Document
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 July 2, 2016
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 8, 2016 was 24,322,965.

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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
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Net sales
$
218,767

 
$
188,502

 
$
608,924

 
$
592,838

 
Cost of sales
124,208

 
109,720

 
341,868

 
348,433

 
Gross profit
94,559

 
78,782

 
267,056

 
244,405

 
Operating expenses:
 

 
 

 


 
 
 
Research and development
21,441

 
21,270

 
61,536

 
61,467

 
Selling, general and administrative
46,256

 
36,154

 
123,970

 
113,777

 
Impairment of investment

 
2,017

 

 
2,017

 
Amortization of intangible assets
574

 
647

 
1,975

 
2,009

 
Total operating expenses
68,271

 
60,088

 
187,481

 
179,270

 
Income from operations
26,288

 
18,694

 
79,575

 
65,135

 
Other income (expense):
 

 
 
 


 
 
 
Interest and dividend income
351

 
183

 
854

 
440

 
Interest expense
(63
)
 
(4
)
 
(108
)
 
(29
)
 
Other—net
564

 
(787
)
 
(1,896
)
 
286

 
Total other income (expense), net
852

 
(608
)
 
(1,150
)
 
697

 
Income before income taxes
27,140

 
18,086

 
78,425

 
65,832

 
Provision for income taxes
8,490

 
4,822

 
21,708

 
16,725

 
Net income
$
18,650

 
$
13,264

 
$
56,717

 
$
49,107

 
 

 
 
 

 
 
 
Net income per share:
 

 
 

 


 
 
 
Basic
$
0.77

 
$
0.54

 
$
2.35

 
$
1.98

 
Diluted
$
0.76

 
$
0.53

 
$
2.33

 
$
1.96

 
 

 
 
 

 
 
 
Shares used in computation:
 

 
 

 


 
 
 
Basic
24,192

 
24,737

 
24,108

 
24,794

 
Diluted
24,467

 
24,972

 
24,355

 
25,018

 
 
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
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
 
 
 
 
 
 
 
 
 
Net income
$
18,650

 
$
13,264

 
$
56,717

 
$
49,107

 
Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
 
  Translation adjustment, net of taxes (2)
(6,396
)
 
1,108

 
(1,334
)
 
(46,691
)
 
  Net gain (loss) on derivative instruments, net of taxes (3)


 
77

 
(28
)
 
627

 
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes (4)
(37
)
 
1,059

 
2,426

 
1,260

 
  Other comprehensive income (loss), net of tax
(6,433
)
 
2,244

 
1,064

 
(44,804
)
 
Comprehensive income
$
12,217

 
$
15,508

 
$
57,781

 
$
4,303

 

(1)
Reclassification adjustments were not significant during the three and nine months ended July 2, 2016 and July 4, 2015.

(2)
Tax expenses of $185 and $304 were provided on translation adjustments during the three and nine months ended July 2, 2016, respectively. Tax benefits of $98 and $1,960 were provided on translation adjustments during the three and nine months ended July 4, 2015, respectively. 

(3)
Tax expenses (benefits) of $0 and $(17) were provided on net gain (loss) on derivative instruments during the three and nine months ended July 2, 2016. Tax expenses of $45 and $364 were provided on net gain (loss) on derivative instruments during the three and nine months ended July 4, 2015.

(4)
Tax expenses (benefits) of $(22) and $1,415 were provided on unrealized gains (losses) on available for sale securities during the three and nine months ended July 2, 2016. Tax expenses of $619 and $738 were provided on unrealized gains (losses) on available-for-sale securities for the three and nine months ended July 4, 2015.


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)
 
July 2,
2016

October 3,
2015
ASSETS
 


 

Current assets:
 


 

Cash and cash equivalents
$
139,407


$
130,607

Short-term investments
234,205


194,908

Accounts receivable—net of allowances of $2,632 and $3,015, respectively
150,184


142,260

Inventories
200,171


156,614

Prepaid expenses and other assets
36,349


28,294

Total current assets
760,316


652,683

Property and equipment, net
111,738


102,445

Goodwill
101,308


101,817

Intangible assets, net
16,092


22,776

Other assets
92,856


89,226

Total assets
$
1,082,310


$
968,947





LIABILITIES AND STOCKHOLDERS’ EQUITY
 


 

Current liabilities:
 


 

Short-term borrowings
$
20,000


$

Accounts payable
44,182


33,379

Income taxes payable
10,136


4,279

Other current liabilities
92,061


84,932

Total current liabilities
166,379


122,590

Other long-term liabilities
44,985


49,939

Commitments and contingencies (Note 11)





