2014.3.29_10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ___________________________________________________
FORM 10-Q
 ___________________________________________________
 
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 29, 2014
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 x 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 x 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 x
 
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 x
 
The number of shares outstanding of registrant’s common stock, par value $.01 per share, on May 5, 2014 was 24,933,997.


Table of Contents

COHERENT, INC.

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2
Table of Contents

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,” "outlook," “forecast” or the negative of such terms, or other comparable terminology, including without limitation statements made under “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 “Our Strategy,” “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 events.


3
Table of Contents

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
 
Six Months Ended
 
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
 
Net sales
$
199,222

 
$
200,058

 
$
392,778

 
$
383,260

 
Cost of sales
118,557

 
123,727

 
234,567

 
229,294

 
Gross profit
80,665

 
76,331

 
158,211

 
153,966

 
Operating expenses:
 

 
 

 


 
 
 
Research and development
20,413

 
20,146

 
41,350

 
39,447

 
Selling, general and administrative
39,296

 
37,346

 
79,187

 
74,328

 
Amortization of intangible assets
916

 
1,942

 
1,850

 
2,796

 
Total operating expenses
60,625

 
59,434

 
122,387

 
116,571

 
Income from operations
20,040

 
16,897

 
35,824

 
37,395

 
Other income (expense):
 

 
 
 


 
 
 
Interest and dividend income
58

 
63

 
117

 
113

 
Interest expense
(8
)
 
(11
)
 
(31
)
 
(23
)
 
Other—net
990

 
1,243

 
734

 
(232
)
 
Total other income (expense), net
1,040

 
1,295


820


(142
)
 
Income before income taxes
21,080

 
18,192

 
36,644

 
37,253

 
Provision for income taxes
5,773


3,190


9,634


8,098

 
Net income
$
15,307

 
$
15,002

 
$
27,010

 
$
29,155

 
 

 
 
 

 
 
 
Net income per share:
 

 
 

 


 
 
 
Basic
$
0.62

 
$
0.62

 
$
1.10

 
$
1.22

 
Diluted
$
0.61

 
$
0.61

 
$
1.08

 
$
1.20

 
 

 
 
 

 
 
 
Shares used in computation:
 

 
 

 


 
 
 
Basic
24,782

 
24,085

 
24,662

 
23,928

 
Diluted
25,044

 
24,475

 
24,980

 
24,348

 
 
See Accompanying Notes to Condensed Consolidated Financial Statements.


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COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited; in thousands) 

 
Three Months Ended
 
Six Months Ended
 
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
 
 
 
 
 
 
 
 
 
 
Net income
$
15,307

 
$
15,002

 
$
27,010

 
$
29,155

 
Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
 
Translation adjustment (2)
2,867

 
(11,228
)
 
4,015

 
(7,108
)
 
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes
(6
)
 
(8
)
 
(17
)
 
(7
)
 
Other comprehensive income (loss), net of tax
2,861

 
(11,236
)
 
3,998

 
(7,115
)
 
Comprehensive income
$
18,168

 
$
3,766

 
$
31,008

 
$
22,040

 

(1)
Reclassification adjustments were not significant during the three and six months ended March 29, 2014 and March 30, 2013.

(2)
Tax expense of $153 and $1,339 was provided on translation adjustments during the three and six months ended March 29, 2014, respectively. Tax expense of $37 and $18 was provided on translation adjustments during the three and six months ended March 30, 2013, respectively.  Tax expense (benefit) on changes in unrealized gains (losses) on available-for-sale securities was insignificant.


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 value)
 
March 29,
2014
 
September 28,
2013
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
140,251

 
$
110,444

Short-term investments
143,217

 
139,666

Accounts receivable—net of allowances of $1,522 and $1,386, respectively
137,470

 
136,759

Inventories
176,462

 
168,067

Prepaid expenses and other assets
52,556

 
52,577

Deferred tax assets
22,280

 
21,713

Total current assets
672,236

 
629,226

Property and equipment, net
114,146

 
114,333

Goodwill
115,354

 
113,408

Intangible assets, net
38,698

 
42,971

Other assets
68,280

 
66,540

Total assets
$
1,008,714

 
$
966,478

 

 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term obligations
$
—

 
$
2

Accounts payable
33,708

 
36,565

Income taxes payable
11,977

 
24,695

Other current liabilities
99,841

 
84,566

Total current liabilities
145,526

 
145,828

Long-term obligations


 
—

Other long-term liabilities
64,702

 
62,132

Commitments and contingencies (Note 11)


 


Stockholders’ equity:
 

 
 

Common stock, par value $.01 per share:
 

 
 

Authorized—500,000 shares
 

 
 

Outstanding—24,870 shares and 24,464 shares, respectively
248

 
244

Additional paid-in capital
171,209

 
162,253

Accumulated other comprehensive income
58,448

 
54,450

Retained earnings
568,581

 
541,571

Total stockholders’ equity
798,486

 
758,518

Total liabilities and stockholders’ equity
$
1,008,714

 
$
966,478


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)
 
Six Months Ended
 
March 29,
2014
 
March 30,
2013
Cash flows from operating activities:
 

 
 

Net income
$
27,010

 
$
29,155

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

Depreciation and amortization
13,524

 
12,787

Amortization of intangible assets
4,879

 
4,589

Deferred income taxes
(2,078
)
 
(2,700
)
Stock-based compensation
9,540

 
9,636

Other non-cash (income) expense
(22
)
 
300

Changes in assets and liabilities, net of effect of acquisitions:
 

 
 

Accounts receivable
(1,574
)
 
5,913

Inventories
(7,142
)
 
1,083

Prepaid expenses and other assets
(8,139
)
 
(10,218
)
Other assets
(2,067
)
 
938

Accounts payable
(2,070
)
 
9,997

Income taxes payable/receivable
(4,474
)
 
