2011.12.31_10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ___________________________________________________
FORM 10-Q
 ___________________________________________________
 
(Mark One)
S
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2011
or
£
 
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: 001-33962 
COHERENT, INC.
Delaware
 
94-1622541
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
5100 Patrick Henry Drive, Santa Clara, California 95054
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (408) 764-4000 
___________________________________________________
 
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 S No £
 
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer S
 
Accelerated filer £
 
 
 
Non-accelerated filer £
 
Smaller reporting company £
(do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £  No S
 
The number of shares outstanding of registrant’s common stock, par value $.01 per share, on January 27, 2012 was 23,559,776.


Table of Contents

COHERENT, INC.

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This quarterly report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included in or incorporated by reference in this quarterly report, other than statements of historical fact, are forward-looking statements. These statements are generally accompanied by words such as “trend,” “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “rely,” “believe,” “estimate,” “predict,” “intend,” “potential,” “continue,” “forecast” or the negative of such terms, or other comparable terminology, including without limitation statements made under “Future Trends,” “Our Strategy,” discussions regarding our bookings and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Actual results of Coherent, Inc. (referred to herein as the Company, we, our or Coherent) may differ significantly from those anticipated in these forward-looking statements as a result of various factors, including those discussed in the sections captioned “Future Trends,” “Risk Factors,” “Key Performance Indicators,” as well as any other cautionary language in this quarterly report. All forward-looking statements included in the document are based on information available to us on the date hereof. We undertake no obligation to update these forward-looking statements as a result of events or circumstances or to reflect the occurrence of unanticipated events or non-occurrence of anticipated event.


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PART I.  FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS
 
COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited; in thousands, except per share data) 

 
Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
Net sales
$
190,767

 
$
183,111

 
Cost of sales
110,408

 
100,717

 
Gross profit
80,359

 
82,394

 
Operating expenses:
 

 
 

 
Research and development
18,779

 
18,530

 
Selling, general and administrative
34,631

 
36,078

 
Amortization of intangible assets
1,636

 
2,095

 
Total operating expenses
55,046

 
56,703

 
Income from operations
25,313

 
25,691

 
Other income (expense):
 

 
 
 
Interest and dividend income
202

 
183

 
Interest expense
(2
)
 
(15
)
 
Other—net
318

 
1,586

 
Total other income (expense), net
518

 
1,754

 
Income before income taxes
25,831

 
27,445

 
Provision for income taxes
8,780

 
8,332

 
Net income
$
17,051

 
$
19,113

 
 
 
 
 
 
Net income per share:
 

 
 

 
Basic
$
0.73

 
$
0.77

 
Diluted
$
0.71

 
$
0.76

 
 
 
 
 
 
Shares used in computation:
 

 
 

 
Basic
23,462

 
24,688

 
Diluted
23,961

 
25,268

 
 
See Accompanying Notes to Condensed Consolidated Financial Statements.


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COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except par data)
 
December 31,
2011
 
October 1,
2011
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
167,662

 
$
167,061

Short-term investments
35,421

 
53,142

Accounts receivable—net of allowances of $1,546 and $1,439, respectively
130,581

 
141,037

Inventories
148,047

 
152,385

Prepaid expenses and other assets
52,314

 
44,964

Deferred tax assets
23,265

 
22,057

Total current assets
557,290

 
580,646

Property and equipment, net
106,028

 
104,504

Goodwill
74,756

 
75,954

Intangible assets, net
16,405

 
17,980

Other assets
63,650

 
64,182

Total assets
$
818,129

 
$
843,266

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term obligations
$
15

 
$
15

Accounts payable
35,379

 
39,841

Income taxes payable
15,258

 
23,929

Other current liabilities
94,573

 
98,620

Total current liabilities
145,225

 
162,405

Long-term obligations
15

 
19

Other long-term liabilities
63,565

 
62,841

Commitments and contingencies (Note 11)


 


Stockholders’ equity:
 

 
 

Common stock, par value $.01 per share:
 

 
 

Authorized—500,000 shares
 

 
 

Outstanding—23,531 shares and 23,722 shares, respectively
234

 
236

Additional paid-in capital
114,829

 
130,250

Accumulated other comprehensive income
40,916

 
51,221

Retained earnings
453,345

 
436,294

Total stockholders’ equity
609,324

 
618,001

Total liabilities and stockholders’ equity
$
818,129

 
$
843,266


See Accompanying Notes to Condensed Consolidated Financial Statements.


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COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
Three Months Ended
 
December 31,
2011
 
January 1,
2011
Cash flows from operating activities:
 

 
 

Net income
$
17,051

 
$
19,113

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 

Depreciation and amortization
5,828

 
4,767

Amortization of intangible assets
1,636

 
2,095

Deferred income taxes
(527
)
 
8,096

Tax benefit from employee stock options
955

 
1,543

Loss on disposal of property and equipment
42

 
156

Stock-based compensation
4,022

 
2,922

Excess tax benefit from stock-based compensation arrangements
(1,681
)
 
(1,678
)
Other non-cash (income) expense
154

 
(58
)
Changes in assets and liabilities, net of effect of acquisitions:
 

 
 

Accounts receivable
9,161

 
1,522

Inventories
2,671

 
(9,109
)
Prepaid expenses and other assets
(7,321
)
 
(2,443
)
Other assets
(497
)
 
(2,011
)
Accounts payable
(4,715
)
 
2,687

Income taxes payable/receivable
(8,210
)
 
(1,314
)
Other current liabilities
(3,110
)
 
1,250

Other long-term liabilities
676

 
2,431

Net cash provided by operating activities
16,135

 
29,969

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(8,139
)
 
(5,129
)
Proceeds from dispositions of property and equipment
26

 
—

Purchases of available-for-sale securities
(12,593
)
 
(71,093
)
Proceeds from sales and maturities of available-for-sale securities
30,188

 
19,506

Changes in restricted cash
—

 
(68
)
Net cash provided by (used in) investing activities
9,482

 
(56,784
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
4,786

 
285

Repayments of short-term borrowing
(4,786
)
 
(285
)
Net change in capital lease obligations
(4
)
 
(5
)
Issuance of common stock under employee stock option and purchase plans
4,568

 
17,331

Repurchase of common stock
(20,665
)
 
—

Net settlement of restricted common stock
(4,413
)
 
(2,086
)
Excess tax benefits from stock-based compensation arrangements
1,681

 
1,678

Net cash provided by (used in) financing activities
(18,833
)
 
16,918

Effect of exchange rate changes on cash and cash equivalents
(6,183
)
 
(7,968
)
Net increase (decrease) in cash and cash equivalents
601

 
(17,865
)
Cash and cash equivalents, beginning of period
167,061

 
245,380

Cash and cash equivalents, end of period
$
167,662

 
$
227,515

Supplemental disclosure of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
3

 
$
11

Income taxes
$
25,818

 
$
3,973

Cash received during the period for:
 

 
 

Income taxes
$
9,662

 
$
3,908

 
 
 
 
Non-cash investing and financing activities:
 

 
 

Unpaid property and equipment
$
1,933

 
$
889

See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    BASIS OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes thereto should be read in conjunction with the Coherent, Inc. (referred to herein as the “Company,” “we,” “our,” “us” or “Coherent”) consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended October 1, 2011. In the opinion of management, all adjustments necessary for a fair presentation of financial condition and results of operation as of and for the periods presented have been made and include only normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year or any other interim periods presented therein. Our fiscal year ends on the Saturday closest to September 30 and our first fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal years 2012 and 2011 each include 52 weeks.
 

2.    RECENT ACCOUNTING STANDARDS
 
Adoption of New Accounting Pronouncement

In September 2011, the Financial Accounting Standards Board (“FASB”) amended existing guidance related to goodwill and other intangible assets by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The qualitative factors are consistent with the existing guidance which requires goodwill of a reporting unit to be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. If this is the case, companies will need to perform a more detailed two-step goodwill impairment test which is used to identify potential goodwill impairments and to measure the amount of goodwill impairment losses to be recognized, if any. We adopted this authoritative guidance in the first quarter of fiscal 2012. The implementation of this authoritative guidance did not have a material impact on our consolidated financial position, results of operations and cash flows.
In October 2009, the FASB issued a new accounting standard for multiple deliverable revenue arrangements. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The FASB also issued a new accounting standard for certain revenue arrangements that include software elements. This new standard excludes software that is contained on a tangible product from the scope of software revenue guidance if the software is essential to the tangible product’s functionality. We prospectively adopted both these standards in the first quarter of fiscal 2011 and it did not have a material impact on our consolidated financial position, results of operations and cash flows.
 
Recently Issued Accounting Pronouncements

In December 2011, the FASB issued guidance which requires an entity to disclose information about offsetting and related arrangements to enable financial statement users to evaluate the effect or potential effect of netting arrangements, including rights of setoff associated with the entity's recognized financial assets and liabilities, on the entity's financial position. The new disclosures will enable financial statement users to compare balance sheets prepared under U.S. GAAP and International Financial Reporting Standards ("IFRS"), which are subject to different offsetting models. The disclosures will be limited to financial instruments (and derivatives) subject to enforceable master netting arrangements or similar agreements. Similar agreements include derivative clearing agreements, global master repurchase agreements, and global master securities lending agreements. Financial instruments and transactions that will be subject to the disclosure requirements may include derivatives, repurchase and reverse repurchase agreements, and securities lending and borrowing arrangements. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The guidance is effective for us beginning in fiscal 2014. We are currently evaluating the potential impact, if any, of the adoption of this guidance on our consolidated financial position, results of operations and cash flows.
In June 2011, the FASB issued a final standard requiring the presentation of net income and other comprehensive income

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in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The new standard eliminates the option currently elected by the Company to present items of other comprehensive income in the annual statement of changes in stockholders' equity. The new requirements do not change the components of comprehensive income recognized in net income or other comprehensive income, or when an item of other comprehensive income must be reclassified to net income. Earnings per share computations do not change. The new requirements are effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. Full retrospective application is required. As this standard relates only to the presentation of other comprehensive income, the adoption of this accounting standard will not have an impact on our consolidated financial position, results of operations and cash flows.
In May 2011, the FASB issued additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our consolidated financial position, results of operations and cash flows.
3.     BUSINESS COMBINATIONS
  
On January 5, 2011, we acquired all of the assets and certain liabilities of Hypertronics Pte Ltd for approximately $14.5 million in cash. Hypertronics designs and manufactures laser-and vision-based tools for flat panel, storage, semiconductor and solar applications at facilities in Singapore and Malaysia. Hypertronics has been included in our Specialty Lasers and Systems segment.
 