Stockholders’ equity:
 


 

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


 

Outstanding—24,295 shares and 23,970 shares, respectively
242


238

Additional paid-in capital
145,350


128,607

Accumulated other comprehensive loss
(8,449
)

(9,513
)
Retained earnings
733,803


677,086

Total stockholders’ equity
870,946


796,418

Total liabilities and stockholders’ equity
$
1,082,310


$
968,947


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
 
July 2,
2016
 
July 4,
2015
Cash flows from operating activities:
 

 
 

Net income
$
56,717

 
$
49,107

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

Depreciation and amortization
19,410

 
18,453

Amortization of intangible assets
6,201

 
6,176

Impairment of investment

 
2,017

Deferred income taxes
(3,356
)
 
5,312

Stock-based compensation
14,821

 
13,737

Other non-cash expense
387

 
8

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

 
 

Accounts receivable
(4,195
)
 
(15,637
)
Inventories
(43,627
)
 
2,011

Prepaid expenses and other assets
(4,809
)
 
(21,193
)
Other assets
(577
)
 
(670
)
Accounts payable
9,824

 
641

Income taxes payable/receivable
(2,759
)
 
(11,800
)
Other current liabilities
4,519

 
19,177

Other long-term liabilities
2,065

 
1,496

Net cash provided by operating activities
54,621

 
68,835

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(28,310
)
 
(16,187
)
Proceeds from dispositions of property and equipment
422

 
1,848

Purchases of available-for-sale securities
(180,842
)
 
(274,832
)
Proceeds from sales and maturities of available-for-sale securities
144,966

 
270,044

Net cash used in investing activities
(63,764
)
 
(19,127
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
54,792

 
24,354

Repayments of short-term borrowings
(34,792
)
 
(24,354
)
Debt issuance costs
(2,530
)
 

Issuance of common stock under employee stock option and purchase plans
7,249

 
7,256

Increase in cash overdraft
880

 

Repurchase of common stock


(25,009
)
Net settlement of restricted common stock
(5,414
)
 
(5,295
)
Net cash provided by(used in) financing activities
20,185

 
(23,048
)
Effect of exchange rate changes on cash and cash equivalents
(2,242
)
 
(14,739
)
Net increase in cash and cash equivalents
8,800

 
11,921

Cash and cash equivalents, beginning of period
130,607

 
91,217

Cash and cash equivalents, end of period
$
139,407

 
$
103,138

 
 
 
 
Noncash investing and financing activities:
 
 
 
  Unpaid property and equipment purchases
$
2,538

 
$
941


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”) condensed consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended October 3, 2015. 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 year 2016 includes 52 weeks and fiscal year 2015 includes 53 weeks. Certain reclassifications have been made to the prior period amounts to conform to the current period's presentation related to the reclassification of $28.1 million of current deferred income tax assets to non-current deferred income tax assets and non-current deferred income tax liabilities.
 
2.    RECENT ACCOUNTING STANDARDS
 
Adoption of New Accounting Pronouncements

In November 2015, the FASB issued amended guidance that clarifies that in a classified statement of financial position, an entity shall classify deferred tax liabilities and assets as noncurrent amounts. The new guidance supersedes ASC 740-10-45-5 which required the valuation allowance for a particular tax jurisdiction be allocated between current and noncurrent deferred tax assets for that tax jurisdiction on a pro rata basis. We elected to early adopt the standard retrospectively in the first quarter of fiscal 2016, which resulted in the reclassification of $28.1 million from current deferred income tax assets to non-current deferred income tax assets and non-current deferred income tax liabilities as of October 3, 2015.

In April 2015, the FASB issued amended guidance that simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amended guidance. The new standard will become effective for our fiscal year beginning October 2, 2016. We elected to early adopt the standard in the second quarter of fiscal 2016 and have recorded the debt issuance costs of $2.5 million as of July 2, 2016 in other assets for the debt commitment we entered into in the second quarter of fiscal 2016.

Recently Issued Accounting Pronouncements

In March 2016, the FASB issued amended guidance that simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under the new guidance, an entity recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. This change eliminates the notion of the APIC pool and significantly reduces the complexity and cost of accounting for excess tax benefits and tax deficiencies. The new standard will become effective for our fiscal year beginning October 2, 2017. We are currently assessing the impact of this amended guidance and the timing of adoption.

In February 2016, the FASB issued amended guidance to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new guidance clarifies the criteria for distinguishing between a finance lease and operating lease, as well as classification between the two types of leases, which is substantially unchanged from the previous lease guidance.
Further, the new guidance requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset, initially measured at the present value of the lease payments. For finance leases, a lessee should recognize interest on the lease liability separately from amortization of the right-of-use

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asset. For operating leases, a lessee should recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. The new standard will become effective for our fiscal year beginning September 29, 2019. We are currently assessing the impact of this amended guidance and the timing of adoption.
 