(97
)
Other current liabilities
14,330

 
8,993

Other long-term liabilities
2,701

 
48

Net cash provided by operating activities
44,418

 
70,424

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(13,995
)
 
(10,492
)
Proceeds from dispositions of property and equipment
500

 
94

Purchases of available-for-sale securities
(89,900
)
 
(116,887
)
Proceeds from sales and maturities of available-for-sale securities
86,346

 
163,405

Acquisition of businesses, net of cash acquired
—

 
(67,289
)
Net cash used in investing activities
(17,049
)
 
(31,169
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
36,768

 
3,199

Repayments of short-term borrowings
(36,768
)
 
(3,199
)
Capital lease repayments
(2
)
 
(8
)
Issuance of common stock under employee stock option and purchase plans
7,038

 
12,306

Cash dividend paid on common stock
—

 
(24,040
)
Net settlement of restricted common stock
(7,689
)
 
(4,046
)
Net cash used in financing activities
(653
)
 
(15,788
)
Effect of exchange rate changes on cash and cash equivalents
3,091

 
2,376

Net increase in cash and cash equivalents
29,807

 
25,843

Cash and cash equivalents, beginning of period
110,444

 
67,761

Cash and cash equivalents, end of period
$
140,251

 
$
93,604


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 September 28, 2013. 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 second fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal years 2014 and 2013 each include 52 weeks.
 
2.    RECENT ACCOUNTING STANDARDS
 
Adoption of New Accounting Pronouncements

In February 2013, the FASB issued guidance which requires an entity to disclose additional information for items reclassified out of accumulated other comprehensive income ("AOCI"). For items reclassified out of AOCI and into net income in their entirety, entities are required to disclose the effect of the reclassification on each affected net income line item. For AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other disclosures is required. This information may be provided either in the notes or parenthetically on the face of the statement that reports net income as long as all the information is disclosed in a single location. We adopted this authoritative guidance in the first quarter of fiscal 2014. The adoption of this accounting standard did not have an impact on our consolidated financial position, results of operations and cash flows.

Recently Issued Accounting Pronouncement

In July 2013, the Financial Accounting Standards Board (“FASB”) issued amended guidance that resolves the diversity in practice for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This new accounting guidance requires the netting of unrecognized tax benefits ("UTBs") against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Under the new standard, UTBs will be netted against all available same-jurisdiction losses or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs. The new standard requires prospective adoption but allows retrospective adoption for all periods presented. We will consider the FASB’s amended guidance for our fiscal year beginning September 28, 2014. We do not expect the amended guidance to have a significant impact on our consolidated financial position, results of operations and cash flows.

3.     BUSINESS COMBINATIONS
  
Fiscal 2013 Acquisitions

Lumera Laser GmbH

On December 20, 2012, we acquired privately held Lumera Laser GmbH (Kaiserslautern, Germany) ("Lumera") for approximately $51.5 million, excluding transaction costs. Lumera manufactures ultrafast solid state lasers for microelectronics, OEM medical and materials processing applications. Lumera has been included in our Specialty Lasers and Systems segment.

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Our allocation of the purchase price is as follows (in thousands):

Tangible assets
 
  Inventories
$
7,364

  Accounts receivable
2,770

  Other tangible assets
4,380

Goodwill
24,640
Intangible assets:
 
  Existing technology
21,000
  In-process R&D
1,800
  Trade name
200
  Customer lists
6,500
  Backlog
900
Deferred tax liabilities
(9,300)
Liabilities assumed
(8,793)
Total
$
51,461


Results of operations for the business have been included in our condensed 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.

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 less than one to six years.
        
In-process research and development (“IPR&D”) consists of two projects that have 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 have been completed as of March 29, 2014.

We expensed $0.6 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in fiscal 2013.

Innolight Innovative Laser and Systemtechnik GmbH

On October 30, 2012, we acquired all of the outstanding shares of Innolight Innovative Laser and Systemtechnik GmbH ("Innolight") for approximately $18.3 million, excluding transaction costs. Innolight provides a core technology building block for an emerging class of commercial, sub-nanosecond lasers for microelectronics manufacturing. Its semiconductor-based architecture delivers pulsed output that can be amplified by conventional or fiber amplifiers to ultimately deliver infrared, green or ultraviolet light capable of processing a range of materials. Innolight has been included in our Specialty Lasers and Systems segment.

Our allocation of the purchase price is as follows (in thousands):


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Tangible assets
$
2,510

 Goodwill
8,312

Intangible assets:
 
  Existing technology
8,500

  In-process R&D
430

  Trade name
100

  Customer lists
2,800

Deferred tax liabilities
(3,836
)
Liabilities assumed
(480
)
Total
$
18,336


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.

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 six to seven years.

IPR&D consists of two projects that have not yet reached technological feasibility. The projects have not been completed as of March 29, 2014.

We expensed $0.2 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in fiscal 2013.


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; these instruments, which mature within two years and are issued by counterparties with high credit ratings, include U.S. Treasury and international government obligations, investment-grade corporate bonds, certificates of deposit and commercial paper. 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 March 29, 2014 and September 28, 2013, we did not have any assets or liabilities valued based on Level 3 valuations.

