Edgar Filing: Lumentum Holdings Inc.

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 December 29, 2018

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from

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 every Interactive Data File required to be submitted 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 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 the definitions 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	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 January 28, 2019, the Registrant had 76.1 million shares of common stock outstanding.



TABLE OF CONTENTS
			Page
PART I - FINANCIAL INFORMATION
	Item 1.	Financial Statements (Unaudited)
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 29, 2018 and December 30, 2017	2
		Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended December 29, 2018 and December 30, 2017	3
		Condensed Consolidated Balance Sheets as of December 29, 2018 and June 30, 2018	4
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 29, 2018 and December 30, 2017	5
		Notes to Condensed Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55
	Item 4.	Controls and Procedures	56

PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings	56
	Item 1A.	Risk Factors	57
	Item 6.	Exhibits	73

SIGNATURES			74

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						Six Months Ended
	December 29, 2018			December 30, 2017			December 29, 2018			December 30, 2017
Net revenue	$	373.7		$	404.6		$	727.8		$	647.8
Cost of sales	244.5			232.7			471.8			406.6
Amortization of acquired intangibles	4.4			0.8			5.2			1.6
Gross profit	124.8			171.1			250.8			239.6
Operating expenses:
Research and development	42.8			43.8			77.4			80.1
Selling, general and administrative	62.7			35.7			95.7			62.3
Restructuring and related charges	7.8			0.8			9.1			3.7
Total operating expenses	113.3			80.3			182.2			146.1
Income from operations	11.5			90.8			68.6			93.5
Unrealized gain (loss) on derivative liability	10.9			7.9			8.8			12.1
Interest and other income (expense), net	(4.7		)	(3.2		)	(7.1		)	(6.6		)
Income before income taxes	17.7			95.5			70.3			99.0
Provision for (benefit from) income taxes	1.4			(109.3		)	6.6			(112.9		)
Net income	$	16.3		$	204.8		$	63.7		$	211.9

Items reconciling net income to net income attributable to common stockholders:
Less: Cumulative dividends on Series A Preferred Stock	(0.1		)	(0.3		)	(0.3		)	(0.5		)
Less: Earnings allocated to Series A Preferred Stock	(0.1		)	(4.7		)	(1.2		)	(4.9		)
Net income attributable to common stockholders - Basic	$	16.1		$	199.8		$	62.2		$	206.5
Add: Earnings allocated to Series A Preferred Stock	0.1			4.7			1.2			4.9
Add/Less: Unrealized (gain) loss on derivative liability on Series A Preferred Stock	(10.9		)	(7.9		)	(8.8		)	(12.1		)
Add: Cumulative dividends on Series A Preferred Stock	0.1			0.3			0.3			0.5
Net income attributable to common stockholders - Diluted ^(a)	$	5.4		$	196.9		$	54.9		$	199.8

Net income per share attributable to common stockholders:
Basic	$	0.24		$	3.21		$	0.96		$	3.34
Diluted	$	0.08		$	3.05		$	0.82		$	3.10

Shares used to compute net income per share attributable to common stockholders:
Basic	66.8			62.2			65.0			61.9
Diluted	67.8			64.6			66.6			64.5

(a) For the three and six months ended December 29, 2018 and December 30, 2017, our diluted earnings per share attributable to common stockholders is calculated using the if-converted method because it is more dilutive than the treasury stock method.

See accompanying Notes to Condensed Consolidated Financial Statements.

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LUMENTUM HOLDINGS INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in millions)

(Unaudited)



	Three Months Ended						Six Months Ended
	December 29, 2018			December 30, 2017			December 29, 2018			December 30, 2017
Net income	$	16.3		$	204.8		$	63.7		$	211.9
Other comprehensive income (loss), net of tax:
Net change in cumulative translation adjustment	(0.7		)	0.1			(0.6		)	2.0
Net change in unrealized gain (loss) on available-for-sale securities	0.1			(0.6		)	0.5			(0.7		)
Net change in defined benefit obligation, net of tax	(0.1		)	—			(0.1		)	—
Other comprehensive income (loss), net of tax	(0.7		)	(0.5		)	(0.2		)	1.3
Comprehensive income (loss), net of tax	$	15.6		$	204.3		$	63.5		$	213.2

See accompanying Notes to Condensed Consolidated Financial Statements.

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LUMENTUM HOLDINGS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except share and per share data)

(Unaudited)



	December 29, 2018		June 30, 2018
ASSETS
Current assets:
Cash and cash equivalents	$	371.3	$	397.3
Short-term investments	312.8		314.2
Accounts receivable, net	266.5		197.1
Inventories	303.2		153.6
Prepayments and other current assets	103.1		65.0
Total current assets	1,356.9		1,127.2
Property, plant and equipment, net	444.7		306.9
Goodwill	344.7		11.3
Other intangible assets, net	445.0		7.0
Deferred income taxes	184.3		125.6
Other non-current assets	21.0		3.5
Total assets	$	2,796.6	$	1,581.5
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	199.2	$	126.5
Accrued payroll and related expenses	41.2		31.5
Accrued expenses	46.5		33.9
Term loan, current	5.0		—
Other current liabilities	33.6		22.1
Total current liabilities	325.5		214.0
Convertible notes	342.9		334.2
Term loan, non-current	485.8		—
Derivative liability	—		52.4
Deferred tax liability	56.1		0.3
Other non-current liabilities	26.6		18.7
Total liabilities	1,236.9		619.6
Commitments and contingencies (Note 18)
Redeemable convertible preferred stock:
Non-controlling interest redeemable convertible Series A Preferred Stock, $0.001 par value, 10,000,000 authorized shares; zero and 35,805 shares issued and outstanding as of December 29, 2018 and June 30, 2018, respectively	—		35.8
Total redeemable convertible preferred stock	—		35.8
Stockholders’ equity:
Common stock, $0.001 par value, 990,000,000 authorized shares, 76,102,664 and 62,790,087 shares issued and outstanding as of December 29, 2018 and June 30, 2018, respectively	0.1		0.1
Additional paid-in capital	1,324.2		753.2
Retained earnings	229.2		166.4
Accumulated other comprehensive income	6.2		6.4
Total stockholders’ equity	1,559.7		926.1
Total liabilities, redeemable convertible preferred stock, and stockholders’ equity	$	2,796.6	$	1,581.5

See accompanying Notes to Condensed Consolidated Financial Statements.