Our allocation of the purchase price is as follows (in thousands):

Tangible assets
$
4,617

Goodwill
5,807

Intangible assets:


Existing technology
3,120

In-process R&D
570

Customer lists
1,880

Trade name
410

Non-compete agreements
60

Liabilities assumed
(1,965)

Total
$
14,499

 
The goodwill recognized from this acquisition resulted primarily from anticipated revenue growth and synergies of integrating Hypertronics scan vision technology and system capabilities with our laser technology and global sales, marketing, distribution and service network. The goodwill was included in our Specialty Lasers and Systems segment.

None of the goodwill from this purchase is deductible for tax purposes.
 
The identifiable intangible assets are being amortized over their respective useful lives of two to six years.
 
In-process research and development (“IPR&D”) consists of seven interrelated projects that will be incorporated into one product and had not yet reached technological feasibility. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. The value assigned to IPR&D was determined by considering the value of the products under development to the overall development plan, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. During the development period, these assets will not be amortized as charges to earnings; instead these assets will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPR&D projects, the assets would then be considered finite-lived intangible assets and amortization of the assets will commence. None of the projects had been completed as of December 31, 2011.
 

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We expensed $0.6 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in the fiscal year ended October 1, 2011.
 
Results of operations for the business have been included in our consolidated financial statements subsequent to the date of acquisition and pro forma results of operations in accordance with authoritative guidance for prior periods have not been presented because the effect of the acquisition was not material to our prior period consolidated financial results.


4.     FAIR VALUES
 
We measure our cash equivalents and marketable securities at fair value. The fair values of our financial assets and liabilities are determined using quoted market prices of identical assets or quoted market prices of similar assets from active markets. Level 1 valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 valuations are obtained from quoted market prices in active markets involving similar assets. Level 3 valuations would be based on unobservable inputs to a valuation model and include our own data about assumptions market participants would use in pricing the asset or liability based on the best information available under the circumstances. As of December 31, 2011 and October 1, 2011, we did not have any assets or liabilities valued based on Level 3 valuations.

Financial assets and liabilities measured at fair value as of December 31, 2011 are summarized below (in thousands):
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Total Fair
Value
 
(Level 1)
 
(Level 2)
 
 
Money market fund deposits (1)
$
16,728

 
$
—

 
$
16,728

Certificates of deposit (2)
—

 
66,916

 
66,916

U.S. and international government obligations (3)
—

 
57,642

 
57,642

Corporate notes and obligations (4)
—

 
31,259

 
31,259

Foreign currency contracts (5)
—

 
627

 
627

Mutual funds — Deferred comp and supplemental plan (6)
8,348

 
—

 
8,348

 ___________________________________________________
(1)          Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet.
(2)          Includes $64,914 recorded in cash and cash equivalents and $2,002 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(3)          Includes $54,919 recorded in cash and cash equivalents and $2,723 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(4)          Includes $563 recorded in cash and cash equivalents and $30,696 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(5)          Includes $627 recorded in other current liabilities on the Condensed Consolidated Balance Sheet (see Note 5).
(6)          Includes $2,859 recorded in prepaid expenses and other assets and $5,489 recorded in other assets on the Condensed Consolidated Balance Sheet.
 
Financial assets and liabilities measured at fair value as of October 1, 2011 are summarized below (in thousands):
 

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Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Total Fair
Value
 
(Level 1)
 
(Level 2)
 
 
Money market fund deposits(1)
$
8,135

 
$
—

 
$
8,135

Certificates of deposit(2)
—

 
65,941

 
65,941

U.S. and international government obligations(3)
—

 
62,079

 
62,079

Corporate notes and obligations(4)
—

 
48,967

 
48,967

Foreign currency contracts(5)
—

 
181

 
181

Mutual funds—Deferred comp and supplemental plan(6)
7,830

 
—

 
7,830

 ___________________________________________________
(1)
Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet.
(2)
Includes $59,431 recorded in cash and cash equivalents and $6,510 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(3)
Includes $60,978 recorded in cash and cash equivalents and $1,101 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(4)
Includes $3,436 recorded in cash and cash equivalents and $45,531 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
(5)
Includes $578 recorded in prepaid expenses and other assets and $397 recorded in other current liabilities on the Condensed Consolidated Balance Sheet.
(6)
Includes $2,844 recorded in prepaid expenses and other assets and $4,986 recorded in other assets on the Condensed Consolidated Balance Sheet.
 

5.     DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
All derivatives, whether designated in hedging relationships or not, are recorded on the condensed consolidated balance sheet at fair value. We enter into foreign exchange forward contracts to minimize the risks of foreign currency fluctuation of specific assets and liabilities on the balance sheet; these are not designated as hedging instruments.

We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, the Japanese Yen and the Korean Won. As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading purposes. If a financial counterparty to any of our hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, we may experience material financial losses.
 
For derivative instruments that are not designated as hedging instruments, gains and losses are recognized in other income (expense).
 
The outstanding notional contract and fair value amounts of hedge contracts, with maximum maturity of two months, are as follows (in thousands):
 

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U.S. Notional Contract Value
 
U.S. Notional Fair Value
 
December 31, 2011
 
October 1, 2011
 
December 31, 2011
 
October 1, 2011
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
47,843

 
$
42,488

 
$
47,344

 
$
42,103

Sell
—

 
—

 
—

 
—

Net
$
47,843

 
$
42,488

 
$
47,344

 
$
42,103

Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
—

 
$
2,351

 
$
—

 
$
2,355

Sell
(47,535
)
 
(16,783
)
 
(47,663
)
 
(16,221
)
Net
$
(47,535
)
 
$
(14,432
)
 
$
(47,663
)
 
$
(13,866
)
 
The fair value of our derivative instruments are included in prepaid expenses and other assets and in other current liabilities in our Condensed Consolidated Balance Sheets; such amounts were not material as of December 31, 2011 and October 1, 2011.
 
The amount of non-designated derivative instruments’ gain (loss) in the Condensed Consolidated Statements of Operations for the three months ended December 31, 2011 and January 1, 2011 is as follows (in thousands):
 
 
 
Amount of Gain or (Loss) Recognized in
 
 
Income on Derivatives
 
 
Three Months Ended
 
 
 
December 31, 2011
 
Derivatives not designated as hedging instruments
 
 
 
Foreign exchange contracts
 
$
1,982

 


 
 
Amount of Gain or (Loss) Recognized in
 
 
Income on Derivatives
 
 
Three Months Ended
 
 
 
January 1, 2011
 
Derivatives not designated as hedging instruments
 
 
 
Foreign exchange contracts
 
$
1,104

 

6.              SHORT-TERM INVESTMENTS
 
We consider all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Investments classified as available-for-sale are reported at fair value with unrealized gains and losses, net of related income taxes, recorded as a separate component of other comprehensive income (“OCI”) in stockholders’ equity until realized. Interest and amortization of premiums and discounts for debt securities are included in interest income. Gains and losses on securities sold are determined based on the specific identification method and are included in other income (expense).

Cash, cash equivalents and short-term investments consist of the following (in thousands):
 

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December 31, 2011
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
167,655

 
$
7

 
$
—

 
$
167,662

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Certificates of deposit
$
2,000

 
$
2

 
$
—

 
$
2,002

International government obligations
2,667

 
61

 
(5
)
 
2,723

Corporate notes and obligations
30,482

 
215

 
(1
)
 
30,696

Total short-term investments
$
35,149

 
$
278

 
$
(6
)
 
$
35,421

 
 
October 1, 2011
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
166,931

 
$
131

 
$
(1
)
 
$
167,061

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Certificates of deposit
$
6,500

 
$
10

 
$
—

 
$
6,510

International government obligations
1,101

 
1

 
(1
)
 
1,101

Corporate notes and obligations
45,282

 
275

 
(26
)
 
45,531

Total short-term investments
$
52,883

 
$
286

 
$
(27
)
 
$
53,142

 
The amortized cost and estimated fair value of available-for-sale investments in debt securities as of December 31, 2011 and October 1, 2011 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):
 
 
December 31, 2011
 
October 1, 2011
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Due in less than 1 year
$
33,149

 
$
33,419

 
$
46,383

 
$
46,632

Total investments in available-for-sale debt securities
$
33,149

 
$
33,419

 
$
46,383

 
$
46,632

 
During the three months ended December 31, 2011, we received proceeds totaling $27.5 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million. During the three months ended January 1, 2011, we received proceeds totaling $18.4 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million.
 
At December 31, 2011, gross unrealized losses on our investments with unrealized losses that are not deemed to be other-than-temporarily impaired were $13,000 on corporate notes and obligations of $15.4 million and US treasury and agency obligations of $2.7 million.
 
At December 31, 2011, approximately $142.5 million of our cash, cash equivalents and short-term investments were held outside the U.S. in certain of our foreign operations, the majority of which was denominated in the Euro. In January 2012 we converted $89.8 million of these assets to U.S. dollars and invested those funds in U.S. Treasury securities within a European subsidiary whose functional currency is the U.S. dollar. Accordingly, there will be no future translation expense arising from these U.S. dollar denominated investments.

7.    GOODWILL AND INTANGIBLE ASSETS
 
Goodwill is tested for impairment on an annual basis and between annual tests if events or circumstances indicate that an

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impairment loss may have occurred, and we write down these assets when impaired. We perform our annual impairment tests during the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.
 
We evaluate long-lived assets and amortizable intangible assets whenever events or changes in business circumstances or our planned use of assets indicate that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. Reviews are performed to determine whether the carrying values of assets are impaired based on comparison to the undiscounted expected future cash flows identifiable to such long-lived and amortizable intangible assets. If the comparison indicates that impairment exists, the impaired asset is written down to its fair value.
 