Financial assets and liabilities measured at fair value as of March 29, 2014 and September 28, 2013 are summarized below (in thousands):
 


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Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
March 29, 2014
 
September 28, 2013
 
(Level 1)
 
(Level 2)
 
(Level 1)
 
(Level 2)
Money market fund deposits(1)
$
11,473

 
$
—

 
$
12,468

 
$
—

Commercial paper(2)(6)
—

 
10,993

 
—

 
9,995

Certificates of deposit(1)
—

 
70,193

 
—

 
28,447

U.S. and international government obligations(3)(6)
—

 
110,929

 
—

 
109,263

Corporate notes and obligations(3)(6)
—

 
23,294

 
—

 
20,408

Foreign currency contracts(4)(7)
—

 
324

 
—

 
746

Mutual funds — Deferred comp and supplemental plan(5)(8)
13,952

 
—

 
13,419

 
—

 ___________________________________________________

(1)
Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet. The carrying amounts approximate fair value due to the short-term maturities of the cash equivalents.
(2)
March 29, 2014: Includes $1,999 recorded in cash and cash equivalents and $8,994 recorded in short-term investments on the Condensed Consolidated Balance Sheet.
September 28, 2013: Included in short-term investments on the Condensed Consolidated Balance Sheet.
(3)
Included in short-term investments on the Condensed Consolidated Balance Sheet.
(4)
March 29, 2014: Includes $346 recorded in prepaid expenses and other assets and $22 recorded in other current liabilities on the Condensed Consolidated Balance Sheet (see Note 5).

September 28, 2013: Includes $1,270 recorded in prepaid expenses and other assets and $524 recorded in other current liabilities on the Condensed Consolidated Balance Sheet (see Note 5).

(5)          March 29, 2014: Includes $1,410 recorded in prepaid expenses and other assets and $12,542 recorded in other assets on the Condensed Consolidated Balance Sheet.

September 28, 2013: Includes $1,361 recorded in prepaid expenses and other assets and $12,058 recorded in other assets on the Condensed Consolidated Balance Sheet.

(6)
Valuations are based upon quoted market prices in active markets involving similar assets. The market inputs used to value these instruments generally consist of market yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Pricing sources include industry standard data providers, security master files from large financial institutions, and other third party sources which are input into a distribution-curve-based algorithm to determine a daily market value. This creates a “consensus price” or a weighted average price for each security.

(7)
The principal market in which we execute our foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment.

(8)
The fair value of mutual funds is determined based on quoted market prices. Securities traded on a national exchange are stated at the last reported sales price on the day of valuation; other securities traded in over-the-counter markets and listed securities for which no sale was reported on that date are stated as the last quoted bid price.


 



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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 forwards to minimize the risks of foreign currency fluctuation of specific assets and liabilities on the balance sheet; these are not designated as hedging instruments. Our derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by us or the counterparties.

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 Japanese Yen, the Euro 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 three 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 three months, are as follows (in thousands):
 
 
U.S. Notional Contract Value
 
U.S. Notional Fair Value
 
March 29, 2014
 
September 28, 2013
 
March 29, 2014
 
September 28, 2013
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
28,902

 
$
46,248

 
$
28,994

 
$
47,299

 
 
 
 
 
 
 
 
Japanese YEN currency hedge contracts
 
 
 
 
 
 
 
  Purchase
$
—

 
$
5,211

 
$
—

 
$
5,307

  Sell
$
(22,232
)
 
$
(11,860
)
 
$
(22,169
)
 
$
(11,753
)
 
 
 
 
 
 
 
 
Korean Won currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(15,377
)
 
$
(17,345
)
 
$
(15,397
)
 
$
(17,545
)
 
 
 
 
 
 
 
 
Chinese RMB currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(11,544
)
 
$
(11,524
)
 
$
(11,374
)
 
$
(11,793
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
3,220

 
$
1,466

 
$
3,233

 
$
1,481

Sell
$
(3,046
)
 
$
(2,512
)
 
$
(3,042
)
 
$
(2,568
)
 
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 March 29, 2014 and September 28, 2013.
 
The amount of non-designated derivative instruments’ gain (loss) in the Condensed Consolidated Statements of Operations included in other income (expense) for the three and six months ended March 29, 2014 and March 30, 2013 is as follows (in thousands):

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Table of Contents

 
 
 
Amount of Gain or (Loss) Recognized in Income on Derivatives
 
 
Three Months Ended
 
Six Months Ended
 
 
March 29, 2014
 
March 29, 2014
Derivatives not designated as hedging instruments
 
 
 
 
Foreign exchange contracts
 
$
197

 
$
159


 
 
Amount of Gain or (Loss) Recognized in Income on Derivatives
 
 
Three Months Ended
 
Six Months Ended
 
 
March 30, 2013
 
March 30, 2013
Derivatives not designated as hedging instruments
 
 
 
 
Foreign exchange contracts
 
$
853

 
$
1,138


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):
 
 
March 29, 2014
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
140,251

 
$
—

 
$
—

 
$
140,251

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
8,994

 
$
—

 
$
—

 
$
8,994

U.S. Treasury and agency obligations
105,375

 
522

 
(2
)
 
105,895

International government obligations
5,008

 
28

 
(2
)
 
5,034

Corporate notes and obligations
23,276

 
42

 
(24
)
 
23,294

Total short-term investments
$
142,653

 
$
592

 
$
(28
)
 
$
143,217

 
 
September 28, 2013
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
110,444

 
$
—

 
$
—

 
$
110,444

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
9,995

 
$
—

 
$
—

 
$
9,995

       U.S. Treasury and agency obligations
103,694

 
507

 
(1
)
 
104,200

International government obligations
5,040

 
28

 
(5
)
 
5,063

Corporate notes and obligations
20,352

 
66

 
(10
)
 
20,408

Total short-term investments
$
139,081

 
$
601

 
$
(16
)
 
$
139,666

 

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None of the unrealized losses as of March 29, 2014 or September 28, 2013 were considered to be other-than-temporary impairments.

The amortized cost and estimated fair value of available-for-sale investments in debt securities as of March 29, 2014 and September 28, 2013 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):
 
 
March 29, 2014
 
September 28, 2013
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year
$
127,481

 
$
128,047

 
$
139,081

 
$
139,666

Investments in available-for-sale debt securities due in one to five years
$
15,172

 
$
15,170

 
$
—

 
$
—

 
During the three and six months ended March 29, 2014, we received proceeds totaling $7.0 million and $14.1 million, respectively, from the sale of available-for-sale securities and realized gross gains of less than $0.1 million and $0.1 million, respectively. During the three and six months ended March 30, 2013, we received proceeds totaling $9.1 million and $65.7 million, respectively, from the sale of available-for-sale securities and realized gross gains of less than $0.1 million and $0.1 million, respectively.
 