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LUMENTUM HOLDINGS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)



	Six Months Ended
	December 29, 2018			December 30, 2017
OPERATING ACTIVITIES:
Net income	$	63.7		$	211.9
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	45.7			34.9
Stock-based compensation	30.5			24.1
Unrealized (gain) loss on derivative liability	(8.8		)	(12.1		)
Amortization of acquired intangibles	6.0			1.6
Loss on disposal of property, plant and equipment	—			0.4
Amortization of discount on convertible notes	8.7			8.2
Amortization of deferred debt issuance cost on term loan	0.1			—
Amortization of inventory fair value adjustment in connection with Oclaro acquisition	1.3			—
Release of valuation allowance, net	—			(124.0		)
Other non-cash (income) expenses	(0.1		)	0.2
Changes in operating assets and liabilities:
Accounts receivable	(0.8		)	(55.8		)
Inventories	0.5			(2.2		)
Prepayments and other current and non-currents assets	(10.7		)	(4.2		)
Income taxes, net	5.8			11.0
Accounts payable	16.5			(7.0		)
Accrued payroll and related expenses	(1.6		)	12.7
Accrued expenses and other current and non-current liabilities	2.8			15.1
Net cash provided by operating activities	159.6			114.8
INVESTING ACTIVITIES:
Payments for acquisition of property, plant and equipment	(53.9		)	(50.2		)
Payment for asset acquisition	(0.7		)	—
Payment for Oclaro acquisition, net of cash acquired	(619.8		)	—
Purchases of short-term investments	(100.1		)	(407.1		)
Proceeds from maturities and sales of short-term investments	102.1			266.2
Net cash used in investing activities	(672.4		)	(191.1		)
FINANCING ACTIVITIES:
Tax payments related to restricted stock	(2.4		)	—
Payment of dividends - Series A Preferred Stock	(0.7		)	(0.2		)
Payment of acquisition related holdback	(1.0		)	—
Proceeds from employee stock plans	4.7			4.4
Proceeds from term loan, net of debt issuance costs	491.0			—
Repayment of capital lease obligation	(4.6		)	(1.2		)
Proceeds from the exercise of stock options	—			1.7
Net cash provided by financing activities	487.0			4.7
Effect of exchange rates on cash and cash equivalents	(0.2		)	0.8
Increase (decrease) in cash and cash equivalents	(26.0		)	(70.8		)
Cash and cash equivalents at beginning of period	397.3			272.9
Cash and cash equivalents at end of period	$	371.3		$	202.1

Supplemental disclosure of cash flow information:
Cash paid for taxes	$	0.4		$	0.7
Cash paid for interest	0.7			0.6

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LUMENTUM HOLDINGS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)



Supplemental disclosure of non-cash transactions:
Unpaid property, plant and equipment in accounts payable and accrued expenses	$	21.7	$	14.4
Equipment acquired under capital lease	—		15.6
Issuance costs in current liabilities	0.3		—
Issuance of common stock upon conversion of Series A Preferred Stock	79.4		—
Issuance of common stock and replacement awards in connection with Oclaro acquisition	460.1		—

See accompanying Notes to Condensed Consolidated Financial Statements.

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LUMENTUM HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 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 Network Equipment Manufacturers’ (“NEMs”) 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, and gaming who then integrate our devices within their products, for eventual resale to consumers and also into other industrial applications.

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 inventory valuation, revenue recognition, income taxes, long-lived asset valuation, warranty, derivative liability, business combinations and goodwill.

On December 10, 2018, the Company completed its merger with Oclaro, Inc. (“Oclaro”), a provider of optical components and modules for the long-haul, metro and data center markets. Our condensed consolidated financial statements include the operating results of Oclaro for the period from the date of acquisition through December 29, 2018. Refer to “Note 5. Business Combination” for further discussion of the merger.

Fiscal Years

We utilize a 52-53 week fiscal year ending on the Saturday closest to June 30th. Our fiscal 2019 is a 52-week year ending on June 29, 2019, with the quarter ended December 29, 2018 being a 13-week quarterly period. Our fiscal 2018 was a 52-week year that ended on June 30, 2018, with the quarter ended December 30, 2017 being a 13-week quarterly period.

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.

Certain prior period amounts have been reclassified to conform to the current year presentation in the notes to the condensed consolidated financial statements. The reclassification of the prior period amounts did not impact previously reported condensed consolidated financial statements, except for the presentation of net income attributable to common stockholders and net income per share attributable to common stockholders for the three and six months ended December 30, 2017. The adjustments are a result of using the two-class method to compute earnings per share for the impact of our Series A Preferred Stock outstanding. Refer to “Note 3. Earnings Per Share” for further details.

Accounting Policies

The accompanying 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 June 30, 2018.

Except for the accounting policies for (i) revenue recognition and the adoption of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), and (ii) the change in our functional currency, from certain foreign currencies to the reporting currency, there have been no significant changes to our significant accounting policies as of and for the

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LUMENTUM HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

six months ended December 29, 2018, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended June 30, 2018.

Adoption of Topic 606

Revenue Recognition Policy

Pursuant to Topic 606, our revenues are recognized upon the application of the following steps:


•	identification of the contract, or contracts, with a customer;


•	identification of the performance obligations in the contract;


•	determination of the transaction price;


•	allocation of the transaction price to the performance obligations in the contract; and


•	recognition of revenues when, or as, the contractual performance obligations are satisfied.

The majority of our revenue comes from product sales, consisting of sales of Lasers and OpComms hardware products to our customers. Our revenue contracts generally include only one performance obligation. Revenues are recognized at a point in time when control of the promised goods or services are transferred to our customers upon shipment or delivery, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We have entered into vendor managed inventory (“VMI”) programs with our customers. Under these arrangements, we receive purchase orders from our customers, and the inventory is shipped to the VMI location upon receipt of the purchase order. The customer then pulls the inventory from the VMI hub based on its production needs. Revenue under VMI programs is recognized when control transfers to the customer, which is generally once the customer pulls the inventory from the hub.

Revenue from all sales types is recognized at the transaction price. The transaction price is determined based on the consideration to which we will be entitled in exchange for transferring goods or services to the customer adjusted for estimated variable consideration, if any. We typically estimate the impact on the transaction price for discounts offered to the customers for early payments on receivables or net of accruals for estimated sales returns. These estimates are based on historical returns, analysis of credit memo data and other known factors. Actual returns could differ from these estimates. We allocate the transaction price to each distinct product based on its relative standalone selling price. The product price as specified on the purchase order is considered the standalone selling price as it is an observable input that depicts the price as if sold to a similar customer in similar circumstances.

Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer and deposited with the relevant government authority, are excluded from revenue. Our revenue arrangements do not contain significant financing components as our standard payment terms are less than one year.

If a customer pays consideration, or the Company has a right to an amount of consideration that is unconditional before we transfer a good or service to the customer, those amounts are classified as deferred revenue or deposits received from customers which are included in other current liabilities or other long-term liabilities when the payment is made or it is due, whichever is earlier.

Transaction Price Allocated to the Remaining Performance Obligations

Remaining performance obligations represent the transaction price allocated to performances obligations that are unsatisfied or partially unsatisfied as of the end of the reporting period. Unsatisfied and partially unsatisfied performance obligations consist of contract liabilities and non-cancellable backlog. Non-cancellable backlog includes goods and services for which customer purchase orders have been accepted that are scheduled or in the process of being scheduled for shipment.

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LUMENTUM HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table includes estimated revenue expected to be recognized in the future for backlog related performance obligations that are unsatisfied as of December 29, 2018 (in millions):



	Less than 1 year	1-2 years	Greater than 2 years	Total
Performance Obligations	$550.1	$11.0	$0.3	$561.4

Warranty

Hardware products regularly include warranties to the end customers such that the product continues to function according to published specifications. We typically offer a twelve month warranty for most of our products. However, in some instances depending upon the product, specific market, product line and geography in which we operate, and what is common in the industry, our warranties can vary and range from six months to five years. These standard warranties are assurance type warranties and do not offer any services in addition to the assurance that the product will continue working as specified. Therefore, warranties are not considered separate performance obligations in the arrangement. Instead, the expected cost of warranty is accrued as expense in accordance with authoritative guidance.

