30, 2015.
The accrued dividends as of March 31, 2018 and July 1, 2017 were $0.2 million and $0.2 million, respectively.
Dividends paid were $0.5 million and $0.7 million for the three and nine months ended March 31, 2018, respectively, and $0.2 million and $0.6 million for the three and nine months ended April 1, 2017, respectively.
Redemption
Optional redemption by the Company
On or after the third anniversary in August 2018, we will have the option to redeem for cash all (but not less than all) of the shares of Series A Preferred Stock at a redemption price equal to the Issuance Value plus the accrued and unpaid dividends on each share and any past due dividends, whether or not authorized or declared.
Optional redemption by holders
Commencing on the fifth anniversary of the Issuance Date of the Series A Preferred Stock, each holder of Series A Preferred Stock may cause the Company to redeem for cash any number of shares of Series A Preferred Stock on any date at a redemption price for share redeemed equal to the Issuance Value plus the accrued and unpaid dividends on each share and any past due dividends, whether or not authorized or declared.
Note 10. Convertible Senior Notes
In March 2017, we issued the 2024 Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under

18

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

the Securities Act of 1933, as amended (the “Securities Act”). The 2024 Notes are governed by an indenture between the Company, as the issuer, and U.S. Bank National Association, as trustee (the “Indenture”). The 2024 Notes are unsecured and do not contain any financial covenants, restrictions on dividends, incurrence of senior debt or other indebtedness, or the issuance or repurchase of securities by us.
The 2024 Notes bear interest at a rate of 0.25% per year. Interest on the 2024 Notes is payable semi-annually in arrears on March 15 and September 15 of each year, beginning on September 15, 2017. The 2024 Notes will mature on March 15, 2024, unless earlier repurchased by us or converted pursuant to their terms.
The initial conversion rate of the 2024 Notes is 16.4965 shares of common stock per $1,000 principal amount of 2024 Notes, which is equivalent to an initial conversion price of approximately $60.62 per share, a 132.5% premium to the fair market value at the date of issuance. Prior to the close of business on the business day immediately preceding December 15, 2023, the 2024 Notes will be convertible only under the following circumstances: (1) during any fiscal quarter (and only during such fiscal quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five consecutive business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes for each trading day of such measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after December 15, 2023 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time. In addition, upon the occurrence of a make-whole fundamental change, we will, in certain circumstances, increase the conversion rate by a number of additional shares for a holder that elects to convert 2024 Notes in connection with such make-whole fundamental change.
We may not redeem the 2024 Notes prior to their maturity date and no sinking fund is provided for the 2024 Notes. Upon the occurrence of a fundamental change, holders may require us to repurchase all or a portion of their 2024 Notes for cash at a price equal to 100% of the principal amount of the 2024 Notes to be repurchased, plus any accrued and unpaid interest.
We considered the features embedded in the 2024 Notes other than the conversion feature, including the holders’ put feature, our call feature, and the make-whole feature, and concluded that they are not required to be bifurcated and accounted for separately from the host debt instrument.
Prior to the Tax Matters Agreement settlement condition (“TMA settlement condition”), because we could only settle the 2024 Notes in cash, we determined that the conversion feature met the definition of a derivative liability. We separated the derivative liability from the host debt instrument based on the fair value of the derivative liability. As of the issuance date, March 8, 2017, the derivative liability fair value of $129.9 million was calculated using the binomial valuation approach. The residual principal amount of the 2024 Notes of $320.1 million before issuance costs was allocated to the debt component. We incurred approximately $7.7 million in transaction costs in connection with the issuance of the 2024 Notes. These costs were allocated to the debt component and recognized as a debt discount. We amortize the debt discount, including both the initial value of the derivative liability and the transaction costs, over the term of the 2024 Notes using the effective interest method. The effective interest rate of the 2024 Notes is 5.4% per year. As of March 31, 2018, the remaining debt discount amortization period was 71 months.
During the year ended July 1, 2017, we satisfied the TMA settlement conditions. As such, the value of the conversion option will no longer be marked to market and was reclassified to additional paid-in capital within stockholders’ equity on our condensed consolidated balance sheet. The value of the conversion option at the time of issuance will be treated as an original issue discount for purposes of accounting for the debt component of the notes. The debt component will accrete up to the principal amount over the expected term of the debt. These accounting standards do not affect the actual amount we are required to repay, and the amount shown in the table below for the notes is the aggregate principal amount of the notes and does not reflect the debt discount we will be required to recognize.
As of March 31, 2018, the 2024 Notes consisted of the following (in millions):

