2014.6.28_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 June 28, 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 August 1, 2014 was 24,942,555.


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,” "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.


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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
 
Nine Months Ended
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
Net sales
$
196,517

 
$
213,725

 
$
589,295

 
$
596,985

 
Cost of sales
122,256

 
130,461

 
356,823

 
359,755

 
Gross profit
74,261

 
83,264

 
232,472

 
237,230

 
Operating expenses:
 

 
 

 


 
 
 
Research and development
19,046

 
21,782

 
60,396

 
61,229

 
Selling, general and administrative
37,226

 
38,748

 
116,413

 
113,076

 
Amortization of intangible assets
841

 
1,290

 
2,691

 
4,086

 
Total operating expenses
57,113

 
61,820

 
179,500

 
178,391

 
Income from operations
17,148

 
21,444

 
52,972

 
58,839

 
Other income (expense):
 

 
 
 


 
 
 
Interest and dividend income
201

 
48

 
318

 
161

 
Interest expense
(9
)
 
(37
)
 
(40
)
 
(60
)
 
Other—net
(415
)
 
(964
)
 
319

 
(1,196
)
 
Total other income (expense), net
(223
)
 
(953
)
 
597

 
(1,095
)
 
Income before income taxes
16,925

 
20,491

 
53,569

 
57,744

 
Provision for income taxes
3,926

 
3,806

 
13,560

 
11,904

 
Net income
$
12,999

 
$
16,685

 
$
40,009

 
$
45,840

 
 

 
 
 

 
 
 
Net income per share:
 

 
 

 


 
 
 
Basic
$
0.52

 
$
0.69

 
$
1.62

 
$
1.91

 
Diluted
$
0.52

 
$
0.68

 
$
1.60

 
$
1.87

 
 

 
 
 

 
 
 
Shares used in computation:
 

 
 

 


 
 
 
Basic
24,837

 
24,310

 
24,720

 
24,055

 
Diluted
25,115

 
24,690

 
25,025

 
24,462

 
 
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
 
Nine Months Ended
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
 
 
 
 
 
 
 
 
 
Net income
$
12,999

 
$
16,685

 
$
40,009

 
$
45,840

 
Other comprehensive income (loss) (1):
 
 
 
 
 
 
 
 
Translation adjustment (2)
(800
)
 
7,558

 
3,215

 
450

 
Net gain (loss) on derivative instruments, net of taxes (3)

(157
)
 
—

 
(157
)
 
—

 
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes (4)
25

 
(14
)
 
8

 
(21
)
 
Other comprehensive income (loss), net of tax
(932
)
 
7,544

 
3,066

 
429

 
Comprehensive income
$
12,067

 
$
24,229

 
$
43,075

 
$
46,269

 

(1)
Reclassification adjustments were not significant during the three and nine months ended June 28, 2014 and June 29, 2013.

(2)
Tax expense (benefit) of $118 and $1,457 was provided on translation adjustments during the three and nine months ended June 28, 2014, respectively. Tax expense (benefit) of $(226) and $(1,365) was provided on translation adjustments during the three and nine months ended June 29, 2013, respectively. 

(3)
Tax expense (benefit) of $(91) was provided on net gain (loss) on derivative instruments during the three and nine months ended June 28, 2014.

(4)
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 data)
 
June 28,
2014
 
September 28,
2013
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
149,568

 
$
110,444

Short-term investments
153,692

 
139,666

Accounts receivable—net of allowances of $1,439 and $1,386, respectively
130,833

 
136,759

Inventories
179,767

 
168,067

Prepaid expenses and other assets
67,644

 
52,577

Deferred tax assets
23,333

 
21,713

Total current assets
704,837

 
629,226

Property and equipment, net
112,530

 
114,333

Goodwill
114,779

 
113,408

Intangible assets, net
36,041

 
42,971

Other assets
68,986

 
66,540

Total assets
$
1,037,173

 
$
966,478

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Short term borrowings and current portion of long-term obligations
$
836

 
$
2

Accounts payable
32,691

 
36,565

Income taxes payable
13,900

 
24,695

Other current liabilities
105,330

 
84,566

Total current liabilities
152,757

 
145,828

Other long-term liabilities
65,900

 
62,132

Commitments and contingencies (Note 11)


 


Stockholders’ equity:
 