We provide reserves for the estimated costs of product warranties at the time revenue is recognized. We estimate the costs of our warranty obligations based on our historical experience of known product failure rates, use of materials to repair or replace defective products and service delivery costs incurred in correcting product failures. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise.

Shipping and Handling Costs

We record shipping and handling costs related to revenue transactions within cost of sales as a period cost.

Contract Costs

The Company recognizes the incremental direct costs of obtaining a contract, which consist of sales commissions, when control over the products they relate to transfers to the customer. Applying the practical expedient, the Company recognizes commissions as expense when incurred, as the amortization period of the commission asset the Company would have otherwise recognized is less than one year.

Contract Balances

The Company records accounts receivable when it has an unconditional right to consideration. Contract liabilities are recorded when cash payments are received or due in advance of performance. Contract liabilities consist of advance payments and deferred revenue, where the Company has unsatisfied performance obligations. Contract liabilities are classified as deferred revenue and customer deposits, and are included in other current liabilities within our condensed consolidated balance sheet. Payment terms vary by customer. The time between invoicing and when payment is due is not significant.

The following table reflects the changes in contract balances for the six months ended December 29, 2018 (in millions, except percentages):



Contract balances	Balance sheet location	December 29, 2018	June 30, 2018	Change	Percentage Change
Accounts receivable, net	Accounts receivable, net	$266.5	$197.1	$69.4	35.2%
Deferred revenue and customer deposits	Other current liabilities	$3.9	$2.8	$1.1	39.3%

Disaggregation of Revenue

We disaggregate revenue by geography and by product. Refer to “Note 19. Operating Segments and Geographic Information” for a presentation of disaggregated revenue. We do not present other levels of disaggregation, such as by type of products, customer, markets, contracts, duration of contracts, timing of transfer of control and sales channels, as this information is not used by our Chief Operating Decision Maker to manage the business.

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LUMENTUM HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Foreign Currency Translation

Concurrent with the acquisition of Oclaro, on December 10, 2018, we established the functional currency for our worldwide operations as the U.S. dollar. The change in our functional currency is a result of significant changes in economic facts and circumstances, primarily the acquisition of Oclaro, a U.S. dollar-denominated functional currency company. The combined business, which requires the integration of our supply chain, manufacturing operations and sales organization, will predominantly use the U.S. dollar, including when negotiating customer and supplier contracts.

Translation adjustments reported prior to December 10, 2018, remain as a component of accumulated other comprehensive income in our condensed consolidated balance sheet. The translated values for any non-monetary assets and liabilities as of December 10, 2018 become the new accounting basis for those assets. Accordingly, monetary assets and liabilities denominated in foreign currencies have been remeasured into U.S. dollars using the exchange rates in effect at the balance sheet date. Foreign currency re-measurement gains (losses) are included in interest and other income (expense), net from December 10, 2018.

Note 2. Recently Issued Accounting Pronouncements

Accounting Pronouncements Recently Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09 (Topic 606), which amended the existing accounting standards for revenue recognition. Topic 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The guidance is effective for annual reporting periods including interim reporting periods beginning after December 15, 2017. On July 1, 2018, we adopted Topic 606 using the modified retrospective method applied to all contracts that are not completed contracts at the date of initial adoption (i.e., July 1, 2018). Results for reporting periods after July 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historical accounting under Topic 605. The adoption of Topic 606 did not have a material impact on the nature and timing of our revenues, condensed consolidated statements of operations, cash flows, and balance sheets and therefore, we do not present results for the three and six months ended December 29, 2018 under Topic 605. Refer to “Note 1. Description of Business and Summary of Significant Accounting Policies” for the changes in our accounting policies due to adoption of Topic 606.

Select condensed consolidated balance sheet line items, as if we had adopted Topic 606 prior to July 1, 2018 are summarized below as of the periods presented (in millions):



	June 30, 2018		Adjustments			July 1, 2018
Assets:
Accounts receivable, net	$	197.1	$	0.6		$	197.7
Inventories	153.6		(1.2		)	152.4
Stockholders’ equity:
Retained earnings	$	166.4	$	(0.6	)	$	165.8

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. We adopted ASU 2016-15 on July 1, 2018 on a prospective basis. The application of ASU 2016-15 will have a material impact on our consolidated financial statements if we elect to settle the principal amounts of our 2024 Notes (refer to “Note 12. Convertible Senior Notes”) in cash. The principal repayment 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 January 2017, 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 test to determine when a set of assets and activities is not a business. Primarily, the test 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

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LUMENTUM HOLDINGS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

after December 15, 2017, including interim periods within those periods. We adopted ASU 2017-01 on July 1, 2018 on a prospective basis. The implementation of ASU 2017-01 did not have an impact on our condensed consolidated financial statements.

In October 2016, FASB issued ASU 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets other than Inventory. The new guidance removes the prohibition in ASC 740 against the immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory. The new guidance became effective for us in the first quarter of our fiscal 2019. The adoption of ASU 2016-16 did not have a material impact on our financial statements.

In August 2018, FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 requires an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. Implementation costs capitalized must be expensed over the term of the hosting arrangement, including the period covered by an option to extend the arrangement. The standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted, including adoption in any interim period, for all entities. We early adopted ASU 2018-15, which did not have a material impact on our financial statements.

Accounting Pronouncements Not Yet Effective

In August 2018, the Securities and Exchange Commission (“SEC”) adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments became effective on November 5, 2018. Among the amendments is the requirement to present the changes in shareholders’ equity in the interim financial statements (either in a separate statement or footnote) in quarterly reports on Form 10-Q. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a consolidated statement of operations is required to be filed. We will include the first presentation of changes in stockholders’ equity on our Form 10-Q in our third quarter of fiscal 2019.

In August 2018, FASB issued ASU 2018-14, Compensation-Retirement Benefits-Defined Benefit Plans-General (Topic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans. ASU 2018-14 modifies the disclosure requirements for defined benefit pension plans and other postretirement benefit plans. The new guidance is effective for fiscal years ending after December 15, 2020 and early adoption is permitted. ASU 2018-14 should be applied retrospectively to all periods presented and is effective for us in our first quarter of fiscal 2022. We are currently evaluating the impact of ASU 2018-14 on our consolidated financial statements.

In August 2018, FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements for fair value measurements. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Entities are permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until the effective date. The standard is effective for us in our first quarter of fiscal 2021. We are currently evaluating the impact of ASU 2018-13 on our consolidated financial statements and related disclosures.

In February 2018, FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows companies to reclassify stranded tax effects resulting from the Tax Act, from accumulated other comprehensive income to retained earnings. The guidance also requires certain new disclosures regardless of the election. The amendments in ASU 2018-02 are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. ASU 2018-02 is effective for us in the first quarter of fiscal 2020. We are currently evaluating the impact of our pending adoption of ASU 2018-02 on our 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 2020. We are currently evaluating the impact of ASU 2017-04 on our consolidated financial statements.