19

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Liability component:
March 31, 2018
 
July 1, 2017
Principal
$
450.0

 
$
450.0

Unamortized debt discount
(120.1
)
 
(132.5
)
Net carrying amount of the liability component
$
329.9

 
$
317.5

The following table sets forth interest expense information related to the 2024 Notes for the three and nine months ended March 31, 2018:
 
March 31, 2018
(in millions, except percentages)
Three Months Ended
 
Nine Months Ended
Contractual interest expense
$
0.3

 
$
0.9

Amortization of the debt discount
4.2

 
12.4

Total interest expense
$
4.5

 
$
13.3

Effective interest rate on the liability component
5.4
%
 
5.4
%
We have the ability and intent to settle the $450 million face value of the debt in cash. Therefore, we use the treasury stock method for calculating the dilutive impact of the debt. The 2024 Notes will have no impact to diluted earnings per share until the average price of our common stock exceeds the conversion price of $60.62.
Note 11. Derivative Liability
We estimate the fair value of the embedded derivative for the Series A Preferred Stock using the binomial lattice model. We applied the lattice model to value the embedded derivative using a “with-and-without method,” where the value of the Series A Preferred Stock, including the embedded derivative, is defined as the “with”, and the value of the Series A Preferred Stock, excluding the embedded derivative, is defined as the “without”. The lattice model requires the following inputs: (i) the Company's common stock price; (ii) conversion price; (iii) term; (iv) yield; (v) recovery rate for the Series A Preferred Stock; (vi) estimated stock volatility; and (vii) risk-free rate. The fair value of the embedded derivative was determined using Level 3 inputs under the fair value hierarchy (unobservable inputs). Changes in the inputs into this valuation model have a material impact in the estimated fair value of the embedded derivative. For example, a decrease (increase) in the stock price and the volatility results in a decrease (increase) in the estimated fair value of the embedded derivative. The changes in the fair value of the bifurcated embedded derivative for the Series A Preferred Stock are primarily related to the change in the price of our common stock and are reflected in the condensed consolidated statements of operations as “Unrealized gain (loss) on derivative liabilities”. Unrealized loss on derivative liability for the Series A Preferred Stock amounted to $(20.7) million and $(8.6) million for the three and nine months ended March 31, 2018, respectively, and $(17.9) million and $(35.8) million for the three and nine months ended April 1, 2017, respectively.
The following table provides a reconciliation of the fair value of the embedded derivative for the Series A Preferred Stock for the three and nine months ended March 31, 2018 and April 1, 2017 (in millions):
 
Three Months Ended

Nine Months Ended
 
March 31, 2018

April 1, 2017

March 31, 2018

April 1, 2017
Balance as of beginning of period
$
(39.5
)
 
$
(28.2
)
 
$
(51.6
)
 
$
(10.3
)
Unrealized loss on the Series A Preferred Stock derivative liability
(20.7
)
 
(17.9
)
 
(8.6
)
 
(35.8
)
Balance as of end of period
$
(60.2
)
 
$
(46.1
)
 
$
(60.2
)
 
$
(46.1
)
The following table summarizes the assumptions used to determine the fair value of the embedded derivative for Series A Preferred Stock:

20

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
March 31, 2018
 
July 1, 2017
Stock price
$
63.80

 
$
57.05

Conversion price
$
24.63

 
$
24.63

Expected term (years)
2.37

 
3.11

Expected annual volatility
50.0
%
 
47.5
%
Risk-free rate
2.31
%
 
1.57
%
Preferred yield
8.32
%
 
7.56
%
Also, during the three and nine months ended April 1, 2017, we recorded an unrealized loss on the derivate liability from the 2024 Notes. On June 29, 2017, we met the requirements to account for the conversion option of the 2024 Notes as equity and the conversion option is no longer marked to market. Refer to “Note 10. Convertible Senior Notes” in the Notes to Unaudited Condensed Consolidated Financial Statements.
The following table provides a reconciliation of the fair value of the embedded derivative for the 2024 Notes for the three and nine months ended March 31, 2018 and April 1, 2017 (in millions):
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2018
 