During the three months ended December 31, 2011, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment. We will conduct our annual goodwill testing during the fourth fiscal quarter.
 
The changes in the carrying amount of goodwill by segment for the period from October 1, 2011 to December 31, 2011 are as follows (in thousands):
 
 
Commercial
Lasers and
Components
 
Specialty
Lasers and
Systems
 
Total
Balance as of October 1, 2011
$
6,365

 
$
69,589

 
$
75,954

Translation adjustments and other
(2
)
 
(1,196
)
 
(1,198
)
Balance as of December 31, 2011
$
6,363

 
$
68,393

 
$
74,756

 
Components of our amortizable intangible assets are as follows (in thousands):
 
 
December 31, 2011
 
October 1, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
52,011

 
$
(42,646
)
 
$
9,365

 
$
52,283

 
$
(41,615
)
 
$
10,668

Patents
6,982

 
(6,956
)
 
26

 
7,246

 
(7,220
)
 
26

Customer lists
9,748

 
(5,248
)
 
4,500

 
9,807

 
(5,142
)
 
4,665

Trade name
3,483

 
(2,539
)
 
944

 
3,566

 
(2,504
)
 
1,062

Non-compete agreement
831

 
(764
)
 
67

 
837

 
(784
)
 
53

Production know-how
910

 
(627
)
 
283

 
910

 
(621
)
 
289

In-process research & development
1,220

 
—

 
1,220

 
1,217

 
—

 
1,217

Total
$
75,185

 
$
(58,780
)
 
$
16,405

 
$
75,866

 
$
(57,886
)
 
$
17,980

 
Amortization expense for intangible assets for the three months ended December 31, 2011 and January 1, 2011 was $1.6 million and $2.1 million, respectively, which includes $1.2 million and $1.4 million, respectively, for amortization of existing technology and production know-how.

At December 31, 2011, estimated amortization expense for the remainder of fiscal 2012, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):

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Estimated
Amortization
Expense
2012 (remainder)
$
4,710

2013
4,857

2014
3,373

2015
2,044

2016
1,257

2017
154

Thereafter
10

Total
$
16,405


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
 
December 31,
2011
 
October 1,
2011
Purchased parts and assemblies
$
41,844

 
$
44,824

Work-in-process
54,582

 
52,457

Finished goods
51,621

 
55,104

Total inventories
$
148,047

 
$
152,385

 
Prepaid expenses and other assets consist of the following (in thousands):
 
December 31,
2011
 
October 1,
2011
Prepaid and refundable income taxes
$
9,517

 
$
9,193

Prepaid expenses and other
42,797

 
35,771

Total prepaid expenses and other assets
$
52,314

 
$
44,964

 
Other assets consist of the following (in thousands):
 
December 31,
2011
 
October 1,
2011
Assets related to deferred compensation arrangements
$
23,133

 
$
22,737

Deferred tax assets
36,136

 
37,156

Other assets
4,381

 
4,289

Total other assets
$
63,650

 
$
64,182

 
Other current liabilities consist of the following (in thousands):
 
December 31,
2011
 
October 1,
2011
Accrued payroll and benefits
$
26,703

 
$
39,639

Deferred income
15,318

 
14,893

Reserve for warranty
16,035

 
16,704

Accrued expenses and other
13,590

 
12,473

Other taxes payable
18,343

 
11,067

Accrued restructuring charges
615

 
634

Customer deposits
3,969

 
3,210

Total other current liabilities
$
94,573

 
$
98,620

 

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During the second quarter of fiscal 2009, we announced our plans to close our facilities in Tampere, Finland and St. Louis, Missouri. The closure of our St. Louis site was completed in the fourth quarter of fiscal 2009.  The closure of our Finland site was completed in the third quarter of fiscal 2011. These closures resulted in charges primarily for employee termination and other exit related costs associated with a plan approved by management.
 
There were no additions to restructuring in the first three months of fiscal 2012. Restructuring charges for the first three months of fiscal 2011 are recorded in cost of sales, research and development and selling, general and administrative expenses in our condensed consolidated statements of operations.

The following table presents our current liability as accrued on our balance sheet for restructuring charges.  The table sets forth an analysis of the components of the restructuring charges and payments and other deductions made against the accrual for the first three months of fiscal 2012 and 2011 (in thousands):
 
 
Severance
Related
 
Facilities-
related
Charges
 
Other
Restructuring
Costs
 
Total
Balance at October 2, 2010
$
912

 
$
17

 
$
1,303

 
$
2,232

Provisions
218

 
—

 
87

 
305

Payments and other
(228
)
 
(17
)
 
(491
)
 
(736
)
Balance at January 1, 2011
$
902

 
$
—

 
$
899

 
$
1,801

 
 
 
 
 
 
 
 
Balance at October 1, 2011
$
—

 
$
—

 
$
634

 
$
634

Payments and other
—

 
—

 
(19
)
 
(19
)
Balance at December 31, 2011
$
—

 
$
—

 
$
615

 
$
615


We provide warranties on certain of our product sales and reserves for estimated warranty costs are recorded during the period of sale. The determination of such reserves requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. The weighted average warranty period covered is approximately 15 months. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to cost of sales may be required in future periods.
 
Components of the reserve for warranty costs during the first three months of fiscal 2012 and 2011 were as follows (in thousands):
 
Three Months Ended
 
December 31,
2011
 
January 1,
2011
Beginning balance
$
16,704

 
$
13,499

Additions related to current period sales
6,374

 
5,876

Warranty costs incurred in the current period
(7,249
)
 
(5,297
)
Adjustments to accruals, including foreign exchange
206

 
(178
)
Ending balance
$
16,035

 
$
13,900

 
Other long-term liabilities consist of the following (in thousands):

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December 31,
2011
 
October 1,
2011
Long-term taxes payable
$
28,195

 
$
27,775

Deferred compensation
23,274

 
22,685

Deferred tax liabilities
1,953

 
2,194

Deferred income
2,483

 
2,636

Asset retirement obligations
1,888

 
1,878

Other long-term liabilities
5,772

 
5,673

Total other long-term liabilities
$
63,565

 
$
62,841

 
9.     SHORT-TERM BORROWINGS
 
We have several lines of credit which allow us to borrow in the applicable local currency. We have a total of $20.2 million of foreign lines of credit as of December 31, 2011.  At December 31, 2011, we had used $2.8 million of these available foreign lines of credit. These credit facilities were used in Europe and Japan during the first fiscal quarter of 2012.  In addition, our domestic line of credit consists of a $40.0 million unsecured revolving credit account with Union Bank of California. The agreement will expire on March 31, 2012 and is subject to covenants related to financial ratios and tangible net worth with which we are currently in compliance.  No amounts have been drawn upon our domestic line of credit as of December 31, 2011.


10.  STOCK-BASED COMPENSATION
 
Fair Value of Stock Compensation
 
We recognize compensation expense for all share based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis over the respective requisite service period of the awards.
 
Determining Fair Value
 
The fair values of shares purchased under the Employee Stock Purchase Plan (“ESPP”) for the three months ended December 31, 2011 and January 1, 2011, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
Three Months Ended
 
 
 
December 31,
2011
 
January 1,
2011
 
Expected life in years
 
0.5

 
0.5

 
Expected volatility
 
49.3
%
 
30.6
%
 
Risk-free interest rate
 
0.1
%
 
0.2
%
 
Expected dividends
 
—

 
—

 
Weighted average fair value per share
 
$
14.93

 
$
9.78

 
___________________________________________________
(1)
There were no options granted during the three months ended December 31, 2011 and January 1, 2011.
 
Restricted stock awards and restricted stock units are independent of option grants and are typically subject to vesting restrictions—either time-based or performance-based conditions for vesting. Until restricted stock vests, shares (including those issuable upon vesting of the applicable restricted stock unit) are subject to forfeiture if employment terminates prior to the release of restrictions and cannot be transferred.
•
The service based restricted stock awards generally vest three years from the date of grant.
•
The service based restricted stock unit awards are generally subject to annual vesting over three years from the date of grant.

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•
The market-based performance restricted stock unit award grants are generally either subject to annual vesting over three years from the date of grant or subject to a single vest measurement three years from the date of grant, depending upon achievement of performance measurements ("Performance RSUs") based on the performance of the Company's Total Shareholder Returns (as defined) compared with the performance of the Russell 2000 Index.
We granted market-based performance restricted stock units to officers and certain employees. The performance stock unit agreements provide for the award of performance stock units with each unit representing the right to receive one share of Coherent, Inc. common stock to be issued after the applicable award period. The final number of units awarded for this grant will be determined as of the vesting dates, based upon our total shareholder return over the performance period compared to the Russell 2000 Index and could range from a minimum of no units to a maximum of twice the initial award. The weighted average fair value for these performance units was $71.59 and was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
 
Risk-free interest rate
0.39
%
Volatility
41.8
%
 
We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period, with no adjustment in future periods based upon the actual shareholder return over the performance period.
 
Stock-Based Compensation Expense
 
The following table shows total stock-based compensation expense and related tax benefits included in the Condensed Consolidated Statements of Operations for the three months ended December 31, 2011 and January 1, 2011 (in thousands):
 
Three Months Ended
 
 
December 31, 2011
 
January 1, 2011
 
Cost of sales
$
369

 
$
244

 
Research and development
393

 
337

 
Selling, general and administrative
3,260

 
2,342

 
Income tax benefit
(1,328
)
 
(675
)
 
 
$
2,694

 
$
2,248

 

During the three months ended December 31, 2011, $0.5 million was capitalized into inventory for all stock plans, $0.4 million was amortized to cost of sales and $0.5 million remained in inventory at December 31, 2011. During the three months ended January 1, 2011, $0.4 million was capitalized into inventory for all stock plans, $0.2 million was amortized to cost of sales and $0.4 million remained in inventory at January 1, 2011.  Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.
 