In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and a subsequent amendment, ASU 2018-19 (collectively, Topic 326). Topic 326 requires measurement

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and recognition of expected credit losses for financial assets held. Topic 326 is effective for annual periods beginning after December 15, 2019, including interim periods within those periods, with early adoption permitted. We are currently evaluating the impact of our pending adoption of Topic 326 on our consolidated financial statements.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842) and subsequent amendments to the initial guidance: ASU 2017-13, ASU 2018-10, ASU 2018-11 and ASU 2018-20 (collectively, Topic 842). 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 Topic 842 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 where we will be required to recognize and measure leases existing at, or entered into after, the beginning of the earliest comparative period presented using a modified retrospective approach, with an option to elect certain practical expedients. 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 Topic 842 which is subject to change.

Note 3. Earnings Per Share

The following table sets forth the computation of basic and diluted net income attributable to common stockholders per share (in millions, except per share data):



	Three Months Ended						Six Months Ended
	December 29, 2018			December 30, 2017			December 29, 2018			December 30, 2017
Basic Earnings per Common Share
Net income	$	16.3		$	204.8		$	63.7		$	211.9
Less: Cumulative dividends on Series A Preferred Stock	(0.1		)	(0.3		)	(0.3		)	(0.5		)
Less: Earnings allocated to Series A Preferred Stock	(0.1		)	(4.7		)	(1.2		)	(4.9		)
Net income attributable to common stockholders - Basic	$	16.1		$	199.8		$	62.2		$	206.5

Weighted average common shares outstanding including Series A Preferred Stock	67.3			63.7			66.0			63.4
Less: Weighted average Series A Preferred Stock	(0.5		)	(1.5		)	(1.0		)	(1.5		)
Basic weighted average common shares outstanding	66.8			62.2			65.0			61.9
Net income per share attributable to common stockholders - Basic	$	0.24		$	3.21		$	0.96		$	3.34

Diluted Earnings per Common Share
Net income attributable to common stockholders - Basic	$	16.1		$	199.8		$	62.2		$	206.5
Add: Earnings allocated to Series A Preferred Stock	0.1			4.7			1.2			4.9
Add/Less: Unrealized (gain) loss on derivative liability on Series A Preferred Stock	(10.9		)	(7.9		)	(8.8		)	(12.1		)
Add: Cumulative dividends on Series A Preferred Stock	0.1			0.3			0.3			0.5
Net income attributable to common stockholders - Diluted ^(a)	$	5.4		$	196.9		$	54.9		$	199.8

Weighted average common shares outstanding for basic earnings per common share	66.8			62.2			65.0			61.9
Effect of dilutive securities from 2015 Equity Incentive Plan	0.5			0.9			0.6			1.1
Effect of dilutive securities from Series A Preferred Stock	0.5			1.5			1.0			1.5
Diluted weighted average common shares outstanding	67.8			64.6			66.6			64.5
Net income per share attributable to common stockholders - Diluted	$	0.08		$	3.05		$	0.82		$	3.10

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Our Series A Preferred Stock was considered a participating security, meaning that it had the right to participate in undistributed earnings with our common stock. Prior to conversion, the holders of our Series A Preferred Stock were entitled to share in dividends, on an as-converted basis, if the holders of our common stock were to receive dividends. On November 2, 2018, the remaining 35,805 shares of our Series A Preferred Stock were converted and we issued 1.5 million shares of our common stock. Refer to “Note 11. Non-Controlling Interest Redeemable Convertible Preferred Stock” for further discussion.

We used the two-class method to compute earnings per share. 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 is calculated similar to basic earnings per common share except that it gives effect to all potentially dilutive common stock equivalents outstanding for the period, using the treasury stock method. Potentially dilutive common shares result from the assumed exercise of outstanding stock options, assumed vesting of outstanding equity awards, assumed issuance of stock under the employee stock purchase plan, and assumed conversion of our outstanding $450 million in aggregate principal amount of 0.25% Convertible Senior Notes due in 2024 (the “2024 Notes”), all using the treasury stock method. 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 on diluted earnings per share until the average price of our common stock exceeds the conversion price of $60.62. Refer to “Note 12. Convertible Senior Notes” for further discussion. Diluted earnings per common share is computed using the more dilutive of the treasury stock method or the if-converted method.

Anti-dilutive potential shares from the 2015 Equity Incentive Plan are excluded from the calculation of diluted earnings per share if their exercise price exceeded the average market price during the period or the share-based awards were determined to be anti-dilutive based on applying the treasury stock method.

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 obligations, and available-for-sale securities.

As of December 29, 2018 and June 30, 2018, balances for the components of accumulated other comprehensive income (loss) were as follows (in millions):



	Foreign currency translation adjustments, net of tax			Defined benefit obligations, net of tax ⁽¹⁾			Unrealized gain (loss) on available-for-sale securities, net of tax			Total
Beginning balance as of June 30, 2018	$	10.3		$	(2.3	)	$	(1.6	)	$	6.4
Other comprehensive income (loss)	(0.6		)	(0.1		)	0.5			(0.2		)
Ending balance as of December 29, 2018	$	9.7		$	(2.4	)	$	(1.1	)	$	6.2

(1) We evaluate the assumptions over the fair value of our defined benefit obligations annually and make changes as necessary.

Note 5. Business Combination

On December 10, 2018, we acquired all of the outstanding common stock of Oclaro, a provider of optical components and modules for the long-haul, metro and data center markets. Oclaro’s products provide differentiated solutions for optical networks and high-speed interconnects driving the next wave of streaming video, cloud computing, application virtualization and other bandwidth-intensive and high-speed applications. This acquisition strengthens our product portfolio, including gaining Oclaro’s leading indium phosphide laser and photonic integrated circuit and coherent component and module capabilities; broadens our revenue mix; and positions us strongly to meet the future needs of our customers.

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Pursuant to the merger agreement, Prota Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Lumentum (“Merger Sub”), merged with and into Oclaro (the “Merger”), with Oclaro surviving the Merger. Each outstanding share of Oclaro common stock, par value $0.01 per share, was automatically converted into the right to receive the following consideration (collectively, the “Merger Consideration”), without interest:

•$5.60 in cash (the “Cash Consideration”) and;


•	0.0636 of a share of Lumentum common stock, par value $0.001 per share (the “Exchange Ratio”).

The total fair value of consideration given in connection with the acquisition of Oclaro consisted of the following:



	Shares	Per Share		Total Consideration (in millions)
Cash paid for outstanding Oclaro common stock				$	964.8
Lumentum common shares issued to Oclaro stockholders	10,941,436	$	41.80	457.4
Replacement equity awards for Oclaro equity awards				2.7
Total consideration				$	1,424.9

Each Oclaro restricted stock unit award (“Oclaro RSU”) that did not become vested at the close of the transaction was converted into a Lumentum restricted stock unit award (a “Lumentum RSU”) with similar terms and conditions, including vesting, that were applicable to such Oclaro RSU, at a ratio of one Oclaro share to 0.1933 shares of Lumentum common stock. The 0.1933 ratio was determined based on the sum of (i) the 0.0636 shares of common stock received by Oclaro common stockholders for every one share of Oclaro common stock, plus (ii) the $5.60 per share received by Oclaro common stockholders, divided by $43.189 (Lumentum’s average closing price for the 10 trading days ending on December 4, 2018, the third trading day prior to the Closing Date).