April 1, 2017
 
March 31, 2018
 
April 1, 2017
Balance as of beginning of period
$

 
$

 
$

 
$

Fair value of the embedded derivative for the 2024 Notes at issuance

 
(129.9
)
 

 
(129.9
)
Unrealized loss on the 2024 Notes derivative liability

 
(38.7
)
 

 
(38.7
)
Balance as of end of period
$

 
$
(168.6
)
 
$

 
$
(168.6
)
Note 12. Goodwill and Other Intangible Assets
Goodwill
The following table presents the changes in goodwill by our reportable segments during the nine months ended March 31, 2018 (in millions):
 
Optical Communications
 
Commercial Lasers
 
Total
Balance as of beginning of period
$
5.9

 
$
5.5

 
$
11.4

Foreign currency translation adjustment
0.4

 

 
0.4

Balance as of end of period
$
6.3

 
$
5.5

 
$
11.8

Impairment of Goodwill
We review goodwill for impairment during the fourth quarter of each fiscal year or more frequently if events or circumstances indicate that an impairment loss may have occurred. In the fourth quarter of fiscal 2017, we completed the annual impairment test of goodwill, which indicated there was no goodwill impairment. During the three and nine months ended March 31, 2018, there have been no events or circumstances that have required us to perform an interim assessment of goodwill for impairment.
Acquired Developed Technology and Other Intangibles
The following tables present details of our acquired developed technology and other intangibles (in millions):

21

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

As of March 31, 2018
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Acquired developed technology
$
105.9

 
$
(97.8
)
 
$
8.1

Other
9.4

 
(9.4
)
 

Total Intangibles
$
115.3

 
$
(107.2
)
 
$
8.1

As of July 1, 2017
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Acquired developed technology
$
105.5

 
$
(95.4
)
 
$
10.1

Other
9.4

 
(9.4
)
 

Total Intangibles
$
114.9


$
(104.8
)

$
10.1

The amounts in the table above include cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying intangibles.
During the three and nine months ended March 31, 2018, we recorded $0.8 million and $2.4 million, respectively, of amortization related to acquired developed technology.
During the three and nine months ended April 1, 2017, we recorded $1.8 million and $5.4 million, respectively, of amortization related to acquired developed technology and other intangibles.
The following table presents details of amortization for the periods presented (in millions):
 
Three Months Ended

Nine Months Ended
 
March 31, 2018

April 1, 2017

March 31, 2018

April 1, 2017
Cost of sales
$
0.8

 
$
1.7

 
$
2.4

 
$
5.1

Operating expenses

 
0.1

 

 
0.3

Total
$
0.8

 
$
1.8

 
$
2.4

 
$
5.4

Based on the carrying amount of acquired developed technology and other intangibles as of March 31, 2018, and assuming no future impairment of the underlying assets, the estimated future amortization is as follows (in millions):
Fiscal Years
 
Remainder of 2018
$
0.8

2019
3.1

2020
3.0

2021
0.5

2022
0.5

Thereafter
0.2

Total amortization
$
8.1


22

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 13. Restructuring and Related Charges
The following table summarizes the activity of restructuring and related charges during the three and nine months ended March 31, 2018 and April 1, 2017 (in millions):
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2018
 
April 1, 2017
 
March 31, 2018
 
April 1, 2017
Balance as of beginning of period
$
0.4

 
$
6.0

 
$
3.8

 
$
5.7

Charges
0.1

 
3.1

 
3.8

 
10.0

Payments
(0.5
)
 
(3.8
)
 
(7.6
)
 