 
 

Common stock, Authorized—500,000 shares, par value $.01 per share:
 

 
 

Outstanding—24,942 shares and 24,464 shares, respectively
248

 
244

Additional paid-in capital
179,172

 
162,253

Accumulated other comprehensive income
57,516

 
54,450

Retained earnings
581,580

 
541,571

Total stockholders’ equity
818,516

 
758,518

Total liabilities and stockholders’ equity
$
1,037,173

 
$
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)
 
Nine Months Ended
 
June 28,
2014
 
June 29,
2013
Cash flows from operating activities:
 

 
 

Net income
$
40,009

 
$
45,840

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

Depreciation and amortization
20,006

 
19,386

Amortization of intangible assets
7,281

 
7,313

Deferred income taxes
(3,115
)
 
(225
)
Stock-based compensation
14,207

 
14,276

Other non-cash (income) expense
(376
)
 
483

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

 
 

Accounts receivable
5,749

 
(6,981
)
Inventories
(10,262
)
 
(76
)
Prepaid expenses and other assets
(11,898
)
 
(9,936
)
Other assets
(2,714
)
 
(535
)
Accounts payable
(3,855
)
 
10,487

Income taxes payable/receivable
(13,808
)
 
(23,800
)
Other current liabilities
19,944

 
8,902

Other long-term liabilities
3,729

 
1,625

Net cash provided by operating activities
64,897

 
66,759

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(17,862
)
 
(15,366
)
Proceeds from dispositions of property and equipment
417

 
131

Purchases of available-for-sale securities
(161,180
)
 
(170,306
)
Proceeds from sales and maturities of available-for-sale securities
147,285

 
206,652

Acquisition of businesses, net of cash acquired
—

 
(67,289
)
Net cash used in investing activities
(31,340
)
 
(46,178
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
45,927

 
9,540

Repayments of short-term borrowings
(45,091
)
 
(9,540
)
Capital lease repayments
(2
)
 
(13
)
Issuance of common stock under employee stock option and purchase plans
10,513

 
15,708

Cash dividend paid on common stock
—

 
(24,040
)
Net settlement of restricted common stock
(7,793
)
 
(4,163
)
Net cash provided by/(used in) financing activities
3,554

 
(12,508
)
Effect of exchange rate changes on cash and cash equivalents
2,013

 
5,477

Net increase in cash and cash equivalents
39,124

 
13,550

Cash and cash equivalents, beginning of period
110,444

 
67,761

Cash and cash equivalents, end of period
$
149,568

 
$
81,311


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. Our fiscal year ends on the Saturday closest to September 30 and our third 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 December 2011, the Financial Accounting Standards Board (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. We adopted this authoritative guidance in fiscal 2014. See Note 5.

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 Pronouncements

In May 2014, the FASB amended the Accounting Standards Codification and created a new Topic 606, Revenue from Contracts with Customers. The new guidance establishes a single comprehensive contract-based model for entities to use in accounting for revenue arising from contracts with customers. The new model significantly changes existing GAAP, requires substantial judgment in its application, and will generally require companies to make more disclosures about revenue. The core principle of the amendment is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new standard provides for two alternative implementation methods. The first is to apply the new standard retrospectively to each prior reporting period presented. This method does allow the use of certain practical expedients. The second method is to apply the new standard retrospectively in the year of initial adoption and record a cumulative effect adjustment for the impact of adjusting contracts open at the date of adoption. Under this transition method, we

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would apply this guidance retrospectively only to contracts that are not completed contracts at the date of initial application. We would then recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. This method also requires us to disclose comparative information for the year of adoption. We will adopt the FASB’s amended guidance for our fiscal year beginning October 1, 2017. We are currently evaluating the new guidance and have not determined the impact this standard may have on our financial statements nor decided upon the method of adoption.

In July 2013, the 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 are considering the adoption of 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.

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.
        

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In-process research and development (“IPR&D”) consists of two projects that 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. The development process for the acquired IPR&D projects was completed and amortization of the assets, as existing technologies, began in the third quarter of fiscal 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):

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 and have not been completed as of June 28, 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.