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 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.
 
During the six months ended March 29, 2014, 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 September 28, 2013 to March 29, 2014 are as follows (in thousands):
 
Specialty
Lasers and
Systems
 
Commercial
Lasers and
Components
 
Total
Balance as of September 28, 2013
$
107,045

 
$
6,363

 
$
113,408

Translation adjustments and other
1,946

 
—

 
1,946

Balance as of March 29, 2014
$
108,991

 
$
6,363

 
$
115,354

 
Components of our amortizable intangible assets are as follows (in thousands):



 
 
March 29, 2014
 
September 28, 2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
82,914

 
$
(55,654
)
 
$
27,260

 
$
82,220

 
$
(51,570
)
 
$
30,650

Customer lists
17,525

 
(8,541
)
 
8,984

 
17,341

 
(7,465
)
 
9,876

Trade name
455

 
(342
)
 
113

 
710

 
(576
)
 
134

Non-compete agreement
60

 
(54
)
 
6

 
570

 
(558
)
 
12

In-process research & development
2,335

 
—

 
2,335

 
2,299

 
—

 
2,299

Total
$
103,289

 
$
(64,591
)
 
$
38,698

 
$
103,140

 
$
(60,169
)
 
$
42,971


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     ** For accounting purposes, when an intangible asset is fully amortized, it is removed from the disclosure schedule.

Amortization expense for intangible assets for the six months ended March 29, 2014 and March 30, 2013 was $4.9 million and $4.6 million, respectively, which includes $3.8 million and $2.8 million, respectively, for amortization of existing technology and production know-how.

At March 29, 2014, estimated amortization expense for the remainder of fiscal 2014, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):
 
Estimated
Amortization
Expense
2014 (remainder)
$
4,616

2015
9,443

2016
9,059

2017
7,971

2018
4,680

2019
2,571

Thereafter
358

Total
$
38,698


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
March 29,
2014
 
September 28,
2013
Purchased parts and assemblies
$
52,458

 
$
50,275

Work-in-process
65,533

 
60,089

Finished goods
58,471

 
57,703

Total inventories
$
176,462

 
$
168,067

 
Prepaid expenses and other assets consist of the following (in thousands):
 
March 29,
2014
 
September 28,
2013
Prepaid and refundable income taxes
$
15,786

 
$
23,939

Other taxes receivable
23,290

 
16,225

Prepaid expenses and other
13,480

 
12,413

Total prepaid expenses and other assets
$
52,556

 
$
52,577

 
Other assets consist of the following (in thousands):
 
March 29,
2014
 
September 28,
2013
Assets related to deferred compensation arrangements
$
25,177

 
$
23,446

Deferred tax assets
37,385

 
37,637

Other assets
5,718

 
5,457

Total other assets
$
68,280

 
$
66,540

 
Other current liabilities consist of the following (in thousands):

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March 29,
2014
 
September 28,
2013
Accrued payroll and benefits
$
31,627

 
$
29,723

Deferred income
16,452

 
16,994

Reserve for warranty
17,981

 
18,508

Accrued expenses and other
10,160

 
11,552

Other taxes payable
20,688

 
6,147

Customer deposits
2,933

 
1,642

Total other current liabilities
$
99,841

 
$
84,566

 
We provide warranties on the majority 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 six months of fiscal 2014 and 2013 were as follows (in thousands):
 
Six Months Ended
 
March 29,
2014
 
March 30,
2013
Beginning balance
$
18,508

 
$
17,442

Additions related to current period sales
12,434

 
11,198

Warranty costs incurred in the current period
(12,713
)
 
(12,991
)
Accruals resulting from acquisitions
—

 
1,735

Adjustments to accruals related to foreign exchange and other
(248
)
 
(107
)
Ending balance
$
17,981

 
$
17,277

 
Other long-term liabilities consist of the following (in thousands):
 
March 29,
2014
 
September 28,
2013
Long-term taxes payable
$
15,659

 
$
15,715

Deferred compensation
26,369

 
24,723

Deferred tax liabilities
10,658

 
10,487

Deferred income
3,236

 
2,734

Asset retirement obligations liability
2,266

 
2,247

Other long-term liabilities
6,514

 
6,226

Total other long-term liabilities
$
64,702

 
$
62,132

 
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 $14.6 million of unsecured foreign lines of credit as of March 29, 2014.  At March 29, 2014, we had used $3.5 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe and Japan during the second fiscal quarter of 2014.  In addition, our domestic line of credit consists of a $50.0 million unsecured revolving credit account with Union Bank of California. The agreement will expire on May 31, 2014. The line of credit 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 March 29, 2014.




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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 and six months ended March 29, 2014 and March 30, 2013, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
 
Three Months Ended
 
Six Months Ended
 
 
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
 
Expected life in years
 
0.5

 
0.5

 
0.5

 
0.5

 
Expected volatility
 
22.8
%
 
34.2
%
 
23.7
%
 
34.5
%
 
Risk-free interest rate
 
0.1
%
 
0.2
%
 
0.1
%
 
0.2
%
 
Expected dividend yield
 
—
%
 
1.0
%
 
—
%
 
1.0
%
 
Weighted average fair value per share
 
$
13.89

 
$
10.30

 
$
13.69

 
$
10.44

 

There were no stock options granted during the three and six months ended March 29, 2014 and March 30, 2013.
 
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.
•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 based on the performance of the Company's Total Shareholder Returns (as defined in the plan) compared with the performance of the Russell 2000 Index.