(10.4
)
Balance as of end of period
$

 
$
5.3

 
$

 
$
5.3

During the three and nine months ended March 31, 2018, we recorded $0.1 million and $3.8 million, respectively, in restructuring and related charges in the condensed consolidated statements of operations, primarily attributable to costs to vacate facilities, temporary labor and employee related benefits, as well as costs for materials used in set up and production activities. We incurred no additional costs related to severance for the same periods.
During the three and nine months ended April 1, 2017, we recorded $3.1 million and $10.0 million, respectively, in restructuring and related charges in the condensed consolidated statements of operations. Of the $3.1 million and $10.0 million charges recorded during the three and nine months ended April 1, 2017, $0.4 million and $2.2 million, respectively, was related to severance, retention, lease termination costs, and employee benefits; and $2.7 million and $7.8 million, respectively, was related to other restructuring related charges which include relocation costs, temporary labor and employee related benefits, as well as costs for materials used in set up and production activities.
Note 14. Income Taxes
Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate, and if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period.
Our quarterly tax provision, and estimate of our annual effective tax rate, is subject to variation due to several factors, including variability in pre-tax income (or loss), the mix of jurisdictions to which such income relates, changes in how we do business, and tax law developments. Our estimated effective tax rate for the year differs from the U.S. statutory rate primarily due to the benefit of foreign earnings of our subsidiaries being taxed at rates lower than the U.S. statutory rate.
We recorded an immaterial tax benefit and a tax benefit of $112.9 million for the three and nine months ended March 31, 2018, respectively. Our tax benefit for the three months ended March 31, 2018 was less than $0.1 million primarily due to a benefit from foreign rate differential, excess windfall benefit from our stock-based compensation tax deduction, offset by the discrete impact of the non-deductible unrealized loss from the embedded derivatives for the Series A Preferred Stock. Our tax benefit for the nine months ended March 31, 2018 was primarily due to the release of our U.S. federal and certain state valuation allowances. The benefit of this valuation allowance release was partially offset by a non-cash deferred expense associated with the change in the U.S. statutory rate as a result of the Tax Act (discussed further below) which was enacted during our second quarter of fiscal 2018.
We recorded a tax provision of $11.6 million and $15.4 million for the three and nine months ended April 1, 2017, respectively. Our tax provision for the three and nine months ended April 1, 2017 was primarily due to the discrete impact of the non-deductible unrealized loss from the embedded derivatives for the Series A Preferred Stock and the 2024 Notes, non-deductible stock-based compensation and partially offset by foreign rate differential, R&D tax credits and the utilization of U.S. deferred tax assets that were subject to a full valuation allowance.
We assess our ability to realize the deferred tax assets on a quarterly basis and establish a valuation allowance if the deferred tax assets are not more-likely-than-not to be realized. We weigh all available positive and negative evidence, including our earnings history and results of recent operations, reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

23

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

As of each reporting date, we consider new evidence, both positive and negative, that could affect our view of the future realization of deferred tax assets. As of December 30, 2017, we determined that there is sufficient positive evidence to conclude that it is more-likely-than-not that the deferred tax assets are realizable. We, therefore, released the valuation allowance for the U.S. federal and certain states and recognized a tax benefit of $207 million as a discrete item for the fiscal second quarter of 2018. Due to the weight of negative evidence, we continue to maintain a full valuation allowance on the California deferred tax assets.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that will affect our fiscal year ending June 30, 2018, including, but not limited to, (1) a reduction in the U.S. federal corporate tax rate; (2) a transition tax on certain deferred income of foreign subsidiaries that, if the taxpayer so elects, is payable over eight years; and (3) bonus depreciation that allows full expensing of qualified property. The Tax Act reduces the federal corporate tax rate to 21 percent in the fiscal year ending June 30, 2018. Section 15 of the Internal Revenue Code stipulates that our fiscal year ending June 30, 2018 will have a blended corporate tax rate of 28 percent, which is based on the applicable tax rates before and after the Tax Act and the number of days in each period.
The Tax Act also establishes new tax laws that will affect our fiscal year ending June 30, 2019, including, but not limited to, (1) reduction of the U.S. federal corporate tax rate; (2) elimination of the corporate alternative minimum tax; (3) the creation of the base erosion anti-abuse tax (“BEAT”), a new minimum tax on taxable income adjusted for certain base erosion payments; (4) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (5) a new provision designed to currently tax certain global intangible low-taxed income (“GILTI”) of controlled foreign corporations, which allows for the possibility of using foreign tax credits (“FTCs”) and a deduction of up to 50 percent to reduce this income tax liability (subject to some limitations); (6) a new limitation on deductible interest expense; (7) the repeal of the domestic production activity deduction; (8) limitations on the deductibility of certain executive compensation; (9) limitations on the use of FTCs to reduce the U.S. income tax liability; and (10) limitations on net operating losses generated in the taxable years beginning after December 31, 2017, to 80 percent of taxable income.
The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
In connection with our initial analysis of the impact of the Tax Act, we have recorded a provisional tax expense of $83 million as a result of the rate decrease, which was accounted for as discrete item in the tax provision for the second quarter of fiscal year 2018. We are required to recognize the effect of this rate change on our deferred tax assets and liabilities and deferred tax asset valuation allowances in the period the tax rate change was enacted.
The reduction in the U.S. federal statutory rate is expected to positively impact our federal cash tax liability. However, the ultimate impact is subject to the effect of other complex provisions in the Tax Act (including the BEAT and GILTI), which we are currently reviewing, and it is possible that any impact of BEAT and GILTI could significantly reduce the benefit of the reduction in the U.S. federal statutory rate. Due to the uncertain practical and technical application of many of these provisions, it is currently not possible to reliably estimate whether BEAT and GILTI will apply and, if so, how it would impact us. We will continue to analyze the Tax Act to assess the full effects on our financial results for the June 30, 2018 fiscal year-end.
Our accounting for the following elements of the Tax Act is incomplete. However, we were able to make reasonable estimates of certain effects and, therefore, recorded provisional adjustments as follows:
The Tax Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. For certain of our deferred tax assets and deferred tax liabilities, we have recorded a provisional net decrease of deferred tax assets by $83 million, with a corresponding net adjustment to deferred income tax expense of $83 million, which was accounted for as discrete item in the tax provision for the second quarter of fiscal year 2018. While we are able to make a reasonable estimate of the impact of the reduction in corporate rate, it may be affected by other analyses related to the Tax Act, including, but not limited to, our calculation of deemed repatriation of deferred foreign income and the state tax effect of adjustments made to federal temporary differences.