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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 June 28, 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 June 28, 2014 are summarized below (in thousands):
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
June 28, 2014
 
September 28, 2013
 
(Level 1)
 
(Level 2)
 
(Level 1)
 
(Level 2)
Money market fund deposits (1)
$
9,061

 
$
—

 
$
12,468

 
$
—

Certificates of deposit (1)
—

 
41,584

 
—

 
28,447

U.S. and international government obligations (2)(5)
—

 
113,071

 
—

 
109,263

Corporate notes and obligations (2)(5)
—

 
28,631

 
—

 
20,408

Commercial paper (2)(5)
—

 
11,990

 
—

 
9,995

Foreign currency contracts (3)(6)
—

 
(372
)
 
—

 
746

Mutual funds — Deferred comp and supplemental plan (4)(7)
14,541

 
—

 
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)
Included in short-term investments on the Condensed Consolidated Balance Sheet.

(3) 
June 28, 2014: Includes $46 recorded in prepaid expenses and other assets, all of which was for non-designated forward contracts and $418 recorded in other current liabilities on the Condensed Consolidated Balance Sheet (see Note 5), of which $231was designated as cash flow contracts and the remainder was for non-designated forward contracts.

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), all of which were non-designated forward contracts.

(4)          June 28, 2014: Includes $1,456 recorded in prepaid expenses and other assets and $13,085 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.

(5)
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.

(6)
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.

(7)
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.

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).

Cash flow hedges related to anticipated transactions are designated and documented at the inception of the hedge when we enter into contracts for specific future transactions. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of OCI in stockholder's equity and is reclassified into earnings when the underlying transaction affects earnings. The majority of the after-tax net income or loss related to derivative instruments included in OCI at June 28, 2014 is expected to be reclassified into earnings within 12 months. Changes in the fair value of currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and recognized in other income (expense) as incurred. We classify the cash flows from the foreign exchange forward contracts that are accounted for as cash flow hedges in the same section as the underlying item, primarily within cash flows from operating activities.
 
The outstanding notional contract and fair value amounts of non-designated hedge contracts, with maximum maturity of three months, are as follows (in thousands):
 
 
U.S. Notional Contract Value
 
U.S. Notional Fair Value
 
June 28, 2014
 
September 28, 2013
 
June 28, 2014
 
September 28, 2013
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
35,599

 
$
46,248

 
$
35,580

 
$
47,299

 
 
 
 
 
 
 
 
Japanese YEN currency hedge contracts
 
 
 
 
 
 
 
Purchase
$
971

 
$
5,211

 
$
960

 
$
5,307

Sell
$
(8,175
)
 
$
(11,860
)
 
$
(8,136
)
 
$
(11,753
)
 
 
 
 
 
 
 
 
Korean Won currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(3,308
)
 
$
(17,345
)
 
$
(3,277
)
 
$
(17,545
)
 
 
 
 
 
 
 
 
Chinese RMB currency hedge contracts
 
 
 
 
 
 
 
Sell
$
(11,551
)
 
$
(11,524
)
 
$
(11,478
)
 
$
(11,793
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
3,053

 
$
1,466

 
$
3,037

 
$
1,481

Sell
$
(2,784
)
 
$
(2,512
)
 
$
(2,741
)
 
$
(2,568
)


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The outstanding notional contract and fair value amounts of designated cash flow hedge contracts, with maximum maturity of twelve months, are as follows (in thousands):

 
U.S. Notional Contract Value
 
U.S. Notional Fair Value
 
June 28, 2014
 
September 28, 2013
 
June 28, 2014
 
September 28, 2013
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
11,149

 
$
—

 
$
11,397

 
$
—

 
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 as of June 28, 2014 and September 28, 2013. See details at Note 4 "Fair Values".

The locations and amounts of designated and non-designated derivative instruments’ gains and losses in the condensed consolidated financial statements for the indicated periods were as follows (in thousands):

 
Location in financial statements
 
Three Months Ended
 
Nine Months Ended
 
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Derivatives designated as hedging instruments
 
 
 

 
 

 
 

 
 

Gains(losses) in AOCI on derivatives (effective portion), after tax
AOCI
 
$
(248
)
 
$
—

 
$
(248
)
 
$
—

Gains(losses) reclassified from AOCI into income (effective portion)
Cost of sales
 
$
—

 
$
—

 
$
—

 
$
—

Gains(losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Other income(expense)
 
$
17

 
$
—

 
$
17

 
$
—

Derivatives not designated as hedging instruments

 
 
 
 
 
 
 
 
 
Gains(losses) recognized in income
Other income(expense)
 
$
(1,367
)
 
$
338

 
$
(1,208
)
 
$
1,476


The amounts that will be reclassified from AOCI to earnings will generally be offset by the recognition of the hedged transactions (e.g., anticipated sales) in earnings, thereby achieving the realization of prices contemplated by the underlying risk management strategies and will vary from the expected amounts presented above as a result of changes in foreign exchange rates.