We grant market-based performance restricted stock unit award grants 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 our 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 determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
 
 
Six Months Ended
 
 
March 29, 2014
 
March 30, 2013
Risk-free interest rate
 
0.62
%
 
0.33
%
Volatility
 
36.9
%
 
37.9
%
Weighted average fair value
 
$
77.10

 
$
48.48


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.
 

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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 and six months ended March 29, 2014 and March 30, 2013 (in thousands):
 
Three Months Ended
 
Six Months Ended
 
 
March 29, 2014
 
March 30, 2013
 
March 29, 2014
 
March 30, 2013
 
Cost of sales
$
648

 
$
594

 
$
1,186

 
$
1,029

 
Research and development
500

 
467

 
1,022

 
943

 
Selling, general and administrative
3,524

 
3,581

 
7,332

 
7,664

 
Income tax benefit
(1,326
)
 
(1,145
)
 
(2,665
)
 
(2,628
)
 
 
$
3,346

 
$
3,497

 
$
6,875

 
$
7,008

 

During the three and six months ended March 29, 2014, $0.6 million and $1.3 million was capitalized into inventory for all stock plans, $0.6 million and $1.2 million was amortized to cost of sales and $0.7 million remained in inventory at March 29, 2014. During the three and six months ended March 30, 2013, $0.6 million and $1.2 million was capitalized into inventory for all stock plans, $0.6 million and $1.0 million was amortized to cost of sales and $0.7 million remained in inventory at March 30, 2013.  Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.
 
At March 29, 2014, 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 $25.4 million, net of estimated forfeitures of $1.0 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 March 29, 2014, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.1 million, which will be recognized over the six month offering period.
 
The stock option exercise tax benefits reported in the statement of cash flows results from the excess tax benefits arising from tax deductions in excess of the stock-based compensation cost recognized, determined on a grant-by-grant basis. During the first six months of fiscal 2014 and fiscal 2013, we have not generated any excess tax benefits as cash flows from financing activities.
 
Stock Options & Awards Activity
 
The following is a summary of option activity for our Stock Option Plans (in thousands, except per share amounts and weighted average remaining contractual term in years):
 
Number of
Shares
 
Weighted
Average
Exercise Price
Per Share
 
Weighted
Average
Remaining
Contractual
Term in Years
 
Aggregate
Intrinsic Value
Outstanding at September 28, 2013
270

 
$
26.90

 
 
 
 

Granted
—

 
—

 
 
 
 

Exercised
(153
)
 
25.47

 
 
 
 

Forfeitures
—

 
—

 
 
 
 

Expirations
—

 
—

 
 
 
 

Outstanding at March 29, 2014
117

 
$
28.75

 
4.1 years
 
$
4,155

Vested and expected to vest at March 29, 2014
117

 
$
28.75

 
4.1 years
 
$
4,155

Exercisable at March 29, 2014
109

 
$
27.58

 
3.9 years
 
$
3,999

 
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.  The aggregate intrinsic value of options exercised under the Company’s stock plans for the three and six months ended March 29, 2014 were $0.4 million and

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$6.2 million, respectively, determined as of the date of option exercise. The aggregate intrinsic value of options exercised under the Company’s stock plans for the three and six months ended March 30, 2013 were $6.9 million and $8.1 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 six months of fiscal 2014 (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 units at September 28, 2013
453

 
$
48.22

 
213

 
$
54.63

Granted
226

 
65.80

 
52

 
77.10

Vested
(268
)
 
47.71

 
(32
)
 
43.25

Forfeited
—

 
—

 
(1
)
 
44.98

Nonvested stock at March 29, 2014
411

 
$
58.21

 
232

 
$
61.29


__________________________________________
(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, including, but not limited to, the matters described below. On May 14, 2013, IMRA America (“Imra”) filed a complaint for patent infringement against two of our subsidiaries in the Regional Court of Düsseldorf, Germany, captioned In re IMRA America Inc. versus Coherent Kaiserslautern GmbH et. al. 4b O 38/13. The complaint alleges that the use of certain of the Company’s lasers infringes upon EP Patent No. 754,103, entitled “Method For Controlling Configuration of Laser Induced Breakdown and Ablation,” issued November 5, 1997. The patent is owned by the University of Michigan and licensed to Imra. The complaint seeks unspecified compensatory damages, the cost of court proceedings and seeks to permanently enjoin the Company from infringing the patent in the future. Management has made an accrual with respect to this matter and has determined, based on its current knowledge, that the amount or range of reasonably possible losses in excess of the amounts already accrued, is not reasonably estimable. Although we do not expect that such legal claims and litigation will ultimately have a material adverse effect on our consolidated financial position, results of operations or cash flows, 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

Accumulated other comprehensive income (net of tax) at March 29, 2014 and September 28, 2013 are substantially comprised of accumulated translation adjustments of $58.5 million and $54.4 million, respectively.
 

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): 

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Three Months Ended
 
Six Months Ended
 
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
 
Weighted average shares outstanding —basic
24,782

 
24,085

 
24,662

 
23,928

 
Dilutive effect of employee stock awards
262

 
390

 
318

 
420

 
Weighted average shares outstanding—diluted
25,044

 
24,475

 
24,980

 
24,348

 
 
 
 
 
 
 
 
 
 
Net income
$
15,307

 
$
15,002

 
$
27,010

 
$
29,155

 
 
 
 
 
 
 
 
 
 
Net income per basic share
$
0.62

 
$
0.62

 
$
1.10

 
$
1.22

 
Net income per diluted share
$
0.61

 
$
0.61

 
$
1.08

 
$
1.20

 
 
A total of zero and 40,738 potentially dilutive securities have been excluded from the diluted share calculation for the three and six months ended March 29, 2014 as their effect was anti-dilutive. A total of zero and 76,877 potentially dilutive securities have been excluded from the diluted share calculation for the three and six months ended March 30, 2013 as their effect was anti-dilutive.
 