24

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The Deemed Repatriation Transition Tax (“Transition Tax”) is a tax on previously untaxed accumulated and current earnings and profits (“E&P”) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, we must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. We are continuing to gather additional information to more precisely compute the amount of the Transition Tax.
Due to complexity of the new GILTI tax rules, we are continuing to evaluate this provision of the Tax Act and the application of ASC 740. Under U.S. GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). Our selection of an accounting policy with respect to the new GILTI tax rules will depend, in part, on analyzing our global income to determine whether we expect to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be. Whether we expect to have future U.S. inclusions in taxable income related to GILTI depends not only on our current structure and estimated future results of global operations but also on our intent and ability to modify our structure and/or our business; as such, we are not yet able to reasonably estimate the effect of this provision of the Tax Act. Therefore, we have not made any adjustments related to potential GILTI tax in our financial statements and have not made a policy decision regarding whether to record deferred taxes on GILTI.
As of March 31, 2018, we had $10.2 million of unrecognized tax benefits, which, if recognized, would affect the effective tax rate. We are subject to examination of income tax returns by various domestic and foreign tax authorities. The timing of resolutions and closures of tax audits is highly unpredictable. Given the uncertainty, it is reasonably possible that certain tax audits may be concluded within the next 12 months that could materially impact the balance of our gross unrecognized tax benefits. An estimate of the range of increase or decrease that could occur in the next twelve months cannot be made. However, the estimated impact to tax expense and net income from the resolution and closure of tax exams is not expected to be significant within the next 12 months.
Note 15. Stock-Based Compensation and Stock Plans
Description of Lumentum Stock-Based Benefit Plans
Stock Option Plans
On June 23, 2015, we adopted, and the board of directors of JDSU approved, the 2015 Equity Incentive Plan (the “2015 Plan”) under which 8.5 million shares of our common stock were authorized for issuance, which was ratified by our board of directors in August 2015. In connection with our Separation from JDSU on July 31, 2015, outstanding JDSU equity-based awards held by service providers continuing in service after the Separation were converted into equity-based awards under the 2015 Plan reducing the number of shares remaining available for grant under the 2015 Plan. Immediately following our Separation from JDSU, 2.1 million shares of our common stock were reserved pursuant to outstanding equity-based awards under the 2015 Plan that were converted from JDSU equity-based awards.
On November 4, 2016, our stockholders approved an amendment to increase the number of shares that may be issued under the 2015 Plan by 3.0 million shares, and certain other material terms of the 2015 Plan.
As of March 31, 2018, we had 2.1 million shares subject to stock options, restricted stock units, restricted stock awards, and performance stock units issued and outstanding under the 2015 Plan. Restricted stock units, restricted stock awards, and performance stock units are performance-based, time-based or a combination of both and are expected to vest over one to four years. The fair value of these grants is based on the closing market price of our common stock on the date of award.
The exercise price for stock options is equal to the fair value of the underlying stock at the date of grant. We issue 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.
As of March 31, 2018, 5.7 million shares of common stock under the 2015 Plan were available for grant.