To mitigate credit risk in derivative transactions, we enter into master netting arrangements that allow each counterparty in the arrangements to net settle amounts of multiple and separate derivative transactions under certain conditions. We present the fair value of derivative assets and liabilities within the Company's consolidated balance sheet on a gross basis even when derivative transactions are subject to master netting arrangements and may otherwise qualify for net presentation. 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.

Offsetting of Financial Assets/Liabilities under Master Netting Agreements with Derivative Counterparties as of June 28, 2014 and September 28, 2013 (in thousands):


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Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
 
 
Gross Amounts of Recognized Derivative Assets
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Derivative Assets Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments (1)
 
Cash Collateral Received
 
Net Amounts
 
As of June 28, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
46

 
$
—

 
$
46

 
$
(41
)
 
$
—

 
$
5

 
As of September 28, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
1,270

 
$
—

 
$
1,270

 
$
(524
)
 
$
—

 
$
746

 
(1) The balances at June 28, 2014 and September 28, 2013 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with the master netting agreements.
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
 
 
 
Gross Amounts of Recognized Derivative Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts of Derivative Liabilities Presented in the Condensed Consolidated Balance Sheets
 
Financial Instruments (1)
 
Cash Collateral Paid
 
Net Amounts
 
As of June 28, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(418
)
 
$
—

 
$
(418
)
 
$
41

 
$
—

 
$
(377
)
 
As of September 28, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(524
)
 
$
—

 
$
(524
)
 
$
524

 
$
—

 
$
—

 
(1) The balances at June 28, 2014 and September 28, 2013 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with the master netting agreements.


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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Table of Contents

 
 
June 28, 2014
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
149,568

 
$
—

 
$
—

 
$
149,568

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
11,990

 
$
—

 
$
—

 
$
11,990

U.S. Treasury and agency obligations
112,443

 
635

 
(7
)
 
113,071

Corporate notes and obligations
28,537

 
98

 
(4
)
 
28,631

Total short-term investments
$
152,970

 
$
733

 
$
(11
)
 
$
153,692

 
 
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


None of the unrealized losses as of June 28, 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 June 28, 2014 and September 28, 2013 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):
 
 
June 28, 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
$
103,239

 
$
103,801

 
$
139,081

 
$
139,666

Investments in available-for-sale debt securities due in one to five years
$
49,731

 
$
49,891

 
$
—

 
$
—

 
During the three and nine months ended June 28, 2014, we received proceeds totaling $7.0 million and $21.1 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 nine months ended June 29, 2013, we received proceeds totaling $3.0 million and $68.7 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

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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 nine months ended June 28, 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 June 28, 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
1,371

 
—

 
1,371

Balance as of June 28, 2014
$
108,416

 
$
6,363

 
$
114,779

 
Components of our amortizable intangible assets are as follows (in thousands):
 
 
June 28, 2014
 
September 28, 2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
84,423

 
$
(57,342
)
 
$
27,081

 
$
82,220

 
$
(51,570
)
 
$
30,650

Customer lists
17,410

 
(9,008
)
 
8,402

 
17,341

 
(7,465
)
 
9,876

Trade name
452

 
(351
)
 
101

 
710

 
(576
)
 
134

Non-compete agreement
60

 
(57
)
 
3

 
570

 
(558
)
 
12

In-process research & development
454

 
—

 
454

 
2,299

 
—

 
2,299

Total
$
103,709

 
$
(67,668
)
 
$
36,041

 
$
103,140

 
$
(60,169
)
 
$
42,971

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

Amortization expense for intangible assets for the nine months ended June 28, 2014 and June 29, 2013 was $7.3 million and $7.3 million, respectively.