14.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 
 
Three Months Ended
 
Six Months Ended
 
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
 
Foreign exchange gain (loss)
$
(388
)
 
$
41

 
$
(2,512
)
 
$
(1,728
)
 
Gain on deferred compensation investments, net
1,291

 
983

 
3,167

 
1,277

 
Other—net
87

 
219

 
79

 
219

 
Other income (expense), net
$
990

 
$
1,243

 
$
734

 
$
(232
)
 

15.  STOCK REPURCHASES AND DIVIDENDS
 
On October 4, 2012, the Board of Directors authorized a buyback program whereby we are authorized to repurchase up to $25.0 million of our common stock. The program was authorized for 12 months from the date of authorization. No shares had been purchased under this program at its expiration in October 2013.

On December 10, 2012, we announced that the Board of Directors approved a $1.00 per share special cash dividend on our outstanding common stock payable on December 27, 2012 to stockholders of record on December 19, 2012, resulting in a payment of $24.0 million in the first quarter of fiscal 2013.

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 rates for the three and six months ended March 29, 2014 were 27.4% and 26.3%. Our effective tax rates for the three and six months ended March 29, 2014 were 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 including Korea and Singapore tax exemptions and the benefit of foreign tax credits. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, 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

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in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.

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 2010 are closed. In our major foreign jurisdictions and our major state jurisdictions, the years prior to 2006 and 2009, respectively, are closed to examination. Earlier years in our various jurisdictions may remain open for adjustment to the extent that we have tax attribute carryforwards from those years. In December 2011 and January 2012, three of our German subsidiaries received notices of tax audits for the fiscal years 2006 through 2010. In fiscal year 2013, we received a preliminary assessment for two of the German subsidiaries and the amount is immaterial; the audit for the other German subsidiary is currently in process. In addition, our German subsidiary of Coherent Kaiserslautern GmbH (formerly Lumera Laser GmbH) that was acquired in December 2012 is currently under audit for the fiscal years 2007 through 2009. As the years under the audit for Coherent Kaiserslautern GmbH are related to the pre-acquisition periods, any tax assessment should be recoverable from the escrow account for the acquisition.

Management believes that it has adequately provided for any adjustments that may result from tax examinations. We regularly engage 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.


17.  SEGMENT INFORMATION
 
We are organized into two reportable operating segments: Specialty Lasers and Systems ("SLS") and Commercial Lasers and Components ("CLC"). This segmentation reflects the go-to-market strategies for various products and markets. While both segments work to deliver cost-effective solutions, SLS develops and manufacturers configurable, advanced-performance products largely serving the microelectronics, scientific research and government programs and OEM components and instrumentation markets. The size and complexity of many of our SLS products require service to be performed at the customer site by factory-trained field service engineers. 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 based upon advanced replacement and depot (i.e., factory) repair. CLC's primary markets include materials processing, OEM components and instrumentation and microelectronics.

We have identified SLS and CLC as operating segments for which discrete financial information is available. Both units have dedicated engineering, manufacturing, product business management and product line management functions. Occasionally, 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.


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The following table provides net sales and income (loss) from operations for our operating segments (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
Net sales:
 
 
 
 
 
 
 
Specialty Laser Systems
$
143,795

 
$
142,682

 
$
280,618

 
$
274,142

Commercial Lasers and Components
55,427

 
57,376

 
112,160

 
109,118

Total net sales
$
199,222

 
$
200,058

 
$
392,778

 
$
383,260

 
 
 
 
 
 
 
 
Income (loss) from operations:
 
 
 
 
 
 
 
Specialty Laser Systems
$
31,117

 
$
26,585

 
$
59,749

 
$
56,919

Commercial Lasers and Components
(129
)
 
1,448

 
177

 
3,272

Corporate and other
(10,948
)
 
(11,136
)
 
(24,102
)
 
(22,796
)
Total income from operations
$
20,040

 
$
16,897

 
$
35,824

 
$
37,395


The following table provides a reconciliation of our total income (loss) from operations to net income (in thousands):

 
Three Months Ended
 
Six Months Ended
Reconciliation of Income From Operations to Net Income
March 29, 2014
 
March 30, 2013
 
March 29, 2014
 
March 30, 2013
Total income from operations
$
20,040

 
$
16,897

 
$
35,824

 
$
37,395

Total other income, net
1,040

 
1,295

 
820

 
(142
)
Income before income taxes
21,080

 
18,192

 
36,644

 
37,253

Provision for income taxes
5,773

 
3,190

 
9,634

 
8,098

Net Income
$
15,307

 
$
15,002

 
$
27,010

 
$
29,155


Major Customers

We had one customer during the three and six months ended March 29, 2014 who accounted for 11.5% and 12.6% respectively, of consolidated revenue; the customer purchased primarily from our SLS segment. We had one customer during the three and six months ended March 30, 2013 who accounted for 13.1% and 11.7% respectively, of consolidated revenue; the customer purchased primarily from our SLS segment.

We had one customer who accounted for 17.2% of accounts receivable at March 29, 2014. There were two customers who accounted for 15.2% and 11.7%, respectively, of accounts receivable at September 28, 2013.

22
Table of Contents

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: Specialty Lasers and Systems (“SLS”) and Commercial Lasers and Components (“CLC”). This segmentation reflects the go-to-market strategies for various products and markets. While both segments deliver cost-effective photonics solutions, SLS develops and manufactures configurable, advanced performance products largely serving the microelectronics, scientific research and government programs and OEM components and instrumentation 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. 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, original equipment manufacturer (“OEM”) components and instrumentation and microelectronics.

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 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 increase our market share in the mid to high power material processing applications.
•
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.

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Table of Contents

•
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. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for our fiscal year ended September 28, 2013.
 

KEY PERFORMANCE INDICATORS
 
Below is a summary of some of the quantitative performance indicators (as defined below) that are evaluated by management to assess our financial performance. Some of the indicators are non-GAAP measures and should not be considered as an alternative to any other measure for determining operating performance or liquidity that is calculated in accordance with generally accepted accounting principles.
 