25

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Employee Stock Purchase Plan
On June 23, 2015, we adopted, and the board of directors of JDSU approved, the 2015 Employee Stock Purchase Plan (the “2015 Purchase Plan”) under which 3.0 million shares of our common stock were authorized for issuance, which was ratified by our board of directors in August 2015. The 2015 Purchase Plan provides eligible employees with the opportunity to acquire an ownership interest in the Company through periodic payroll deductions and provides a 15% purchase price discount as well as a six-month look-back period. The 2015 Purchase Plan is structured as a qualified employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986. However, the 2015 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 2015 Purchase Plan will terminate upon the date on which all shares available for issuance have been sold. Of the 3.0 million shares authorized under the 2015 Purchase Plan, 2.4 million shares remained available for issuance as of March 31, 2018.
Restricted Stock Units
Restricted stock units (“RSUs”) under the 2015 Plan are grants of shares of our common stock valued at fair value based on the closing price of our common stock on the date of grant. RSUs result in a payment to a holder if any performance goals or other vesting criteria are achieved or the awards otherwise vest. Generally, our RSUs have service conditions and are expected to vest over one to four years.
Restricted Stock Awards
Restricted stock awards (“RSAs”) under the 2015 Plan are grants of shares of our common stock that are subject to various restrictions, including restrictions on transferability and forfeiture provisions. RSAs are expected to vest over one to four years, and the shares acquired may not be transferred by the holder until the vesting conditions (if any) are satisfied.
Performance Stock Units
Performance stock units (“PSUs”) under the 2015 Plan are grants of shares of our common stock that vest upon the achievement of certain performance and service conditions. We begin recognizing compensation expense when we conclude that it is probable that the performance conditions will be achieved. We reassess the probability of vesting at each reporting period and adjust our compensation cost based on this probability assessment. Our PSUs are subject to risk of forfeiture until performance and service conditions are satisfied and generally vest over three years.
During the nine months ended March 31, 2018, we granted 116,788 PSUs to senior members of our management team and recorded $1.6 million expense related to these grants based on the revenue performance condition that is expected to be achieved. During the three months ended March 31, 2018, we recorded $0.4 million expense related to these grants.
Stock-Based Compensation
The impact on our results of operations of recording stock-based compensation by function for the three and nine months ended March 31, 2018 and April 1, 2017 was as follows (in millions):

Three Months Ended

Nine Months Ended

March 31, 2018

April 1, 2017

March 31, 2018

April 1, 2017
Cost of sales
$
2.4


$
1.9


$
9.5


$
6.0

Research and development
3.6


3.0


10.5


8.8

Selling, general and administrative
5.0

 
3.2

 
15.1

 
10.2

 
$
11.0

 
$
8.1

 
$
35.1

 
$
25.0

Approximately $2.1 million and $1.8 million of stock-based compensation was capitalized to inventory as of March 31, 2018 and July 1, 2017, respectively.

26

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Stock Option and Stock Award Activity
We did not grant any stock options during the three and nine months ended March 31, 2018 and April 1, 2017. During the nine months ended March 31, 2018, there were 41,727 options exercised. No options were exercised during the three months ended March 31, 2018.
As of March 31, 2018, 3,057 options were outstanding under the 2015 Plan. During the nine months ended March 31, 2018, the total intrinsic value of options exercised by our employees was $0.8 million. The total intrinsic value of options exercised by our employees during the three and nine months ended April 1, 2017 was $1.0 million and $4.6 million, respectively.
In connection with these exercises, the tax benefit realized during the three and nine months ended April 1, 2017 was $2.3 million and $5.2 million, respectively. During the three and nine months ended March 31, 2018, due to adoption of ASU 2016-09, all excess tax benefits and deficiencies were recognized in the income tax provision in the condensed consolidated statements of operations, rather than in additional paid-in-capital in the condensed consolidated balance sheets. Refer to “Note 1. Description of Business and Summary of Significant Accounting Policies” in the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion on the impact of the adoption of ASU 2016-09.
The following table summarizes our awards activity for the nine months ended March 31, 2018 (in millions, except per share amounts):
 