Each Oclaro stock option (“Oclaro Option”), whether vested or unvested, was converted into a Lumentum stock option (“Lumentum Option”) with similar terms and conditions, including vesting, that were applicable to such Oclaro Option, except that (i) the number of shares subject to the Lumentum Option equals the number of Oclaro shares subject to such Oclaro Option multiplied by 0.1933 and (ii) the exercise price of the Lumentum Option equals the exercise price per share of the Oclaro Option divided by 0.1933. Any Oclaro Option that was held by non-employees was cancelled and converted into the right to receive the Merger Consideration for each net option share covered by such Oclaro Option, subject to applicable withholding taxes.

In addition, each Oclaro restricted stock award (“Oclaro Restricted Stock Award”) and Oclaro RSU that became vested with the close of the transaction was converted into the right to receive the Merger Consideration.

The total transaction consideration was $1.4 billion, which was funded by the issuance of Lumentum common stock, new debt (refer to “Note 6. Term Loan Facility”), and cash balances of the combined company. We also recorded $14.4 million and $15.9 million, respectively, in acquisition-related costs in each of the three and six months ended December 29, 2018, representing professional and other direct acquisition costs. These costs are recorded within selling, general and administrative operating expense and within interest and other income (expense), net in our condensed consolidated statements of operations. The Company also incurred $9.3 million of debt financing costs which has been recorded as a contra liability. “Refer to Note 6. Term Loan Facility.”

From the acquisition date, Oclaro contributed $29.6 million of our consolidated net revenue for each of the three and six months ended December 29, 2018. Due to the continued integration of the combined businesses, it is impractical to determine Oclaro’s contribution to our net income.

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We allocated the fair value of the purchase consideration to the tangible assets, liabilities and intangible assets acquired, including in-process research and development, or IPR&D, generally based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. IPR&D is initially capitalized at fair value as an intangible asset with an indefinite life and assessed for impairment thereafter. When an IPR&D project is completed, the IPR&D is reclassified as an amortizable purchased intangible asset and amortized over the asset’s estimated useful life. Our valuation assumptions of acquired assets and assumed liabilities require significant estimates, especially with respect to intangible assets. Our preliminary allocation of the purchase price of Oclaro, based on the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date, is as follows (in millions):



	Purchase Price Allocation
Cash and cash equivalents	$	345.0
Accounts receivable, net	68.0
Inventories	153.2
Prepayments and other current assets	33.7
Property, plant and equipment, net	128.6
Intangibles	444.0
Deferred income tax asset	54.1
Other non-current assets	16.6
Accounts payable	(57.8		)
Accrued payroll and related expenses	(11.4		)
Accrued expenses	(8.3		)
Other current liabilities	(8.1		)
Deferred tax liability	(55.8		)
Other non-current liabilities	(10.3		)
Goodwill	333.4
Total purchase price	$	1,424.9

The merger consideration allocation set forth herein is preliminary and may be revised as additional information becomes available during the measurement period which could be up to 12 months from the closing date of the acquisition. Any such revisions or changes may be material. The primary areas of the preliminary purchase price allocation that are not yet finalized are certain tax matters, intangible assets, and identification of contingencies.

Goodwill and intangibles has been assigned to the OpComms segment. The preliminary goodwill of $333.4 million arising from the acquisition is attributed to the expected synergies, including future cost efficiencies, and other benefits that are expected to be generated by combining Lumentum and Oclaro. Substantially all of the goodwill recognized is not expected to be deductible for tax purposes. See “Note 14. Goodwill and Other Intangible Assets” for more information on goodwill and IPR&D.

During the three and six months ended December 29, 2018, we recorded $20.9 million in restructuring and stock-based compensation expense in our condensed consolidated statements of operations, primarily attributable to severance and employee related benefits associated with Oclaro’s executive severance and retention agreements. These retention agreements provide, under certain circumstances, for payments and benefits upon an involuntary termination of employment, including following a change in control of Oclaro. The payments and benefits payable under these arrangements in the event of a change in control of Oclaro are subject to a “double trigger,” meaning that both a change in control of Oclaro and a subsequent involuntary termination of employment are required by Lumentum. In other words, the change in control of Oclaro does not by itself trigger any payments or benefits. Instead, payments and benefits are paid only if the employment of the employee is subsequently terminated without “cause” (or the employee resigns for “good reason”) during a specified period following the change in control. The total expense incurred by us is $20.9 million for the three and six months ended December 29, 2018, out of which $5.7 million relates to cash severance as part of our restructuring expense which is recorded within restructuring and related charges in our condensed consolidated statements of operations (refer to “Note 15. Restructuring and Related Charges”) and $15.2 million relates to the acceleration of equity awards which is recorded within both cost of sales and selling, general and administrative expense, in our condensed consolidated statements of operations (refer to “Note 17. Stock-Based Compensation and Stock Plans”).

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Supplemental Pro Forma Information

The supplemental pro forma financial information presented below is for illustrative purposes only and is not necessarily indicative of the financial position or results of operations that would have been realized if the acquisition had been completed on the date indicated, does not reflect synergies that might have been achieved, nor is it indicative of future operating results or financial position. The pro forma adjustments are based upon currently available information and certain assumptions we believe are reasonable under the circumstances.

The following supplemental pro forma information presents the combined results of operations for the six months ended December 29, 2018 and December 30, 2017, as if Oclaro had been acquired as of the beginning of fiscal year 2018. The supplemental pro forma information includes adjustments to amortization and depreciation for acquired intangible assets and property and equipment, adjustments to share-based compensation expense, the fair value adjustments on the inventories acquired, transaction costs, interest expense and amortization of the term loan debt issuance costs. For fiscal year 2018, nonrecurring pro forma adjustments directly attributable to the Oclaro acquisition included (i) restructuring and stock-based compensation expense of $20.9 million, (ii) the purchase accounting effect of inventories acquired of $60.3 million and (iii) transaction costs of $23.0 million.

The supplemental pro forma financial information for the periods presented is as follows (in millions):



	Six Months Ended
	December 29, 2018		December 30, 2017

Net revenue	$	941.8	$	942.7
Net income	32.7		168.4

Note 6. Term Loan Facility

On March 11, 2018, in connection with the Oclaro merger, Lumentum entered into a commitment letter with Deutsche Bank Securities Inc. and Deutsche Bank AG New York Branch (“Deutsche Bank”), pursuant to which, Deutsche Bank committed to provide a senior secured term loan facility to finance the merger.

On December 10, 2018 (the “Closing Date”), concurrent with the closing of the Oclaro merger, Lumentum entered into a Credit and Guarantee Agreement (the “Credit Agreement”), by and among Lumentum, certain subsidiaries of Lumentum, the lenders party thereto, and Deutsche Bank, as administrative agent and collateral agent for the lenders. The Credit Agreement provides for a senior secured term loan facility (the “Term Loan Facility”) in an aggregate principal amount of $500.0 million. The term loans available under the Term Loan Facility were fully drawn on the Closing Date and the proceeds of the term loans were used to consummate the merger and pay fees and expenses in connection with the merger and the Term Loan Facility.