Three Months Ended
 
 
 
 
 
March 29, 2014
 
March 30, 2013
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
261,837

 
$
201,825

 
$
60,012

 
29.7
 %
Book-to-bill ratio
1.31

 
1.01

 
0.3

 
29.7
 %
Net sales—Specialty Lasers and Systems
$
143,795

 
$
142,682

 
$
1,113

 
0.8
 %
Net sales—Commercial Lasers and Components
$
55,427

 
$
57,376

 
$
(1,949
)
 
(3.4
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
43.5
%
 
39.9
%
 
3.6
 %
 
9.0
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
33.9
%
 
34.8
%
 
(0.9
)%
 
(2.6
)%
Research and development as a percentage of net sales
10.2
%
 
10.1
%
 
0.1
 %
 
1.0
 %
Income before income taxes
$
21,080

 
$
18,192

 
$
2,888

 
15.9
 %
Net cash provided by operating activities
$
15,742

 
$
23,101

 
$
(7,359
)
 
(31.9
)%
Days sales outstanding in receivables
62.1

 
60.5

 
1.6

 
2.6
 %
Annualized second quarter inventory turns
2.7

 
3.0

 
(0.3
)
 
(10.0
)%
Capital spending as a percentage of net sales
3.6
%
 
3.3
%
 
0.3
 %
 
9.1
 %
Net income as a percentage of net sales
7.7
%
 
7.5
%
 
0.2
 %
 
2.7
 %
Adjusted EBITDA as a percentage of net sales
17.7
%
 
17.0
%
 
0.7
 %
 
4.1
 %
 

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Table of Contents

 
Six Months Ended
 
 
 
 
 
March 29, 2014
 
March 30, 2013
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
463,299

 
$
377,798

 
$
85,501

 
22.6
 %
Book-to-bill ratio
1.18

 
0.99

 
0.19

 
19.2
 %
Net sales—Specialty Lasers and Systems
$
280,618

 
$
274,142

 
$
6,476

 
2.4
 %
Net sales—Commercial Lasers and Components
$
112,160

 
$
109,118

 
$
3,042

 
2.8
 %
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
43.3
%
 
42.3
%
 
1.0
 %
 
2.4
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
34.0
%
 
36.0
%
 
(2.0
)%
 
(5.6
)%
Research and development as a percentage of net sales
10.5
%
 
10.3
%
 
0.2
 %
 
1.9
 %
Income before income taxes
$
36,644

 
$
37,253

 
$
(609
)
 
(1.6
)%
Net cash provided by operating activities
$
44,418

 
$
70,424

 
$
(26,006
)
 
(36.9
)%
Capital spending as a percentage of net sales
3.6
%
 
2.7
%
 
0.9
 %
 
33.3
 %
Net income as a percentage of net sales
6.9
%
 
7.6
%
 
(0.7
)%
 
(9.2
)%
Adjusted EBITDA as a percentage of net sales
17.0
%
 
17.5
%
 
(0.5
)%
 
(2.9
)%

Definitions and analysis of these performance indicators are as follows:

Bookings and Book-to-Bill Ratio
 
Bookings represent orders received during the current period for products 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 whereas a ratio of less than 1.0 indicates that demand for our products is less than what we supply in the quarter.

Bookings increased 29.7% in the second quarter of fiscal 2014 compared to the same quarter one year ago, led by a significant increase in the microelectronics market. Compared to the first quarter of fiscal 2014, bookings increased 30.0% with a significant increase in the microelectronics market partially offset by decreases in the OEM components and instrumentation, scientific and government programs and materials processing markets. The book-to-bill ratio was 1.31 in the second quarter of fiscal 2014.

 Microelectronics
 
Microelectronics bookings increased 89% compared to the same quarter one year ago and increased 113% from bookings in the first quarter of fiscal 2014. The book-to-bill ratio for the second quarter of fiscal 2014 was 1.82.
 
Flat panel display orders in the second quarter of fiscal 2014 increased 222% from orders in the second quarter of fiscal 2013, and increased 238% from orders in the first quarter of fiscal 2014 primarily due to the receipt of a large order from one customer for excimer laser annealing systems for LTPS processing, some of which are expected to ship during the latter half of fiscal 2014 with the majority scheduled for shipment during fiscal 2015. In the beginning of the third quarter of fiscal 2014, we received another round of system orders, with deliveries scheduled to begin in the fourth quarter of fiscal 2014, from a different set of end users to be used in making mobile displays. We expect continued fluctuations in order volumes on a quarterly basis.

Orders in the advanced packaging (API) market decreased 43% from orders in the second quarter of fiscal 2013 but increased 12% from orders in the first quarter of fiscal 2014. We believe the decrease in demand in this market is the result of a capacity overbuild by customers in prior quarters since demand has been slow for lasers serving several applications in this market. We expect that orders will begin to increase in the fourth quarter of fiscal 2014.

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Table of Contents


Orders from semiconductor capital equipment OEMs decreased 15% from the second quarter of fiscal 2013 and 33% from the first quarter of fiscal 2014 following two quarters of strong orders. Inspection applications for 1X nm nodes have led the demand growth over the past three quarters.

We recently completed application development for sapphire cutting that has led to a sizeable order for pulsed lasers that will begin shipping later in the third quarter of fiscal 2014 and we are scheduled to complete deliveries in the fourth quarter of fiscal 2014.

Materials Processing
 
Materials processing orders decreased 21% compared to the same quarter one year ago and decreased 5% from the first quarter of fiscal 2014. The book-to-bill ratio for the second quarter of fiscal 2014 was 0.99. The decrease in demand was from a combination of slower growth and tighter inventory controls by customers in China. However, there are positive market indicators including new environmental regulations that are increasing prospects for laser cladding in China by limiting or prohibiting new installations of traditional plating technologies; our Highlight™ direct diode system, used in cladding applications, is qualified with multiple vendors. In addition, volume for our recently released J-Series Diamond™ CO2 lasers is growing and planned expansion of the product line should further enhance the opportunity.