At December 31, 2011, the total compensation cost related to unvested stock-based awards granted to employees under the Company’s stock plans but not yet recognized was approximately $24.6 million, net of estimated forfeitures of $2.7 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.6 years and will be adjusted for subsequent changes in estimated forfeitures.

At December 31, 2011, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.7 million, which will be recognized over the offering period.
 
The cash flows resulting from excess tax benefits (tax benefits related to the excess of tax deduction resulting from an employee’s exercises of stock options over the stock-based compensation cost recognized for those options) are classified as financing cash flows. During the first three months of fiscal 2012 and fiscal 2011, we recorded $1.7 million and $1.7 million, respectively, of excess tax benefits as cash flows from financing activities.
 
Stock Options & Awards Activity
 
The following is a summary of option activity for our Stock Plans (in thousands, except per share amounts and weighted average remaining contractual term in years):

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Number of
Shares
 
Weighted
Average
Exercise Price
Per Share
 
Weighted
Average
Remaining
Contractual
Term in Years
 
Aggregate
Intrinsic Value
Outstanding at October 1, 2011
917

 
$
27.80

 
 

 
 

Granted
—

 
—

 
 

 
 

Exercised
(66
)
 
26.27

 
 

 
 

Forfeitures
—

 
—

 
 

 
 

Expirations
—

 
—

 
 

 
 

Outstanding at December 31, 2011
851

 
$
27.91

 
4.0

 
$
20,742

Vested and expected to vest at December 31, 2011
845

 
$
27.87

 
4.0

 
$
20,626

Exercisable at December 31, 2011
662

 
$
27.67

 
3.5

 
$
16,291

 
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and the quoted price of our common stock at the end of the reporting period.  There were approximately 0.9 million outstanding options that were in-the-money as of December 31, 2011.  The aggregate intrinsic value of options exercised under the Company’s stock plans for the three months ended December 31, 2011 and January 1, 2011 were $1.6 million and $6.6 million, respectively, determined as of the date of option exercise.
 
The following table summarizes the activity of our time based and market- performance based restricted stock units for the first three months of fiscal 2012 (in thousands, except per share amounts):

 
Time Based Restricted Stock Units
 
Market-Based Performance Restricted Stock Units
 
Number of
Shares(1)
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares(2)
 
Weighted
Average
Grant Date
Fair Value
Nonvested stock at October 1, 2011
404

 
$
34.71

 
101

 
$
49.77

Granted
224

 
53.46

 
95

 
63.85

Vested
(172
)
 
30.93

 
(44
)
 
53.18

Forfeited
—

 
—

 
—

 
—

Nonvested stock at December 31, 2011
456

 
$
45.37

 
152

 
$
57.55


__________________________________________
(1)Service-based restricted stock vested during each fiscal year.
(2)Performance-based awards and units included at 100% of target goal; under the terms of the awards, the recipient may earn between 0% and 200% of the award.



11.      COMMITMENTS AND CONTINGENCIES
 
We are subject to legal claims and litigation arising in the ordinary course of business, such as product liability, employment or intellectual property claims. The outcome of any such matters is currently not determinable. Although we do not expect that such legal claims and litigation will ultimately have a material adverse effect on our consolidated financial position or results of operations, an adverse result in one or more matters could negatively affect our results in the period in which they occur.

 
12.       ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The components of comprehensive income (loss), net of income taxes, are as follows (in thousands):

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Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
 
 
 
 
 
Net income
$
17,051

 
$
19,113

 
Other comprehensive income (loss):
 
 
 
 
Translation adjustment
(10,321
)
 
(11,426
)
 
Changes in unrealized gains on available-for-sale securities, net of taxes
16

 
(1
)
 
Other comprehensive income (loss), net of tax
(10,305
)
 
(11,427
)
 
Comprehensive income (loss)
$
6,746

 
$
7,686

 
 
Accumulated other comprehensive income (net of tax) at December 31, 2011 is comprised of accumulated translation adjustments of $40.9 million. Accumulated other comprehensive income (net of tax) at October 1, 2011 is comprised of accumulated translation adjustments of $51.2 million.
 

13.  EARNINGS PER SHARE
 
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
 
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data): 
 
Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
Weighted average shares outstanding —basic
23,462

 
24,688

 
Dilutive effect of employee stock awards
499

 
580

 
Weighted average shares outstanding—diluted
23,961

 
25,268

 
 
 
 
 
 
Net income
$
17,051

 
$
19,113

 
 
 
 
 
 
Net income per basic share
$
0.73

 
$
0.77

 
Net income per diluted share
$
0.71

 
$
0.76

 
 
 
A total of 207,517 and 52,192 potentially dilutive securities have been excluded from the dilutive share calculation for the three months ended December 31, 2011 and January 1, 2011, respectively, as their effect was anti-dilutive.
 
 
14.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 

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Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
Foreign exchange gain
$
313

 
$
6

 
Gain (loss) on deferred compensation investments, net
(41
)
 
1,554

 
Interest and dividend income
202

 
183

 
Interest expense
(2
)
 
(15
)
 
Other—net
46

 
26

 
Other income (expense), net
$
518

 
$
1,754

 


15.  STOCK REPURCHASES
 
On August 25, 2011, we announced that the Board of Directors had authorized the repurchase of up to $50.0 million of our common stock.  The program is authorized for 12 months from the date of authorization. At October 1, 2011, $25.0 million of shares remained authorized for repurchase under this stock repurchase program.

During the quarter ended December 31, 2011, we repurchased and retired 450,500 shares of outstanding common stock at an average price of $45.84 per share for a total of $20.7 million, excluding expenses. Such repurchases were accounted for as a reduction in additional paid in capital.

At December 31, 2011, $4.3 million remains authorized for repurchase under our current stock repurchase program. The timing and size of any purchases will be subject to, among other things, market conditions.


16.  INCOME TAXES
 
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discrete to the period. Our estimated effective tax rate for the three months ended December 31, 2011 was 34.0%. Our effective tax rate for the three months ended December 31, 2011 was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of foreign tax credits, the benefit of federal and California research and development tax credits and the benefit of a domestic production activities deduction. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, state income taxes, limitations on the utilization of certain foreign losses, stock compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).
 
Determining the consolidated provision for income taxes, income tax liabilities and deferred tax assets and liabilities involves judgment. We calculate and provide for income taxes in each of the tax jurisdictions in which we operate, which involves estimating current tax exposures as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.
 
As of December 31, 2011, the total amount of gross unrecognized tax benefits was $28.8 million of which $19.8 million, if recognized, would affect our effective tax rate. Our total gross unrecognized tax benefits, net of certain deferred tax assets, were classified as other long-term liabilities in the condensed consolidated balance sheets.
 
Our policy is to include interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 31, 2011, the total amount of gross interest and penalties accrued was $3.5 million, which is classified as other long-term liabilities in the condensed consolidated balance sheets.
 
We are subject to taxation and file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2005 are closed. In our major state jurisdiction and our major foreign jurisdiction, the years subsequent to 2000 and 2005, respectively, currently remain open and could be subject to examination by the taxing authorities. In December 2011 and January 2012, our three German subsidiaries received notices of tax audits for the fiscal years 2006 through 2010. These audits have either commenced or are expected to begin by March 2012.

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Management believes that it has adequately provided for any adjustments that may result from tax examinations. The Company regularly engages in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign and state tax matters may be concluded in the next 12 months and we anticipate a lapse in certain statute of limitations which could result in a release of interest expense under ASC 740 "Income Taxes." Specific positions that may be resolved include issues involving research and development credits, transfer pricing and various other matters. The Company estimates that the net unrecognized tax benefits and related interest at December 31, 2011 could be reduced by approximately $1.0 million to $3.0 million in the next 12 months.

Deferred Income Taxes
 
As of December 31, 2011, our condensed consolidated balance sheet included net deferred tax assets, before valuation allowance, of approximately $63.3 million, which consists of tax credits carryovers, accruals and reserves, competent authority offset to transfer pricing tax reserves, employee stock-based compensation expenses, and certain other liabilities. Management periodically evaluates the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is solely dependent on our ability to generate sufficient future taxable income in the applicable jurisdictions during periods prior to the expiration of tax statutes to fully utilize these assets.  After evaluating all available evidence, we have determined that it is “more likely than not” that a portion of the deferred tax assets would not be realized and we have a total valuation allowance of $8.5 million as of December 31, 2011.  We intend to maintain the valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance.


17.  SEGMENT INFORMATION
 
We are organized into two reportable operating segments: Commercial Lasers and Components (“CLC”) and Specialty Lasers and Systems (“SLS”). This segmentation reflects the go-to-market strategies for various products and markets.  While both segments work to deliver cost-effective solutions, CLC focuses on higher volume products that are offered in set configurations. The product architectures are designed for easy exchange at the point of use such that product service and repairs are generally based upon advanced replacement and depot (i.e., factory) repair. CLC’s primary markets include OEM components and instrumentation and materials processing. SLS develops and manufactures configurable, advanced-performance products largely serving the microelectronics and scientific research markets. The size and complexity of many of the SLS products generally require service to be performed at the customer site by factory-trained field service engineers.
 
We have identified CLC and SLS as operating segments for which discrete financial information is available. Both units have dedicated engineering, manufacturing, product business management and product line management functions. A small portion of our outside revenue is attributable to projects and recently developed products for which a segment has not yet been determined. The associated direct and indirect costs are presented in the category of Corporate and other, along with other corporate costs as described below.
 
Our Chief Executive Officer has been identified as the chief operating decision maker (CODM) as he assesses the performance of the segments and decides how to allocate resources to the segments. Income (loss) from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. As assets are not a measure used to assess the performance of the company by the CODM, asset information is not tracked or compiled by segment and is not available to be reported in our disclosures. Income (loss) from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain research and development, management, finance, legal and human resources) and are included in the results below under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
 
The following table provides net sales and income (loss) from operations for our operating segments (in thousands):
 

21
Table of Contents

 
Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
Net sales:
 
 
 
 
Commercial Lasers and Components
$
55,150

 
$
61,358

 
Specialty Laser Systems
135,617

 
121,753

 
Corporate and other
—

 
—

 
Total net sales
$
190,767

 
$
183,111

 
 
 
 
 
 
Income (loss) from operations:
 
 
 
 
Commercial Lasers and Components
$
4,020

 
$
8,325

 
Specialty Laser Systems
31,030

 
28,861

 
Corporate and other
(9,737
)
 
(11,495
)
 
Total income from operations
$
25,313

 
$
25,691

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
COMPANY OVERVIEW
 
BUSINESS BACKGROUND
 
We are one of the world’s leading suppliers of photonics-based solutions in a broad range of commercial and scientific research applications. We design, manufacture, service and market lasers and related accessories for a diverse group of customers. Since
inception in 1966, we have grown through internal expansion and through strategic acquisitions of complementary businesses, technologies, intellectual property, manufacturing processes and product offerings.
 