At June 28, 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)
$
2,355

2015
9,375

2016
8,990

2017
7,903

2018
4,641

2019
2,470

Thereafter
307

Total
$
36,041


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):

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Table of Contents

 
June 28,
2014
 
September 28,
2013
Purchased parts and assemblies
$
54,054

 
$
50,275

Work-in-process
70,568

 
60,089

Finished goods
55,145

 
57,703

Total inventories
$
179,767

 
$
168,067

 
Prepaid expenses and other assets consist of the following (in thousands):
 
June 28,
2014
 
September 28,
2013
Prepaid and refundable income taxes
$
27,090

 
$
23,939

Other taxes receivable
28,693

 
16,225

Prepaid expenses and other
11,861

 
12,413

Total prepaid expenses and other assets
$
67,644

 
$
52,577

 
Other assets consist of the following (in thousands):
 
June 28,
2014
 
September 28,
2013
Assets related to deferred compensation arrangements
$
25,731

 
$
23,446

Deferred tax assets
37,439

 
37,637

Other assets
5,816

 
5,457

Total other assets
$
68,986

 
$
66,540

 
Other current liabilities consist of the following (in thousands):
 
June 28,
2014
 
September 28,
2013
Accrued payroll and benefits
$
30,736

 
$
29,723

Deferred income
16,631

 
16,994

Reserve for warranty
17,875

 
18,508

Accrued expenses and other
9,735

 
11,552

Other taxes payable
27,666

 
6,147

Customer deposits
2,687

 
1,642

Total other current liabilities
$
105,330

 
$
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 nine months of fiscal 2014 and 2013 were as follows (in thousands):

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Table of Contents

 
Nine Months Ended
 
June 28,
2014
 
June 29,
2013
Beginning balance
$
18,508

 
$
17,442

Additions related to current period sales
17,990

 
18,739

Warranty costs incurred in the current period
(18,320
)
 
(19,681
)
Accruals resulting from acquisitions
—

 
1,728

Adjustments to accruals related to foreign exchange and other
(303
)
 
(154
)
Ending balance
$
17,875

 
$
18,074

 
Other long-term liabilities consist of the following (in thousands):
 
June 28,
2014
 
September 28,
2013
Long-term taxes payable
$
15,786

 
$
15,715

Deferred compensation
27,042

 
24,723

Deferred tax liabilities
10,565

 
10,487

Deferred income
3,896

 
2,734

Asset retirement obligations liability
2,276

 
2,247

Other long-term liabilities
6,335

 
6,226

Total other long-term liabilities
$
65,900

 
$
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 $15.6 million of unsecured foreign lines of credit as of June 28, 2014.  At June 28, 2014, $0.8 million was used as a cash overdraft in Japan and we had used $3.0 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe and Japan during the third 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, 2017. 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 June 28, 2014.

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 nine months ended June 28, 2014 and June 29, 2013, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
Expected life in years
 
0.5

 
0.5

 
0.5

 
0.5

 
Expected volatility
 
24.2
%
 
30.8
%
 
23.9
%
 
33.3
%
 
Risk-free interest rate
 
0.06
%
 
0.11
%
 
0.07
%
 
0.14
%
 
Expected dividend yield
 
—
%
 
—
%
 
—
%
 
1.0
%
 
Weighted average fair value per share
 
$
13.55

 
$
10.60

 
$
13.64

 
$
10.49

 

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There were no stock options granted during the three and nine months ended June 28, 2014 and June 29, 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:
 
 
Nine Months Ended
 
 
June 28, 2014
 
June 29, 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.
 
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 nine months ended June 28, 2014 and June 29, 2013 (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
 
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
 
Cost of sales
$
611

 
$
576

 
$
1,797

 
$
1,605

 
Research and development
504

 
455

 
1,526

 
1,398

 
Selling, general and administrative
3,552

 
3,610

 
10,884

 
11,274

 
Income tax benefit
(1,270
)
 
(1,195
)
 
(3,935
)
 
(3,823
)
 
 
$
3,397

 
$
3,446

 
$
10,272

 
$
10,454

 

During the three and nine months ended June 28, 2014, $0.6 million and $1.9 million was capitalized into inventory for all stock plans, $0.6 million and $1.8 million was amortized to cost of sales and $0.7 million remained in inventory at June 28, 2014. During the three and nine months ended June 29, 2013, $0.5 million and $1.7 million was capitalized into inventory for all stock plans, $0.6 million and $1.6 million was amortized to cost of sales and $0.7 million remained in inventory at June 29, 2013.  Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.
 