The term loans will mature on the seventh anniversary of the Closing Date, at which time all outstanding principal and accrued and unpaid interest on the term loans must be repaid. Commencing on the last business day of the first full fiscal quarter after the Closing Date, the term loans will amortize in equal quarterly installments equal to 0.25% of the original principal amount of the Term Loans, with the balance payable due on December 10, 2025, the maturity date. We are required to make mandatory prepayments of the outstanding principal amount of term loans with the net cash proceeds from the disposition of certain assets and the receipt of insurance proceeds upon certain casualty and condemnation events, in each case, to the extent in excess of the certain threshold amounts and to the extent not reinvested within a specified time period. We are also required to make mandatory prepayments of the outstanding principal amount of term loans from the incurrence of certain types of indebtedness and from any excess cash flow beyond stated threshold amounts. We have the right to prepay the term loans, in whole or in part, at any time without premium or penalty, subject to certain limitations and a 1.00% soft call premium applicable during the first six months following the Closing Date.

The term loans bear interest at a rate equal to an applicable margin plus, at our option, either (a) a base rate equal to the highest of (i) the prime rate then in effect, (ii) the federal funds rate, plus 0.50% and (iii) an adjusted LIBOR rate determined on the basis of a one-month interest period, plus 1.0%, subject to a floor of 0.0%, or (b) an adjusted LIBOR rate, subject to a floor of 0.0%. The applicable margin with respect to the initial term loans is equal to 2.50% in the case of LIBOR rate loans and 1.50% in the case of base rate loans. The applicable margin is adjusted following the first full fiscal quarter after the Closing Date, if our first lien net leverage ratio is equal to or less than 0.50:1.00, to 2.25% in the case of LIBOR rate loans and 1.25% in the case of

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base rate loans. During the three and six months ended December 29, 2018, we recorded interest expense of $1.4 million related to the initial term loans, which is included in interest and other income (expense), net in our condensed consolidated statements of operations.

The commitment letter with Deutsche Bank required payment of a ticking fee. During the three and six months ended December 29, 2018, we recorded total expenses in connection with the ticking fee of $2.3 million and $2.7 million, respectively. This ticking fee expense is included in interest and other income (expense), net in our condensed consolidated statements of operations.

The Credit Agreement permits us to add one or more incremental term loan facilities. Incremental loans are subject to certain additional conditions, including, without limitation, obtaining additional commitments from the lenders then party to the Credit Agreement or from new lenders.

Our obligations under the Credit Agreement are required to be guaranteed by certain of our domestic subsidiaries meeting materiality thresholds set forth in the Credit Agreement. Such obligations, including the guaranties, are secured by substantially all of the assets of Lumentum and Lumentum’s subsidiary guarantors (other than customarily excluded assets) pursuant to a Pledge and Security Agreement, dated as of December 10, 2018, by and among Lumentum and Deutsche Bank.

The Credit Agreement contains customary affirmative and negative covenants, including covenants limiting the ability of Lumentum and its restricted subsidiaries to, among other things, incur debt, grant liens, undergo certain fundamental changes, make investments, make certain restricted payments, dispose of assets, and enter into transactions with affiliates, in each case, subject to limitations and exceptions set forth in the Credit Agreement. The Credit Agreement also contains customary events of default that include, among other things, certain payment defaults, cross defaults to other indebtedness, covenant defaults, change of control defaults, judgment defaults, and bankruptcy and insolvency defaults. If an event of default exists, the lenders may require the immediate payment of all obligations under the Credit Agreement, and may exercise certain other rights and remedies provided for under the Credit Agreement, the other loan documents and applicable law. As of December 29, 2018, we were in compliance with all of the covenants.

We incurred $9.3 million of debt issuance costs in connection with the Term Loan Facility which were capitalized and recorded as a contra liability in our condensed consolidated balance sheet. These costs will be amortized to interest expense using the effective interest rate method from the issuance date of December 10, 2018, through the end of the term of the loan. As of December 29, 2018, the effective interest rate is 5.16% and the stated interest rate is 4.89%.

The following table sets forth balance sheet information related to the term loan at December 29, 2018 (in millions):



	December 29, 2018
Principal	$	500.0
Unamortized value of the debt issuance costs	(9.2		)
Net carrying value	$	490.8

Term loan, current	$	5.0
Term loan, non-current	$	485.8

The following table sets forth interest expense information related to the term loan, including interest expense associated with the ticking fee, for the periods presented (in millions):



	Three Months Ended				Six Months Ended
	December 29, 2018		December 30, 2017		December 29, 2018		December 30, 2017
Contractual interest expense	$	3.7	$	—	$	4.1	$	—
Amortization of the debt issuance costs	0.1		—		0.1		—
Total interest expense	$	3.8	$	—	$	4.2	$	—

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Note 7. 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 either our manufacturing facility in Thailand or our third party contract manufacturers, 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. During the six months ended December 29, 2018, we paid $0.7 million and accrued an additional $2.0 million for the manufacturing equipment acquired under this TSA. This amount is included in machinery and equipment within property, plant and equipment in our condensed consolidated balance sheet as of December 29, 2018.

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 are expensed as incurred.

Note 8. Balance Sheet Details

Accounts receivable allowances

As of each of December 29, 2018 and June 30, 2018, our accounts receivable allowance balance was $2.6 million.

Inventories

The components of inventories were as follows (in millions):



	December 29, 2018		June 30, 2018
Finished goods	$	118.1	$	98.2
Work in process	129.0		34.5
Raw materials and purchased parts	56.1		20.9
Inventories	$	303.2	$	153.6

The inventory balance at December 29, 2018 includes $60.3 million related to the inventory step-up adjustment from the Oclaro acquisition.

Prepayments and other current assets

The components of prepayments and other current assets were as follows (in millions):



	December 29, 2018		June 30, 2018
Capitalized manufacturing overhead	$	17.1	$	20.5
Prepayments	26.8		19.5
Advances to contract manufacturers	12.6		14.0
Other current assets	46.6		11.0
Prepayments and other current assets	$	103.1	$	65.0

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Property, plant and equipment, net

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



	December 29, 2018			June 30, 2018
Land	$	10.6		$	10.6
Buildings and improvement	65.9			55.1
Machinery and equipment ⁽¹⁾	595.2			463.6
Computer equipment and software	41.4			26.3
Furniture and fixtures	4.0			2.2
Leasehold improvements	28.9			25.8
Construction in progress	63.6			52.6
	809.6			636.2
Less: Accumulated depreciation ⁽¹⁾	(364.9		)	(329.3		)
Property, plant and equipment, net	$	444.7		$	306.9

(1) In fiscal 2018, we started leasing equipment from a vendor and have accounted for the transaction as a capital lease. Included in the table above are our capital lease assets of $17.5 million, gross and $8.2 million in accumulated depreciation as of December 29, 2018, and $15.6 million, gross and $5.2 million in accumulated depreciation as of June 30, 2018.