OEM Components and Instrumentation
 
OEM Components and Instrumentation orders decreased 20% compared to the same quarter one year ago and decreased 30% from the first quarter of fiscal 2014. The book-to-bill ratio for the second quarter of fiscal 2014 was 0.82.

Instrumentation orders decreased 13% compared to the same quarter one year ago and 35% compared to the first quarter of fiscal 2014. Although bioinstrumentation orders were lower following a record-setting performance last quarter, the outlook remains positive due to higher life sciences investment particularly in Asia, market share gains for OBIS™ and planned wavelength and power expansion of our portfolio.

Orders for medical OEM products were 29% lower in the second quarter of fiscal 2014 compared to the same quarter one year ago and 28% lower than orders in the first quarter of fiscal 2014. After strong orders in the first quarter of fiscal 2014, bookings for medical OEM lasers were solid in the second quarter of fiscal 2014, with lasers for cataract treatment, aesthetic procedures and consumables contributing.

Scientific and Government Programs
 
Scientific and government programs orders decreased 14% compared to the same quarter one year ago and decreased 35% from the first quarter of fiscal 2014. The book-to-bill for the second quarter of fiscal 2014 was 0.80.
 
The bookings results were in-line with our expectations following very strong orders during the first quarter of fiscal 2014 and the fourth quarter of fiscal 2013. The mix between biological imaging and applied sciences remains unchanged as does the regional mix. We are introducing new products designed and tested to highly accelerated life testing (HALT) and highly accelerated stress screening (HAAS) standards including the Astrella™, a new single-box, ultrafast amplifier that delivers superior performance and reliability, and the Fidelity™ laser system, a new ultrafast, fiber laser system configured for a range of scientific and commercial applications. We expect this laser to be especially attractive for optogenetics research wherein a Fidelity laser could trigger a neural response and a Chameleon™ laser could image the system; such techniques will be used in Europe’s Human Brain Project and the Brain Research through Advancing Innovative Neurotechnologies (BRAIN) program in the U.S.

Net Sales
 
Net sales include sales of lasers, laser tools, related accessories and service. Net sales for the second fiscal quarter increased 0.8% in our SLS segment from the same quarter one year ago and decreased 3.4% in our CLC segment from the same quarter one year ago. Net sales for the first six months increased 2.4% in our SLS segment from the same period one year ago and increased 2.8% in our CLC segment from the same period 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
 

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Table of Contents

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 second quarter increased from 39.9% to 43.5% in our SLS segment and decreased from 34.8% to 33.9% in our CLC segment from the same quarter one year ago. Gross profit percentage in the first six months increased from 42.3% to 43.3% in our SLS segment and decreased from 36.0% to 34.0% in our CLC segment from the same period 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 managing our business as investing in new technologies is a key to future growth.  R&D percentage increased to 10.2% from 10.1% in our second fiscal quarter and increased to 10.5% from 10.3% for the first six months of fiscal 2014 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 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 higher 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 second quarter of fiscal 2014 increased 1.6 days from the same quarter one year ago primarily due to unfavorable sales linearity, particularly in Asia, the timing of payments at quarter-end and the unfavorable impact of foreign exchange rates.
 
Annualized Second Quarter Inventory Turns
 
We calculate annualized second quarter inventory turns as the cost of sales during the second quarter annualized and divided by net inventories at the end of the second quarter. 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 second quarter of fiscal 2014 decreased by 0.3 turns from the same quarter one year ago primarily due to the impact of foreign exchange rates, higher service inventories to support the higher installed base and timing of inventory levels to support the large annealing laser systems orders.

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 and equipment.  Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage increased to 3.6% from 3.3% for the second quarter and to 3.6% from 2.7% for the first six months of fiscal 2014 compared to the same periods one year ago primarily due to higher purchases of production-related assets to support new product introductions and continued growth in Asia.
 
Adjusted EBITDA as a Percentage of Net Sales


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Table of Contents

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.

We utilize a number of different financial measures, both GAAP and non-GAAP, such as adjusted EBITDA as a percentage of net sales, in analyzing and assessing our overall business performance, for making operating decisions and for forecasting and planning future periods. We consider the use of non-GAAP financial measures helpful in assessing our current financial performance and ongoing operations. While we use non-GAAP financial measures as a tool to enhance our understanding of certain aspects of our financial performance, we do not consider these measures to be a substitute for, or superior to, the information provided by GAAP financial measures. We provide adjusted EBITDA in order to enhance investors' understanding of our ongoing operations. This measure is used by some investors when assessing our performance.
Below is the reconciliation of our net income as a percentage of net sales to our adjusted EBITDA as a percentage of net sales:

 
Three Months Ended
 
Six Months Ended
 
March 29,
2014
 
March 30,
2013
 
March 29,
2014
 
March 30,
2013
Net income as a percentage of net sales
7.7
%
 
7.5
 %
 
6.9
%
 
7.6
%
Income tax expense
2.9
%
 
1.6
 %
 
2.4
%
 
2.1
%
Interest and other income (expense), net
0.1
%
 
(0.1
)%
 
0.6
%
 
0.5
%
Depreciation and amortization
4.7
%
 
5.1
 %
 
4.7
%
 
4.5
%
Inventory step up
—
%
 
0.6
 %
 
—
%
 
0.3
%
Stock based compensation
2.3
%
 
2.3
 %
 
2.4
%
 
2.5
%
Adjusted EBITDA as a percentage of net sales
17.7
%
 
17.0
 %
 
17.0
%
 
17.5
%


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:
 
 
Three Months Ended
 
Six Months Ended
 
 
March 29,
2014