19
Table of Contents

At June 28, 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 $21.2 million, net of estimated forfeitures of $0.8 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.5 years and will be adjusted for subsequent changes in estimated forfeitures.

At June 28, 2014, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.6 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 nine 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
(156
)
 
25.45

 
 
 
 

Forfeitures
—

 
—

 
 
 
 

Expirations
—

 
—

 
 
 
 

Outstanding at June 28, 2014
114

 
$
28.87

 
4.0 years
 
$
3,759

Vested and expected to vest at June 28, 2014
114

 
$
28.87

 
4.0 years
 
$
3,759

Exercisable at June 28, 2014
106

 
$
27.68

 
3.7 years
 
$
3,622

 
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 nine months ended June 28, 2014 were $0.1 million and $6.3 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 nine months ended June 29, 2013 were $0.5 million and $8.5 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 nine 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 at September 28, 2013
453

 
$
48.22

 
213

 
$
54.63

Granted
226

 
65.80

 
52

 
77.10

Vested
(273
)
 
47.78

 
(33
)
 
43.25

Forfeited
(8
)
 
56.47

 
(3
)
 
46.99

Nonvested stock at June 28, 2014
398

 
$
58.31

 
229

 
$
61.46


__________________________________________
(1)Service-based restricted stock vested during each fiscal year.

20
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(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 June 28, 2014 and September 28, 2013 is substantially comprised of accumulated translation adjustments of $57.8 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
 
Nine Months Ended
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
Weighted average shares outstanding —basic
24,837

 
24,310

 
24,720

 
24,055

 
Dilutive effect of employee stock awards
278

 
380

 
305

 
407

 
Weighted average shares outstanding—diluted
25,115

 
24,690

 
25,025

 
24,462

 
 
 
 
 
 
 
 
 
 
Net income
$
12,999

 
$
16,685

 
$
40,009

 
$
45,840

 
 
 
 
 
 
 
 
 
 
Net income per basic share
$
0.52

 
$
0.69

 
$
1.62

 
$
1.91

 
Net income per diluted share
$
0.52

 
$
0.68

 
$
1.60

 
$
1.87

 
 
A total of 758 and 44,563 potentially dilutive securities have been excluded from the diluted share calculation for the three and nine months ended June 28, 2014 as their effect was anti-dilutive. A total of 2,999 and 82,053 potentially dilutive securities have been excluded from the diluted share calculation for the three and nine months ended June 29, 2013 as their effect was anti-dilutive.
 
14.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 
 
Three Months Ended
 
Nine Months Ended
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
Foreign exchange gain (loss)
$
(736
)
 
$
(1,927
)
 
$
(3,248
)
 
$
(3,655
)
 
Gain on deferred compensation investments, net
331

 
1,010

 
3,498

 
2,287

 
Other—net
(10
)
 
(47
)
 
69

 
172

 
Other income (expense), net
$
(415
)
 
$
(964
)
 
$
319

 
$
(1,196
)
 

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.

See Note 18 "Subsequent Event".

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 effective tax rates for the three and nine months ended June 28, 2014 were 23.2% and 25.3%. Our effective tax rates for the three and nine months ended June 28, 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).


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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.

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 2011 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, we received in July 2014 a final tax assessment for our German subsidiary of Coherent Kaiserslautern GmbH (formerly Lumera Laser GmbH) that was acquired in December 2012 and was under audit for the fiscal years 2007 through 2009. The tax assessment is immaterial and since the years under the audit for Coherent Kaiserslautern GmbH are related to the pre-acquisition periods, the amount 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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Table of Contents

The following table provides net sales and income (loss) from operations for our operating segments (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
June 28,
2014
 
June 29,
2013
 
June 28,
2014
 
June 29,
2013
 
Net sales:
 
 
 
 
 
 
 
 
Specialty Laser Systems
$
137,590

 
$
149,466

 
$
418,208

 
$
423,608

 
Commercial Lasers and Components
58,927

 
64,259

 
171,087

 
173,377

 
Total net sales
$
196,517

 
$
213,725

 
$
589,295

 
$
596,985

 
 
 
 