During the three and six months ended December 29, 2018, we recorded depreciation expense of $26.0 million and $45.7 million, respectively. During the three and six months ended December 30, 2017, we recorded depreciation expense of $18.2 million and $34.9 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):



	December 29, 2018		June 30, 2018
Warranty accrual ⁽¹⁾	$	9.7	$	6.6
Restructuring accrual and related charges ⁽²⁾	3.5		1.9
Deferred revenue and customer deposits	3.9		2.8
Capital lease obligation ⁽³⁾	3.7		7.3
Income tax payable ⁽⁴⁾	7.2		0.7
Other current liabilities	5.6		2.8
Other current liabilities	$	33.6	$	22.1

(1) Refer to “Note 18. Commitments and Contingencies.”

(2) Refer to “Note 15. Restructuring and Related Charges.”

(3) In addition to the $3.7 million of capital lease obligations recorded within other current liabilities, we also recorded $1.6 million within accounts payable and $0.5 million within other non-current liabilities in the condensed consolidated balance sheet as of December 29, 2018. Refer to “Note 18. Commitments and Contingencies.”

(4) Refer to “Note 16. Income Taxes.”

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Other non-current liabilities

The components of other non-current liabilities were as follows (in millions):



	December 29, 2018		June 30, 2018
Asset retirement obligation	$	2.8	$	2.7
Pension and related accrual ⁽¹⁾	10.9		3.5
Deferred rent	2.5		2.6
Unrecognized tax benefit	9.0		6.1
Capital lease obligation	0.5		0.4
Other non-current liabilities	0.9		3.4
Other non-current liabilities	$	26.6	$	18.7

(1) In connection with our acquisition of Oclaro, we assumed a defined benefit plan, which covers certain Japan employees. As of December 29, 2018, we recorded $6.9 million in other non-current liabilities in our condensed consolidated balance sheet to account for the projected benefit obligations.

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Note 9. 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
December 29, 2018:
Cash	$	294.4	$	—	$	—		$	294.4
Cash equivalents:
Certificates of deposit	2.0		—		—			2.0
Commercial paper	24.1		—		—			24.1
Corporate debt securities	5.0		—		—			5.0
Money market funds	4.8		—		—			4.8
Foreign government bonds	3.5		—		—			3.5
U.S. Treasury	35.6		—		—			35.6
Asset-backed securities	1.9		—		—			1.9
Total cash and cash equivalents	$	371.3	$	—	$	—		$	371.3
Short-term investments:
Commercial paper	$	13.3	$	—	$	—		$	13.3
Asset-backed securities	60.6		—		(0.1		)	60.5
Corporate debt securities	231.4		0.1		(1.1		)	230.4
Municipal bonds	1.3		—		—			1.3
Mortgage-backed securities	2.2		—		—			2.2
Foreign government bonds	5.1		—		—			5.1
Total short-term investments	$	313.9	$	0.1	$	(1.2	)	$	312.8

June 30, 2018:
Cash	$	103.6	$	—	$	—		$	103.6
Cash equivalents:
Certificates of deposit	3.0		—		—			3.0
Commercial paper	112.1		—		—			112.1
Money market funds	0.8		—		—			0.8
U.S. Treasury securities	143.6		—		—			143.6
U.S. Agency securities	34.2		—		—			34.2
Total cash and cash equivalents	$	397.3	$	—	$	—		$	397.3
Short-term investments:
Certificates of deposit	$	7.5	$	—	$	—		$	7.5
Commercial paper	10.5		—		—			10.5
Asset-backed securities	68.0		—		(0.2		)	67.8
Corporate debt securities	220.6		0.1		(1.5		)	219.2
Municipal bonds	1.6		—		—			1.6
Mortgage-backed securities	4.2		—		—			4.2
Foreign government bonds	3.4		—		—			3.4
Total short-term investments	$	315.8	$	0.1	$	(1.7	)	$	314.2

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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 six months ended December 29, 2018 and December 30, 2017, 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.

During the three and six months ended December 29, 2018, our interest and other income (expense), net was $4.7 million expense and $7.1 million expense, respectively, and includes interest income on cash equivalents and short-term investments of $3.4 million and $6.1 million, respectively. During the three and six months ended December 30, 2017, our interest and other income (expense), net was $3.2 million expense and $6.6 million expense, respectively, and includes interest income on cash equivalents and short-term investments of $1.7 million and $3.1 million, respectively.

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
December 29, 2018:
Commercial paper	$	12.8	$	—		$	—	$	—		$	12.8	$	—
Asset-backed securities	32.1		(0.1		)	12.3		—			44.4		(0.1		)
Corporate debt securities	101.1		(0.4		)	88.1		(0.7		)	189.2		(1.1		)
Mortgage-backed securities	0.1		—			—		—			0.1		—
Foreign government bonds	2.9		—			2.1		—			5.0		—
Total	$	149.0	$	(0.5	)	$	102.5	$	(0.7	)	$	251.5	$	(1.2	)

June 30, 2018:
Certificates of deposit	$	5.4	$	—		$	—	$	—		$	5.4	$	—
Commercial paper	8.5		—			—		—			8.5		—
Asset-backed securities	66.6		(0.2		)	0.3		—			66.9		(0.2		)
Corporate debt securities	188.6		(1.5		)	2.0		—			190.6		(1.5		)
Municipal bonds	0.6		—			—		—			0.6		—
U.S. Agency securities	4.0		—			—		—			4.0		—
Foreign government bonds	3.4		—			—		—			3.4		—
Total	$	277.1	$	(1.7	)	$	2.3	$	—		$	279.4	$	(1.7	)

The following table classifies our short-term investments by contractual maturities (in millions):



	December 29, 2018				June 30, 2018
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in 1 year	$	165.1	$	164.7	$	150.1	$	149.6
Due in 1 year through 5 years	143.2		142.5		157.2		156.1
Due in 5 years through 10 years	4.3		4.3		6.1		6.1
Due after 10 years	1.3		1.3		2.4		2.4
	$	313.9	$	312.8	$	315.8	$	314.2

All available-for-sale securities have been classified as current, based on management’s intent and ability to use the funds in current operations.

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Note 10. 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:



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 our 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 our 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. Our procedures include controls to ensure that appropriate fair values are recorded, including comparing the fair values obtained from our pricing service against fair values obtained from another independent source.

Prior to the conversion of the Series A Preferred Stock in the second quarter of fiscal 2019, we estimated the fair value of the embedded derivative for the Series A Preferred Stock using the binomial lattice model to be $43.6 million. The binomial lattice model requires various assumptions to be made to determine the fair value of the embedded derivatives. These assumptions represent Level 3 inputs. Refer to “Note 13. Derivative Liability.” Upon the conversion of the Series A Preferred Stock and the settlement of the Series A Preferred Stock and the embedded derivative, we recorded $79.4 million in additional paid in capital in the condensed consolidated balance sheet as of December 29, 2018.

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. We estimated the likelihood of meeting the production targets at 90 percent and recorded the fair value of such contingent consideration in other current liabilities on the condensed consolidated balance sheet as of December 29, 2018. This contingent consideration will result in a cash payment of $3.0 million (based on the exchange rate as of the acquisition date), if and when the production targets are achieved, which we expect to occur within the following 12 months. There was no change in the fair value of our contingent consideration during the three and six months ended December 29, 2018 and December 30, 2017.

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.