We are organized into two operating segments: Commercial Lasers and Components (“CLC”) and Specialty Lasers and Systems (“SLS”). This segmentation reflects the go-to-market strategies for various products and markets. While both segments deliver cost-effective photonics solutions, CLC focuses on higher volume products that are offered in set configurations. The product architectures are designed for easy exchange at the point of use such that substantially all product service and repairs are based upon advanced replacement and depot (i.e., factory) repair. CLC’s primary markets include materials processing and original equipment manufacturer (“OEM”) components and instrumentation. SLS develops and manufactures configurable, advanced performance products largely serving the microelectronics, OEM components and instrumentation and scientific research and government programs markets. The size and complexity of many of the SLS products require service to be performed at the customer site by factory trained field service engineers.
 
Income (loss) from operations is the measure of profit and loss that our chief operating decision maker (“CODM”) uses to assess performance and make decisions. Income (loss) from operations represents the sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses, which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain advanced research and development, management, finance, legal and human resources) and are included in Corporate and other. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
 
MARKET APPLICATIONS
 
Our products address a broad range of applications that we group into the following markets: Microelectronics, Scientific Research and Government Programs, OEM Components and Instrumentation and Materials Processing.
 
OUR STRATEGY
We strive to develop innovative and proprietary products and solutions that meet the needs of our customers and that are based on our core expertise in lasers and optical technologies. In pursuit of our strategy, we intend to:
•
Leverage our technology portfolio and application engineering to lead the proliferation of photonics into

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broader markets—We will continue to identify opportunities in which our technology portfolio and application engineering can be used to offer innovative solutions and gain access to new markets. We plan to utilize our expertise to expand into new markets, such as laser-based processing development tools for solar manufacturing and high power materials processing solutions.
•
Optimize our leadership position in existing markets—There are a number of markets where we have historically been at the forefront of technological development and product deployment and from which we have derived a substantial portion of our revenues. We plan to optimize our financial returns from these markets.
•
Maintain and develop additional strong collaborative customer and industry relationships—We believe that the Coherent brand name and reputation for product quality, technical performance and customer satisfaction will help us to further develop our loyal customer base. We plan to maintain our current customer relationships and develop new ones with customers who are industry leaders and work together with these customers to design and develop innovative product systems and solutions as they develop new technologies.
•
Develop and acquire new technologies and market share—We will continue to enhance our market position through our existing technologies and develop new technologies through our internal research and development efforts, as well as through the acquisition of additional complementary technologies, intellectual property, manufacturing processes and product offerings.
•
Streamline our manufacturing structure and improve our cost structure—We will focus on optimizing the mix of products that we manufacture internally and externally. We will utilize vertical integration where our internal manufacturing process is considered proprietary and seek to leverage external sources when the capabilities and cost structure are well developed and on a path towards commoditization.
•
Focus on long-term improvement of adjusted EBITDA, in dollars and as a percentage of net sales—We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock compensation expenses, major restructuring costs and certain other non-operating income and expense items. Key initiatives to reach our goals for EBITDA improvements include utilization of our Asian manufacturing locations, rationalizing our supply chain and continued leveraging of our infrastructure.

 
APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, accounting for long-lived assets (including goodwill and intangible assets), inventory valuation, warranty reserves, stock-based compensation and accounting for income taxes.
 
Revenue Recognition
 
We recognize revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists, the product has been delivered or the service has been rendered, the price is fixed or determinable and collection is probable. 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 any price protection or return rights.
 
The vast majority of our sales are made to original equipment manufacturers (OEMs), distributors, resellers and end-users in the non-scientific market. Sales made to these customers do not require installation of the products by us and are not subject to other post-delivery obligations, except in occasional instances where we have agreed to perform installation or provide training. In those instances, we defer revenue related to installation services or training until these services have been rendered. We allocate revenue from multiple element arrangements to the various elements based upon fair values or a selling price hierarchy, for arrangements entered into subsequent to October 2, 2010, as discussed below.
 

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Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. Failure to obtain anticipated orders due to delays or cancellations of orders could have a material adverse effect on our revenue. In addition, pressures from customers to reduce our prices or to modify our existing sales terms may have a material adverse effect on our revenue in future periods.
 
Our sales to distributors, resellers and end-user customers typically do not have customer acceptance provisions and only certain of our sales to OEM customers have customer acceptance provisions. Customer acceptance is generally limited to performance under our published product specifications. For the few product sales that have customer acceptance provisions because of higher than published specifications, (1) the products are tested and accepted by the customer at our site or by the customer’s acceptance of the results of our testing program prior to shipment to the customer, or (2) the revenue is deferred until customer acceptance occurs.
 
Sales to end-users in the scientific market typically require installation and, thus, involve post-delivery obligations; however our post-delivery installation obligations are not essential to the functionality of our products. We defer revenue related to installation services until completion of these services.
 
For most products, training is not provided; therefore, no post-delivery training obligation exists. However, when training is provided to our customers, it is typically priced separately and recognized as revenue after these services have been provided.
 
In October 2009, the FASB issued a new accounting standard for multiple deliverable revenue arrangements. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. The FASB also issued a new accounting standard for certain revenue arrangements that include software elements. This new standard excludes software that is contained on a tangible product from the scope of software revenue guidance if the software is essential to the tangible product’s functionality. We prospectively adopted both these standards in the first quarter of fiscal 2011. The impact of adopting these standards was not material to net sales or our condensed consolidated financial statements for the three months ended January 1, 2011.

Under these new standards, when a sales arrangement contains multiple elements, such as products and/or services, we allocate revenue to each element based on a selling price hierarchy. Using the selling price hierarchy, we determine the selling price of each deliverable using vendor specific objective evidence (“VSOE”), if it exists, and otherwise third-party evidence (“TPE”). If neither VSOE nor TPE of selling price exists, we use estimated selling price (“ESP”). We generally expect that we will not be able to establish TPE due to the nature of the markets in which we compete, and, as such, we typically will determine selling price using VSOE or if not available, ESP.
 
Our basis for establishing VSOE of a deliverable’s selling price consists of standalone sales transactions when the same or similar product or service is sold separately. However, when services are never sold separately, such as product installation services, VSOE is based on the product’s estimated installation hours based on historical experience multiplied by the standard service billing rate. In determining VSOE, we require that a substantial majority of the selling price for a product or service fall within a reasonably narrow price range, as defined by us. We also consider the geographies in which the products or services are sold, major product and service groups, and other environmental variables in determining VSOE. Absent the existence of VSOE and TPE, our determination of a deliverable’s ESP involves evaluating several factors based on the specific facts and circumstances of these arrangements, which include pricing strategy and policies driven by geographies, market conditions, competitive landscape, correlation between proportionate selling price and list price established by management having the relevant authority, and other environmental variables in which the deliverable is sold.
 
For multiple element arrangements which include extended maintenance contracts, we allocate and defer the amount of consideration equal to the separately stated price and recognize revenue on a straight-line basis over the contract period.
 
Long-Lived Assets and Goodwill
 
We evaluate long-lived assets and amortizable intangible assets whenever events or changes in business circumstances or our planned use of assets indicate that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. Reviews are performed to determine whether the carrying values of assets are impaired based on comparison to the undiscounted expected future cash flows identifiable to such long-lived and amortizable intangible assets. If the comparison indicates that impairment exists, the impaired asset is written down to its fair value.
 
We have determined that our reporting units are the same as our operating segments as each constitutes a business for which discrete financial information is available and for which segment management regularly reviews the operating results.  We

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make this determination in a manner consistent with how the operating segments are managed.  Based on this analysis, we have identified two reporting units which are our reportable segments: CLC and SLS.
 
Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired (see Note 7 in the Notes to Condensed Consolidated Financial Statements). We perform our annual impairment tests during the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.
 
During the three months ended December 31, 2011, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment.
 
At December 31, 2011, we had $74.8 million of goodwill, $16.4 million of purchased intangible assets and $106.0 million of property and equipment on our condensed consolidated balance sheet.
 
It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In addition, if the price of our common stock were to significantly decrease combined with any other adverse change in market conditions, thus indicating that the underlying fair value of our reporting units or other long-lived assets may have decreased, we may be required to assess the recoverability of such assets in the period such circumstances are identified. In that event, impairment charges or shortened useful lives of certain long-lived assets may be required.
 
Inventory Valuation
 
We record our inventory at the lower of cost (computed on a first-in, first-out basis) or market. We write-down our inventory to its estimated market value based on assumptions about future demand and market conditions. Inventory write-downs are generally recorded within guidelines set by management when the inventory for a device exceeds 12 months of its demand and when individual parts have been in inventory for greater than 12 months. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required which could materially affect our future results of operations. Due to rapidly changing forecasts and orders, additional write-downs for excess or obsolete inventory, while not currently expected, could be required in the future. In the event that alternative future uses of fully written down inventories are identified, we may experience better than normal profit margins when such inventory is sold. Differences between actual results and previous estimates of excess and obsolete inventory could materially affect our future results of operations. We write-down our demonstration inventory by amortizing the cost of demonstration inventory over a twenty month period starting from the fourth month after such inventory is placed in service.
 
Warranty Reserves
 
We provide warranties on certain of our product sales and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. The weighted average warranty period covered is approximately 15 months. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to cost of sales may be required in future periods.
 