 
 
 
 
 
 
Income (loss) from operations:
 
 
 
 
 
 
 
 
Specialty Laser Systems
$
27,144

 
$
28,071

 
$
86,893

 
$
84,990

 
Commercial Lasers and Components
(162
)
 
4,395

 
15

 
7,667

 
Corporate and other
(9,834
)
 
(11,022
)
 
(33,936
)
 
(33,818
)
 
Total income from operations
$
17,148

 
$
21,444

 
$
52,972

 
$
58,839

 

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

 
Three Months Ended
 
Nine Months Ended
Reconciliation of Income From Operations to Net Income
June 28, 2014
 
June 29, 2013
 
June 28, 2014
 
June 29, 2013
Total income from operations
$
17,148

 
$
21,444

 
$
52,972

 
$
58,839

Total other income (expense), net
(223
)
 
(953
)
 
597

 
(1,095
)
Income before income taxes
16,925

 
20,491

 
53,569

 
57,744

Provision for income taxes
3,926

 
3,806

 
13,560

 
11,904

Net Income
$
12,999

 
$
16,685

 
$
40,009

 
$
45,840


Major Customers

We had one customer who accounted for 13.9% and 13.0% of consolidated net sales during the three and nine months ended June 28, 2014, respectively. This customer purchased primarily from our SLS segment. There were two customers who accounted for 16.2% and 11.2% of consolidated net sales for the three months ended June 29, 2013 and the same two customers accounted for 13.3% and 10.0%, respectively, of consolidated revenue for the nine months ended June 29, 2013; both customers purchased primarily from our SLS segment.

We had one customer who accounted for 16.5% of accounts receivable at June 28, 2014. There were two customers who accounted for 15.2% and 11.7%, respectively, of accounts receivable at September 28, 2013.

18.  SUBSEQUENT EVENT

On July 25, 2014, our Board of Directors authorized a buyback program authorizing the Company to repurchase up to $25 million of our common stock from time to time through July 31, 2015.




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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
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
244,527

 
$
189,206

 
$
55,321

 
29.2
 %
Book-to-bill ratio
1.24

 
0.89

 
0.35

 
39.3
 %
Net sales—Specialty Lasers and Systems
$
137,590

 
$
149,466

 
$
(11,876
)
 
(7.9
)%
Net sales—Commercial Lasers and Components
$
58,927

 
$
64,259

 
$
(5,332
)
 
(8.3
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
40.9
%
 
40.3
%
 
0.6
 %
 
1.5
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
31.6
%
 
36.7
%
 
(5.1
)%
 
(13.9
)%
Research and development as a percentage of net sales
9.7
%
 
10.2
%
 
(0.5
)%
 
(4.9
)%
Income before income taxes
$
16,925

 
$
20,491

 
$
(3,566
)
 
(17.4
)%
Net cash provided by (used in) operating activities
$
20,478

 
$
(3,665
)
 
$
24,143

 
(658.7
)%
Days sales outstanding in receivables
59.9

 
61.6

 
(1.7
)
 
(2.8
)%
Annualized third quarter inventory turns
2.7

 
3.1

 
(0.4
)
 
(12.9
)%
Capital spending as a percentage of net sales
2.0
%
 
2.3
%
 
(0.3
)%
 
(13.0
)%
Net income as a percentage of net sales
6.6
%
 
7.8
%
 
(1.2
)%
 
(15.4
)%
Adjusted EBITDA as a percentage of net sales
15.8
%
 
17.3
%
 
(1.5
)%
 
(8.7
)%
 

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Table of Contents

 
Nine Months Ended
 
 
 
 
 
June 28, 2014
 
June 29, 2013
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
707,826

 
$
567,004

 
$
140,822

 
24.8
 %
Book-to-bill ratio
1.20

 
0.95

 
0.25

 
26.3
 %
Net sales—Specialty Lasers and Systems
$
418,208

 
$
423,608

 
$
(5,400
)
 
(1.3
)%
Net sales—Commercial Lasers and Components
$
171,087

 
$
173,377

 
$
(2,290
)
 
(1.3
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
42.5
%
 
41.6
%
 
0.9
 %
 
2.2
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
33.2
%
 
36.3
%
 
(3.1
)%
 
(8.5
)%
Research and development as a percentage of net sales