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Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in millions):



	Level 1		Level 2		Level 3		Total
December 29, 2018: ⁽¹⁾
Assets:
Cash equivalents:
Certificates of deposit	$	—	$	2.0	$	—	$	2.0
Commercial paper	—		24.1		—		24.1
Corporate debt securities	—		5.0		—		5.0
Money market funds	4.8		—		—		4.8
Foreign government bonds	—		3.5		—		3.5
U.S. Treasury	35.6		—		—		35.6
Asset-backed securities	—		1.9		—		1.9
Short-term investments:
Commercial paper	—		13.3		—		13.3
Asset-backed securities	—		60.5		—		60.5
Corporate debt securities	—		230.4		—		230.4
Municipal bonds	—		1.3		—		1.3
Mortgage-backed securities	—		2.2		—		2.2
Foreign government bonds	—		5.1		—		5.1
Total assets	$	40.4	$	349.3	$	—	$	389.7
Other current liabilities:
Acquisition contingencies	$	—	$	—	$	2.7	$	2.7
Total other accrued liabilities	$	—	$	—	$	2.7	$	2.7

(1) Excludes $294.4 million in cash held in our bank accounts at December 29, 2018.

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	Level 1		Level 2		Level 3		Total
June 30, 2018: ⁽¹⁾
Assets:
Cash equivalents:
Certificates of deposit	$	—	$	3.0	$	—	$	3.0
Commercial paper	—		112.1		—		112.1
Money market funds	0.8		—		—		0.8
U.S. Treasury securities	143.6		—		—		143.6
U.S. Agency securities	—		34.2		—		34.2
Short-term investments:
Certificates of deposit	—		7.5		—		7.5
Commercial paper	—		10.5		—		10.5
Asset-backed securities	—		67.8		—		67.8
Corporate debt securities	—		219.2		—		219.2
Municipal bonds	—		1.6		—		1.6
Mortgage-backed securities	—		4.2		—		4.2
Foreign government bonds	—		3.4		—		3.4
Total assets	$	144.4	$	463.5	$	—	$	607.9
Other accrued liabilities:
Derivative liability	$	—	$	—	$	52.4	$	52.4
Acquisition contingencies	—		—		2.7		2.7
Total other accrued liabilities	$	—	$	—	$	55.1	$	55.1

(1) Excludes $103.6 million in cash held in our bank accounts at June 30, 2018.

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 2018, we concluded that our intangible and other long-lived assets were not impaired.

No impairment charges were recorded during the three and six months ended December 29, 2018 and December 30, 2017. Refer to “Note 5. Business Combination” and “Note 14. Goodwill and Other Intangible Assets.”

Note 11. 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 us, 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.

As of June 30, 2018, the Series A Preferred Stock was referred to as our Non-Controlling Interest Redeemable Convertible Preferred Stock within these condensed consolidated financial statements, and was recorded at $35.8 million.

On October 15, 2018, we issued a 30-day notice of intent to the holders of Series A Preferred Stock to convert all shares of Series A Preferred Stock at a conversion price equal to the Issuance Value divided by $24.63 plus the accrued and unpaid dividends on each share and any past due dividends, whether or not authorized or declared. On November 2, 2018, we received notice from Amada of their intent to convert the Series A Preferred Stock and we issued 1.5 million shares of our common stock to Amada

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upon the conversion of the 35,805 shares of Series A Preferred Stock and recorded $79.4 million in additional paid in capital in the condensed consolidated balance sheet as of December 29, 2018.

Up through the date of conversion, 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, and at the date of conversion, with the change in fair value recorded in the condensed consolidated statements of operations. Refer to “Note 13. Derivative Liability”.

Up through the date of conversion, 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, were 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 were payable on March 31, June 30, September 30 and December 31 of each year commencing on September 30, 2015. The accrued dividends as of November 2, 2018, the effective date of the conversion of all outstanding Series A Preferred Stock, and June 30, 2018 were $0.3 million and $0.4 million, respectively. During the three and six months ended December 29, 2018, we paid $0.3 million and $0.7 million, respectively, in dividends to the holders of Series A Preferred Stock. During the three and six months ended December 30, 2017, we paid zero and $0.2 million, respectively, in dividends to the holders of Series A Preferred Stock.

Note 12. Convertible Senior Notes

In March 2017, we issued the 2024 Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under 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, or $78.80 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

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(Unaudited)

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 December 29, 2018, the remaining debt discount amortization period was 62 months.

During the year ended July 1, 2017, we satisfied the TMA settlement condition. 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.

The 2024 Notes consisted of the following components as of the periods presented (in millions):



Liability component:	December 29, 2018			June 30, 2018
Principal	$	450.0		$	450.0
Unamortized debt discount	(107.1		)	(115.8		)
Net carrying amount of the liability component	$	342.9		$	334.2

The following table sets forth interest expense information related to the 2024 Notes for the periods presented (in millions, except percentages):



	Three Months Ended						Six Months Ended
	December 29, 2018			December 30, 2017			December 29, 2018			December 30, 2017
Contractual interest expense	$	0.3		$	0.3		$	0.6		$	0.6
Amortization of the debt discount	4.4			4.1			8.7			8.2
Total interest expense	$	4.7		$	4.4		$	9.3		$	8.8
Effective interest rate on the liability component	5.4		%	5.4		%	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 13. Derivative Liability

Up through the date of conversion of the Series A Preferred Stock, we estimated the fair value of the embedded derivative using the binomial lattice model. We applied the binomial 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 binomial 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 liability.” Prior to the conversion of the Series A Preferred Stock on November 2, 2018, we marked to market the embedded derivative, resulting in a gain of $10.9 million. The gain (loss) on derivative liability for the Series A Preferred Stock up through the conversion date of November 2, 2018, amounted to a $10.9 million gain and a $8.8 million gain for the three and six months ended December 29, 2018, respectively. In connection with the conversion of the Series A Preferred Stock we also recorded $79.4 million in additional paid in capital within the condensed consolidated balance sheet as of December 29, 2018.

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(Unaudited)

Unrealized gain (loss) on derivative liability for the Series A Preferred Stock amounted to a $7.9 million gain and a $12.1 million gain for the three and six months ended December 30, 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 six months ended December 29, 2018 and December 30, 2017 (in millions):



	Three Months Ended						Six Months Ended
	December 29, 2018			December 30, 2017			December 29, 2018			December 30, 2017
Balance as of beginning of period	$	54.5		$	47.4		$	52.4		$	51.6
Unrealized (gain) loss on the Series A Preferred Stock derivative liability up through the conversion date	(10.9		)	(7.9		)	(8.8		)	(12.1		)
Settlement of the derivative liability upon conversion of Series A Preferred Stock	(43.6		)	—			(43.6		)	—
Balance as of end of period	$	—		$	39.5		$	—		$	39.5

Note 14. Goodwill and Other Intangible Assets

Goodwill

On December 10, 2018, we completed the merger with Oclaro. As of the acquisition date, we recognized goodwill in the amount of $333.4 million and allocated it to OpComms. The following table presents the changes in goodwill by our reportable segments during the six months ended December 29, 2018 (in millions):



	Optical Communications		Commercial Lasers		Total
Balance as of beginning of period	$	5.9	$	5.4	$	11.3
Acquisition of Oclaro	333.4		—		333.4
Balance as of end of period	$	339.3	$	5.4	$