Stock-Based Compensation
 
We account for stock-based compensation using fair value. We estimate the fair value of stock options granted using the Black-Scholes Merton model and estimate the fair value of market-based performance restricted stock units granted using a Monte Carlo simulation model. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. We amortize the fair value of stock options on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. We value service-based restricted stock units using the intrinsic value method and amortize the value on a straight-line basis over the restriction period. We value market-based performance restricted stock units using a Monte Carlo simulation model and amortize the value over the performance period, with no adjustment in future periods, based upon the actual shareholder return over the performance period. See Note 10 “Stock-Based Compensation” for a description of our stock-based employee compensation plans and the assumptions we use to calculate the fair value of stock-based employee compensation.
 
Income Taxes
 

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As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets.
 
We record a valuation allowance to reduce our deferred tax assets to an amount that more likely than not will be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the allowance for the deferred tax assets would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance for the deferred tax assets would be charged to income in the period such determination was made.
 
We evaluate our need for reserves for our uncertain tax positions using a two-step approach. The first step, recognition, occurs when we conclude (based solely on the technical aspects of the matter) that a tax position is more likely than not to be sustained upon examination by a taxing authority. The second step, measurement, is only considered after step one has been satisfied and measures any tax benefit at the largest amount that is deemed more likely than not to be realized upon ultimate settlement of the uncertainty. These determinations involve significant judgment by management. Tax positions that fail to qualify for initial recognition are recognized in the first subsequent interim period that they meet the more likely than not standard or when they are resolved through negotiation or litigation with factual interpretation, judgment and certainty. Tax laws and regulations themselves are complex and are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court filings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially to reverse previously recorded tax liabilities.
 


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KEY PERFORMANCE INDICATORS
 
The following is a summary of some of the quantitative performance indicators (as defined below) that may be used to assess our results of operations and financial condition:
 
Three Months Ended
 
 
 
 
 
December 31, 2011
 
January 1, 2011
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
201,848

 
$
234,424

 
$
(32,576
)
 
(13.9
)%
Book-to-bill ratio
1.06

 
1.28

 
(0.22
)
 
(17.2
)%
Net sales—Commercial Lasers and Components
$
55,150

 
$
61,358

 
$
(6,208
)
 
(10.1
)%
Net sales—Specialty Lasers and Systems
$
135,617

 
$
121,753

 
$
13,864

 
11.4
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
39.0
%
 
43.7
%
 
(4.7
)%
 
(10.8
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
43.8
%
 
46.0
%
 
(2.2
)%
 
(4.8
)%
Research and development as a percentage of net sales
9.8
%
 
10.1
%
 
(0.3
)%
 
(3.0
)%
Income before income taxes
$
25,831

 
$
27,445

 
$
(1,614
)
 
(5.9
)%
Net cash provided by operating activities
$
16,135

 
$
29,969

 
$
(13,834
)
 
(46.2
)%
Days sales outstanding in receivables
61.6

 
53.1

 
8.5

 
16.0
 %
First quarter inventory turns
3.0

 
3.3

 
(0.3
)
 
(9.1
)%
Capital spending as a percentage of net sales
4.3
%
 
2.8
%
 
1.5
 %
 
53.6
 %
 
Definitions and analysis of these performance indicators are as follows:
 
Bookings and Book-to-Bill Ratio
 
Bookings represent orders expected to be shipped within 12 months and services to be provided pursuant to service contracts. While we generally have not experienced a significant rate of cancellation, bookings are generally cancelable by our customers without substantial penalty and, therefore, we cannot assure all bookings will be converted to net sales.
 
The book-to-bill ratio is calculated as quarterly bookings divided by quarterly net sales.  This is an indication of the strength of our business but can sometimes be impacted by a single large order. A ratio of greater than 1.0 indicates that demand for our products is greater than what we supply in the quarter.
 
Although bookings decreased 13.9% in the first quarter of fiscal 2012 compared to the same quarter one year ago, the book-to-bill ratio was 1.06. Decreases in all four markets included a significant decrease in the microelectronics market. Compared to the fourth quarter of fiscal 2011, bookings increased 3.3% with a significant increase in the microelectronics market offset by decreases in the OEM components and instrumentation, materials processing and scientific and government programs markets.
 
Microelectronics
 
Microelectronics bookings decreased 23% compared to the same quarter one year ago but increased 34% from bookings in the fourth quarter of fiscal 2011. The book-to-bill for the first quarter of fiscal 2012 was 1.08.
 
Flat panel display orders in the first quarter of fiscal 2012 increased significantly from the fourth quarter of fiscal 2011, including system orders from new customers as well as increases in service orders. We expect this market to be strong in the remainder of fiscal 2012 as the primary market driver, the proliferation of smartphones and tablets, remains intact. Our facility expansion in Göttingen and new service center in Korea will start shipping product in the third quarter of fiscal 2012.

In the first quarter of fiscal 2012, the semiconductor capital equipment market was strong, with increased orders for new systems and service suggesting improvement in utilization rates. We expect this market to improve further during the remainder of fiscal 2012. We continue to develop next generation technologies to support higher throughput and higher accuracy.

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In spite of strong demand for smartphones and tablets, the advanced packaging (API) market is being impacted by tight credit in China where it is difficult for customers to establish letters of credit for new equipment purchases. We expect that China's credit policies will improve in the second quarter of fiscal 2012. We anticipate that market growth will come from increased adoption of smartphones and tablets as well as from the 3D packaging market.
 
Materials Processing
 
Materials processing orders decreased 10% compared to the same quarter one year ago and decreased 18% from the fourth quarter of fiscal 2011. The book-to-bill for the first quarter of fiscal 2012 was 0.98. During the first quarter of fiscal 2012, materials processing orders were negatively impacted by the tight credit policies in China and sovereign debt issues in Europe.

Marking and engraving for commodity and consumer product applications remains our largest submarket, with modest growth anticipated in fiscal 2012. We introduced several new products at the Fabtech tradeshow in November 2011 to diversify our laser systems and manufacturing tools to address more applications. In addition, our upcoming kilowatt class fiber laser will address metal cutting and we expect first revenue shipments in fiscal 2012.

OEM Components and Instrumentation
 
OEM Components and Instrumentation orders decreased 2% compared to the same quarter one year ago but decreased 26% from the fourth quarter of fiscal 2011. The book-to-bill for the first quarter of fiscal 2012 was 0.99.
 
The decrease compared to the fourth quarter of fiscal 2011 is primarily due to timing in the medical OEM market as the fourth quarter of fiscal 2011included several large orders to address market growth in Asia. While these orders were not repeated in the first quarter of fiscal 2012, we expect market growth to remain high, especially due to government investment in China. Markets for eye disease management and home-based aesthetic products remain strong.

We have increased our product offerings for the instrumentation market with new versions of the Sapphire™ optically pumped semiconductor ("OPS") laser and wavelength extensions of our OBIS™ platform, which can be used in a wide array of applications including super resolution microscopy and cytometry.

Scientific and Government Programs
 
Scientific and government programs orders decreased slightly compared to the same quarter one year ago and decreased 3% from the fourth quarter of fiscal 2011. The book-to-bill for the first quarter of fiscal 2012 was 1.12.
 
Scientific orders remain strong, with orders for multiphoton spectroscopy applications the largest contributor to first quarter fiscal 2012 bookings. Our Chameleon™ product family continues to lead this market due to a combination of power, stability and tunability. First quarter bookings were favorably impacted by significant investment in biological research in China, which is consistent with the country's five-year research plan. In addition, multi photon excitation bookings were also strong in Europe.

Net Sales
 
Net sales include sales of lasers, laser tools, related accessories and service contracts. Net sales for the first fiscal quarter decreased 10.1% in our CLC segment and increased 11.4% in our SLS segment from the same quarter one year ago. For a description of the reasons for changes in net sales refer to the “Results of Operations” section of this quarterly report.
 
Gross Profit as a Percentage of Net Sales
 
Gross profit as a percentage of net sales (“gross profit percentage”) is calculated as gross profit for the period divided by net sales for the period.  Gross profit percentage in the first quarter decreased from 43.7% to 39.0% in our CLC segment and decreased from 46.0% to 43.8% in our SLS segment from the same quarter one year ago. For a description of the reasons for changes in gross profit refer to the “Results of Operations” section of this quarterly report.
 
Research and Development as a Percentage of Net Sales
 
Research and development as a percentage of net sales (“R&D percentage”) is calculated as research and development expense for the period divided by net sales for the period.  Management considers R&D percentage to be an important indicator in

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managing our business as investing in new technologies is a key to future growth.  R&D percentage decreased to 9.8% from 10.1% in our first fiscal quarter compared to the same period one year ago.  For a description of the reasons for changes in R&D spending refer to the “Results of Operations” section of this quarterly report.
 
Net Cash Provided by Operating Activities
 
Net cash provided by operating activities as reflected on our Condensed Consolidated Statements of Cash Flows primarily represents the excess or shortfall of cash collected from billings to our customers and other receipts over cash paid to our vendors for expenses and inventory purchases to run our business.  We believe that cash flows from operations is an important performance indicator because cash generation over the long term is essential to maintaining a healthy business and providing funds to help fuel growth.  For a description of the reasons for changes in Net Cash Provided by Operating Activities refer to the “Liquidity and Capital Resources” section of this quarterly report.
 
Days Sales Outstanding in Receivables
 
We calculate days sales outstanding (“DSO”) in receivables as net receivables at the end of the period divided by net sales during the period and then multiplied by the number of days in the period, using 90 days for quarters.  DSO in receivables indicates how well we are managing our collection of receivables, with lower DSO in receivables resulting in working capital availability.  The more money we have tied up in receivables, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business.  Our DSO in receivables for the first quarter of fiscal 2012 increased 8.5 days from the same quarter one year ago primarily due to a higher mix of receivables and revenue in regions with longer payment terms.
 
Annualized Inventory Turns
 
We calculate annualized inventory turns as the cost of sales during the quarter annualized and divided by net inventories at the end of the period. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. The more money we have tied up in inventory, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our annualized inventory turns for the first quarter of fiscal 2012 decreased by 0.3 turns from the same quarter one year ago primarily due to increased inventory levels to support increasing volumes.
 