Restricted Stock Units
 
Restricted Stock Awards
 
Performance Stock Units
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share
Unvested balance as of beginning of period
1.9

 
$
28.04

 
0.3

 
$
32.51

 

 
$

Granted
1.0

 
53.35

 

 

 
0.1

 
52.00

Vested
(0.9
)
 
26.60

 
(0.1
)
 
32.51

 

 

Canceled
(0.2
)
 
38.23

 

 

 

 

Unvested balance as of end of period
1.8

 
$
43.08

 
0.2

 
$
32.51

 
0.1

 
$
52.00

As of March 31, 2018, $72.5 million of stock-based compensation cost related to awards granted to our employees remains to be amortized. That cost is expected to be recognized over an estimated amortization period of 1.8 years.
A summary of awards available for grant is as follows (in millions):
 
Awards Available for Grant
Balance as of beginning of period
6.6

Granted
(1.1
)
Canceled
0.2

Balance as of end of period
5.7

Employee Stock Purchase Plan Activity
The 2015 Purchase Plan expense for the three and nine months ended March 31, 2018 was $0.8 million and $2.4 million, respectively. The expense related to the 2015 Purchase Plan is recorded on a straight-line basis over the relevant subscription period. During the nine months ended March 31, 2018, there were 93,044 shares issued to employees through the 2015 Purchase Plan in one offering period from May 16, 2017 to November 15, 2017.
The 2015 Purchase Plan expense for the three and nine months ended April 1, 2017 was $0.7 million and $2.0 million, respectively. During the nine months ended April 1, 2017, there were 188,864 shares issued to employees through the 2015 Purchase Plan in one offering period from May 16, 2016 to November 15, 2016.

27

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

We estimate the fair value of the 2015 Purchase Plan shares on the date of grant using the Black-Scholes option-pricing model. The assumptions used to estimate the fair value of the 2015 Purchase Plan shares to be issued during the nine months ended March 31, 2018 and April 1, 2017 were as follows:
 
March 31, 2018
 
April 1, 2017
Expected term (years)
0.5

 
0.5

Expected volatility
49.9
%
 
46.0
%
Risk-free interest rate
1.42
%
 
0.62
%
Dividend yield
%
 
%
Note 16. Commitments and Contingencies
Operating Leases
We lease certain real and personal property from unrelated third parties under non-cancellable operating leases that expire at various dates through fiscal 2026. Certain leases require us to pay property taxes, insurance and routine maintenance, and include escalation clauses. As of March 31, 2018, the future minimum annual lease payments under non-cancellable operating leases were as follows (in millions):
Fiscal Years
 
Remainder of 2018
$
2.9

2019
11.9

2020
9.0

2021
5.2

2022
3.5

Thereafter
4.3

Total minimum operating lease payments
$
36.8

During the three and nine months ended March 31, 2018, rental expense relating to building and equipment was $2.8 million and $9.2 million, respectively. During the three and nine months ended April 1, 2017, rental expense relating to building and equipment was $2.6 million and $7.0 million, respectively.
Capital Lease
As of March 31, 2018, equipment acquired under a capital lease agreement was $15.6 million. Our capital lease asset is included in property, plant and equipment, net in our condensed consolidated balance sheets as of March 31, 2018. Amortization expense on this capital lease asset is recorded as depreciation expense and is included in cost of sales in our condensed consolidated statements of operations for the three and nine months ended March 31, 2018. Our capital lease obligation is recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and is included in other current liabilities and other non-current liabilities in our condensed consolidated balance sheets as of March 31, 2018. Refer to “Note 6. Balance Sheet Details” for capital lease obligation amounts in other current liabilities and other non-current liabilities. Interest on these obligations is included in interest expense in our condensed consolidated statements of operations.
As of March 31, 2018 the future minimum annual lease payments under our capital lease were as follows (in millions):

28

LUMENTUM HOLDINGS INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Fiscal Years
 
Remainder of 2018