Capital Spending as a Percentage of Net Sales
 
Capital spending as a percentage of net sales (“capital spending percentage”) is calculated as capital expenditures for the period divided by net sales for the period.  Capital spending percentage indicates the extent to which we are expanding or improving our operations, including investments in technology.  Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage increased to 4.3% from 2.8% for the first quarter of fiscal 2012 compared to the same period one year ago primarily due to building improvements and purchases of production-related assets to support our expansion in Asia and higher sales volumes.
 
SIGNIFICANT EVENTS
 
On August 25, 2011, the Board of Directors authorized the repurchase of up to $50.0 million of our common stock. The program is authorized for 12 months from the date of authorization. At October 1, 2011, $25.0 million remained authorized for repurchase under this stock repurchase program. During the quarter ended December 31, 2011, we repurchased and retired 450,500 shares of outstanding common stock at an average price of $45.84 per share for a total of $20.7 million, excluding expenses.


RESULTS OF OPERATIONS
 
CONSOLIDATED SUMMARY
 
The following table sets forth, for the periods indicated, the percentage of total net sales represented by the line items reflected in our condensed consolidated statements of operations:
 

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Three Months Ended
 
 
December 31,
2011
 
January 1,
2011
 
Net sales
100.0
%
 
100.0
%
 
Cost of sales
57.9
%
 
55.0
%
 
Gross profit
42.1
%
 
45.0
%
 
Operating expenses:
 
 
 
 
Research and development
9.8
%
 
10.1
%
 
Selling, general and administrative
18.2
%
 
19.7
%
 
Amortization of intangible assets
0.9
%
 
1.2
%
 
Total operating expenses
28.9
%
 
31.0
%
 
Income from operations
13.2
%
 
14.0
%
 
Other income (net)
0.3
%
 
1.0
%
 
Income before income taxes
13.5
%
 
15.0
%
 
Provision for income taxes
4.6
%
 
4.6
%
 
Net income
8.9
%
 
10.4
%
 
 
Net income for the first quarter of fiscal 2012 was $17.1 million ($0.71 per diluted share) including $2.7 million of after-tax stock-related compensation expense. Net income for the first quarter of fiscal 2011 was $19.1 million ($0.76 per diluted share) including $2.2 million of after-tax stock-related compensation expense.
 
NET SALES
 
Market Application
 
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands):
 
Three Months Ended
 
December 31, 2011
 
January 1, 2011
 
Amount
 
Percentage
of total
 net sales
 
Amount
 
Percentage
 of total
 net sales
Consolidated:
 
 
 
 
 
 
 
Microelectronics
$
92,892

 
48.7
%
 
$
84,431

 
46.1
%
OEM components and instrumentation
35,940

 
18.8
%
 
38,350

 
20.9
%
Materials processing
23,379

 
12.3
%
 
22,275

 
12.2
%
Scientific and government programs
38,556

 
20.2
%
 
38,055

 
20.8
%
   Total
$
190,767

 
100.0
%
 
$
183,111

 
100.0
%

Net sales for the first quarter of fiscal 2012 increased by $7.7 million, or 4%, including an increase of $3.2 million due to the impact of foreign currency exchange rates, compared to the first quarter of fiscal 2011.  Sales increases in the microelectronics, materials processing and scientific and government programs markets were partially offset by a decrease in the OEM components and instrumentation market.
 
The increase in the microelectronics market of $8.5 million, or 10%, was due to higher sales in flat panel display applications partially offset by lower shipments for advanced packaging, semiconductor, solar and micro materials processing applications. The decrease in the OEM components and instrumentation market of $2.4 million, or 6%, was due primarily to lower shipments for military, machine vision and bio-instrumentation applications partially offset by higher shipments for medical applications.  Sales in the materials processing market increased $1.1 million, or 5%, primarily due to higher shipments for marking and engraving applications. Sales in the scientific and government programs market increased $0.5 million, or 1%, primarily due to higher demand for advanced research applications used by university and government research groups.

Segments

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We are organized into two reportable operating segments: Commercial Lasers and Components (“CLC”) and Specialty Lasers and Systems (“SLS”). CLC focuses on higher volume products that are offered in set configurations. CLC’s primary markets include OEM components and instrumentation and materials processing. SLS develops and manufacturers configurable, advanced-performance products largely serving the microelectronics and scientific research markets.
 
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands):
 
Three Months Ended
 
December 31, 2011
 
January 1, 2011
 
Amount
 
Percentage
of total
net sales
 
Amount
 
Percentage
of total
net sales
Consolidated:
 
 
 
 
 
 
 
Commercial Lasers and Components (CLC)
$
55,150

 
28.9
%
 
$
61,358

 
33.5
%
Specialty Lasers and Systems (SLS)
135,617

 
71.1
%
 
121,753

 
66.5
%
   Total
$
190,767

 
100.0
%
 
$
183,111

 
100.0
%
 
Net sales for the first quarter of fiscal 2012 increased by $7.7 million, or 4%, compared to the first quarter of fiscal 2011, with increases of $13.9 million, or 11%, in our SLS segment and decreases of $6.2 million, or 10%, in our CLC segment.
 
The increase in our SLS segment sales was primarily due to higher revenue for flat panel display applications partially offset by lower shipments for materials processing, semiconductor, solar and micro materials processing applications. The decrease in our CLC segment sales was primarily due to lower advanced packaging, flat panel display and military application sales partially offset by higher materials processing application sales. 

GROSS PROFIT
 
Consolidated
 
Our gross profit rate decreased to 42.1% in the first quarter of fiscal 2012 from 45.0% in the first quarter of fiscal 2011. The decrease in the gross profit rate was primarily due to unfavorable product margins (1.9%) due to lower volumes in several business units, higher manufacturing expense to expand Excimer tube production in Korea and increased expense related to the flooding in Thailand, higher warranty and installation costs (0.7%) for installations to support the service and flat panel display markets, higher other costs (0.2%) due to higher inventory provisions and higher stock-based compensation expense (0.1%).

Our gross profit rate has been and will continue to be affected by a variety of factors including market mix, pricing on volume orders, manufacturing efficiencies, excess and obsolete inventory write-downs, warranty costs, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, commodity prices and foreign currency fluctuations.
 
Commercial Lasers and Components

The gross profit rate in our CLC segment decreased to 39.0% in the first quarter of fiscal 2012 from 43.7% in the first quarter of fiscal 2011. The 4.7% decrease in the gross profit rate was primarily due to unfavorable product costs (2.2%) primarily due to the impact of lower volumes in a few business units serving primarily the advanced packaging and components markets, higher warranty costs (1.4%) due to a higher installed base from high sales volumes in fiscal 2011 and lower current quarter volumes and higher other costs (1.1%) primarily due to higher inventory provisions.

Specialty Lasers and Systems
 
The gross profit rate in our SLS segment decreased to 43.8% in the first quarter of fiscal 2012 from 46.0% in the first quarter of fiscal 2011. The 2.2% decrease in the gross profit rate was primarily due to unfavorable product costs (1.9%) due to lower volumes in several business units serving primarily non-flat panel display markets, increased investments in Excimer manufacturing capabilities to support the growing flat panel display revenue net of favorable product mix within the microelectronics market and higher installation costs net of lower warranty costs (0.3%) due to higher service costs to support installations of a growing number of laser annealing systems in the flat panel display market.

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OPERATING EXPENSES:
 
 
Three Months Ended
 
December 31, 2011
 
January 1, 2011
 
Amount
 
Percentage of
total net sales
 
Amount
 
Percentage of
total net sales
 
(Dollars in thousands)
Research and development
$
18,779

 
9.8
%
 
$
18,530

 
10.1
%
Selling, general and administrative
34,631

 
18.2
%
 
36,078

 
19.7
%
Amortization of intangible assets
1,636

 
0.9
%
 
2,095

 
1.2
%
Total operating expenses
$
55,046

 
28.9
%
 
$
56,703

 
31.0
%

Research and development
 
Research and development (“R&D”) expenses increased $0.2 million, or 1%, during the first fiscal quarter ended December 31, 2011 compared to the same quarter one year ago.  The increase was primarily due to higher project spending ($0.6 million), the acquisition of Hypertronics in the second quarter of fiscal 2011 ($0.3 million) and higher stock-related compensation expense ($0.1 million) partially offset by lower payroll spending ($0.5 million) due to lower performance-related compensation net of increased headcount, lower charges for increases in deferred compensation plan liabilities ($0.2 million) and higher net reimbursements from customers for development projects ($0.1 million). On a segment basis as compared to the prior year period, CLC spending decreased $0.4 million primarily due to lower project spending and lower payroll spending. SLS research and development spending increased $0.8 million primarily due to higher project spending and the acquisition of Hypertronics in the second quarter of fiscal 2011 partially offset by lower payroll spending and higher net reimbursements from customers for development projects. Corporate and other spending decreased $0.2 million due to lower charges for increases in deferred compensation plan liabilities partially offset by higher stock-related compensation expense.

Selling, general and administrative

Selling, general and administrative (“SG&A”) expenses decreased $1.4 million or 4%, during the first fiscal quarter ended December 31, 2011 compared to the same quarter one year ago.  The decrease was primarily due to $2.2 million lower payroll spending due to lower performance-related compensation spending partially offset by higher headcount and increased salaries, $1.4 million lower charges for increases in deferred compensation plan liabilities with the related earnings for increases in deferred compensation plan assets recorded in other income (expense) and decreased spending on legal and consulting related to acquisitions ($0.7 million) partially offset by $0.9 million higher stock-related compensation expense, the acquisition of Hypertronics in the second quarter of fiscal 2011 ($0.7 million), higher spending on demo amortization and tradeshows ($0.6 million), the impact of foreign currency exchange rates ($0.3 million) and higher other variable net spending ($0.4 million). On a segment basis as compared to the prior year period, CLC spending decreased $0.4 million primarily due to lower payroll spending. SLS segment expenses increased $0.7 million primarily due to the acquisition of Hypertronics, higher spending on demo amortization and tradeshows and the impact of foreign exchange rates partially offset by lower payroll spending.  Spending for Corporate and other decreased $1.7 million primarily due to lower charges for increases in deferred compensation plan liabilities, lower payroll spending and decreased spending on legal and consulting related to acquisitions partially offset by higher stock-related compensation expense.

Amortization of intangible assets
 
Amortization of intangible assets decreased $0.5 million in the three months ended December 31, 2011 compared to the same period last year primarily due to the completion of amortization of intangibles from older acquisitions partially offset by amortization of intangibles from the acquisition of Hypertronics in the second quarter of fiscal 2011.
 
OTHER INCOME (EXPENSE) — NET
 
Other income, net of other expense, decreased $1.2 million during the three months ended December 31, 2011 compared to the same period one year ago. The decrease was primarily due to lower gains, net of expenses, on our deferred compensation plan assets ($1.6 million) partially offset by higher net foreign exchange gains ($0.3 million).
 

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INCOME TAXES
 
The effective tax rate for the first quarter of fiscal 2012 of 34.0% was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of foreign tax credits, the benefit of federal and California research and development tax credits and the benefit of a domestic production activities deduction. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, state income taxes, limitations on the utilization of certain foreign losses, stock compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).
 
The effective tax rate for the first quarter of fiscal 2011 of 30.4%was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of federal research and development tax credits, including additional credits reinstated from fiscal 2010 resulting from the enactment of the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” and the benefit of unrealized gain on life insurance policy investments related to our deferred compensation plans. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, state income taxes, limitations on the deductibility of compensation under IRC Section 162(m) and stock compensation not deductible for tax purposes.

DEFERRED INCOME TAXES

As of December 31, 2011, our condensed consolidated balance sheet included net deferred tax assets, before valuation allowance, of approximately $63.3 million, which consists of tax credit carryovers, accruals and reserves, competent authority offset to transfer pricing tax reserves, employee stock-based compensation expenses, and certain other liabilities. Management periodically evaluates the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is solely dependent on our ability to generate sufficient future taxable income in the applicable jurisdictions during periods prior to the expiration of tax statutes to fully utilize these assets.  After evaluating all available evidence, we have determined that it is “more likely than not” that a portion of the deferred tax assets would not be realized and we have a total valuation allowance of $8.5 million as of December 31, 2011. We intend to maintain the valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance.


LIQUIDITY AND CAPITAL RESOURCES
 
At December 31, 2011, we had assets classified as cash and cash equivalents, as well as time deposits and fixed income securities classified as short-term investments, in an aggregate amount of $203.1 million, compared to $220.2 million at October 1, 2011. At December 31, 2011, approximately $142.5 million of this cash and securities was held outside the U.S. in certain of our foreign operations, the majority of which was denominated in the Euro. In January 2012, we converted $89.8 million of these assets to U.S. dollars and invested those funds in U.S. Treasury securities within a European subsidiary whose functional currency is the U.S. dollar. Accordingly, there will be no future translation expense arising from these U.S. dollar denominated investments. The converted funds were not repatriated to the U.S. and no U.S. tax was triggered on the transfer of these funds to the European subsidiary. We expect to incur additional foreign income taxes of approximately $650,000 related to this distribution. We currently intend to permanently reinvest approximately $135 million of the cash held by our foreign subsidiaries, including the investment in U.S. Treasury securities. If, however, a portion of these funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes. The amount of the taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated. We actively monitor the third-party depository institutions that hold these assets, primarily focusing on the safety of principal and secondarily maximizing yield on these assets. We diversify our cash and cash equivalents and investments among various financial institutions, money market funds and sovereign debt in order to reduce our exposure should any one of these financial institutions or financial instruments fail or encounter difficulties. To date, we have not experienced any material loss or lack of access to our invested cash, cash equivalents or short-term investments. However, we can provide no assurances that access to our invested cash, cash equivalents or short-term investments will not be impacted by adverse conditions in the financial markets.

Sources and Uses of Cash
 
Historically, our primary source of cash has been provided by operations. Other sources of cash in the past three fiscal years include proceeds received from the sale of our stock through our employee stock option and purchase plans. Our historical uses of cash have primarily been for the repurchase of our common stock, capital expenditures and acquisitions of businesses and technologies. Supplemental information pertaining to our historical sources and uses of cash is presented as follows and should

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be read in conjunction with our condensed consolidated statements of cash flows and the notes to condensed consolidated financial statements:
 
 
Three Months Ended
 
December 31,
2011
 
January 1,
2011
 
(in thousands)
Net cash provided by operating activities
$
16,135

 
$
29,969

Sales of shares under employee stock plans
4,568

 
17,331

Repurchase of common stock
(20,665
)
 
—

Capital expenditures
(8,139
)
 
(5,129
)
 
Net cash provided by operating activities decreased by $13.8 million for the first three months of fiscal 2012 compared to the same period one year ago. The decrease in cash provided by operating activities was primarily due to higher tax payments and lower cash flows from accounts payable and other current liabilities, including accrued variable compensation. We believe that our existing cash, cash equivalents and short term investments combined with cash to be provided by operating activities will be adequate to cover our working capital needs and planned capital expenditures for at least the next 12 months to the extent such items are known or are reasonably determinable based on current business and market conditions. However, we may elect to finance certain of our capital expenditure requirements through borrowings under our bank credit facilities or other sources of capital. We continue to follow our strategy to further strengthen our financial position by using available cash flow to fund operations.
 
We intend to continue pursuing acquisition opportunities at valuations we believe are reasonable based upon market conditions as demonstrated by our acquisition of Hypertronics in the second quarter of fiscal 2011. However, we cannot accurately predict the timing, size and success of our acquisition efforts or our associated potential capital commitments. Furthermore, we cannot assure you that we will be able to acquire businesses on terms acceptable to us. We expect to fund future acquisitions through existing cash balances and cash flows from operations. If required, we will look for additional borrowings or consider the issuance of securities. The extent to which we will be willing or able to use our common stock to make acquisitions will depend on its market value at the time and the willingness of potential sellers to accept it as full or partial payment.
 
On August 25, 2011, the Board of Directors authorized the repurchase of up to $50.0 million of our common stock. The program is authorized for 12 months from the date of authorization. At October 1, 2011, $25.0 million of shares remained authorized for repurchase under this stock repurchase program. During the quarter ended December 31, 2011, we repurchased and retired 450,500 shares of outstanding common stock at an average price of $45.84 per share for a total of $20.7 million, excluding expenses.

During fiscal year 2008, we initiated restructuring plans to decrease costs by consolidating facilities and by reducing our workforce. As of December 31, 2011, we had made payments in connection with the restructuring plans in the amount of $27.7 million. We completed payments for substantially all anticipated costs related to the restructuring plans in the third quarter of fiscal 2011.
 
Additional sources of cash available to us were domestic and international currency lines of credit and bank credit facilities totaling $60.2 million as of December 31, 2011, of which $57.4 million was unused and available. These unsecured credit facilities were used in Europe and Japan during the first three months of fiscal 2012. Our domestic line of credit consists of a $40 million unsecured revolving credit account with Union Bank of California, which expires on March 31, 2012 and is subject to covenants related to financial ratios and tangible net worth. No amounts have been drawn upon our domestic line of credit and $2.8 million of the international currency lines has been used as of December 31, 2011.
 
Our ratio of current assets to current liabilities was 3.8:1 at December 31, 2011 compared to 3.6:1 at October 1, 2011. The increase in our ratio from October 1, 2011 to December 31, 2011 is primarily due to a higher proportion of decreases in current liabilities (taxes payable, accounts payable and other current liabilities) than current assets (short-term investments and accounts receivable). Our cash and cash equivalents, short-term investments, working capital and debt obligations are as follows:
 

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December 31, 2011
 
October 1, 2011
 
(in thousands)
Cash and cash equivalents
$
167,662

 
$
167,061

Short-term investments
35,421

 
53,142

Working capital
412,065

 
418,241

Total debt obligations
30

 
34

 
Contractual Obligations and Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements as defined under Regulation S-K of the Securities Act of 1933. Information regarding our long-term debt payments, operating lease payments, asset retirement obligations, purchase commitments with suppliers and purchase obligations is provided in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended October 1, 2011. There have been no material changes in contractual obligations outside of the ordinary course of business since October 1, 2011. Information regarding our other financial commitments at December 31, 2011 is provided in the notes to the condensed consolidated financial statements in this filing.
 
Changes in Financial Condition
 
Cash provided by operating activities during the first three months of fiscal 2012 was $16.1 million, which included net income of $17.1 million, depreciation and amortization of $7.5 million and stock-based compensation expense of $4.0 million partially offset by cash used by operating assets and liabilities of $11.3 million, decreases in net deferred tax assets of $0.5 million due to utilization of tax credits and $0.7 million other.

Cash provided by investing activities during the first three months of fiscal 2012 was $9.5 million, which included $17.6 million net sales of available-for-sale securities partially offset by $8.1 million used to acquire property and equipment and improve buildings.
 
Cash used by financing activities during the first three months of fiscal 2012 was $18.8 million, which included $20.7 million used to repurchase our common stock and $2.7 million other partially offset by $4.6 million generated from our employee stock option and stock purchase plans.
 
Changes in exchange rates during the first three months of fiscal 2012 used $6.2 million.
 
RECENT ACCOUNTING STANDARDS
 
See Note 2. “Recent Accounting Standards” in the Notes to Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our condensed consolidated financial position, results of operations and cash flows.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk disclosures
 
We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
 
Interest rate sensitivity
 
A portion of our investment portfolio is composed of fixed income securities. These securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2011, the fair value of the portfolio, based on quoted market prices in active markets involving similar assets, would decline by an immaterial amount. We have the ability to generally hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. If necessary, we may sell short-term investments prior to maturity to meet our liquidity needs.
 
At December 31, 2011, the fair value of our available-for-sale debt securities was $33.4 million, all of which were classified as short-term investments.  Gross unrealized gains and losses on available-for-sale debt securities were $276,000 and $(6,000), respectively, at December 31, 2011.
 
Foreign currency exchange risk
 
We maint