In January 2016, the FASB issued amended guidance that revises the recognition and measurement of financial instruments. The new guidance requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The new standard will become effective for our fiscal year beginning September 30, 2018. We are currently assessing the impact of this amended guidance and the timing of adoption.

3.     BUSINESS COMBINATIONS
Rofin-Sinar Technologies, Inc.
On March 16, 2016, we entered into a definitive agreement to acquire Rofin-Sinar Technologies, Inc. ("Rofin"), one of the world's leading developers and manufacturers of high-performance industrial laser sources and laser-based solutions and components. The acquisition will be an all-cash transaction at a price of $32.50 per share of Rofin common stock for a total approximate offer value of $942.0 million before fees and transaction costs. The completion of the acquisition is subject to customary closing conditions, including regulatory approvals.
Fiscal 2015 Acquisitions
Raydiance, Inc.
On July 24, 2015, we acquired certain assets of Raydiance, Inc. ("Raydiance") for approximately $5.0 million, excluding transaction costs. Raydiance manufactured complete tools and lasers for ultrafast processing systems and subsystems in the precision micromachining processing market. The Raydiance assets have been included in our Specialty Lasers and Systems segment.
Our allocation of the purchase price is as follows (in thousands):
Tangible assets
$
1,048

Goodwill
1,552

Intangible assets:
 
    Existing technology
800

    Customer lists
1,600

Total
$
5,000

The purchase price allocated to goodwill was finalized in the first quarter of fiscal 2016, with an increase of $0.4 million and a corresponding decrease of $0.4 million to tangible assets, and has been updated from the preliminary allocation in the fourth quarter of fiscal 2015.
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.
The identifiable intangible assets are being amortized over their respective useful lives of three to five years.
None of the goodwill from this purchase is deductible for tax purposes.
We expensed $0.1 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations for our fiscal year 2015.
Tinsley Optics

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On July 27, 2015, we acquired the assets and certain liabilities of the Tinsley Optics ("Tinsley") business from L-3 Communications Corporation for approximately $4.3 million, excluding transaction costs. Tinsley is a specialized manufacturer of high precision optical components and subsystems sold primarily in the aerospace and defense industry. Tinsley manufactures the large form factor optics for our excimer laser annealing systems. Tinsley has been included in our Specialty Lasers and Systems segment.
Our allocation of the purchase price is as follows (in thousands):
Tangible assets:
 
  Inventories
$
2,240

  Accounts receivable
2,263

  Prepaid expenses and other assets
1,132

  Property and equipment
2,451

Liabilities assumed
(1,702
)
Deferred tax liabilities
(768
)
Gain on business combination
(1,316
)
Total
$
4,300

The purchase price was lower than the fair value of net assets purchased, resulting in a gain of $1.3 million recorded as a separate line item in our consolidated statements of operations for our fiscal year 2015. We reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that all acquired assets and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate.
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.
The gain from the bargain purchase is not subject to income taxation.
We expensed $0.4 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations for our fiscal year 2015.

4.    FAIR VALUES
 
We have not changed our valuation techniques in measuring the fair value of any financial assets and liabilities during the period. We recognize transfers between levels within the fair value hierarchy, if any, at the end of each quarter. There were no transfers between levels during the periods presented. As of July 2, 2016 and October 3, 2015, we did not have any assets or liabilities valued based on Level 3 valuations.

Financial assets and liabilities measured at fair value as of July 2, 2016 and October 3, 2015 are summarized below (in thousands):


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Aggregate Fair Value
 
Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Aggregate Fair Value
 
Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
 
July 2, 2016
 
October 3, 2015
 
 
 
 
(Level 1)
 
(Level 2)
 
 
 
(Level 1)
 
(Level 2)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
Money market fund deposits
 
$
29,112

 
$
29,112

 
$

 
$
8,297

 
$
8,297

 
$

Commercial paper (2)
 
4,727

 

 
4,727

 

 

 

Short-term investments:
 
 
 
 
 


 


 


 


U.S. Treasury and agency obligations (2)
 
$
145,752

 
$

 
$
145,752

 
$
150,748

 
$

 
$
150,748

Corporate notes and obligations (2)
 
19,780

 

 
19,780

 
17,942

 

 
17,942

Commercial paper (2)
 
48,318

 

 
48,318

 
9,740

 

 
9,740

Equity securities (1)
 
20,355

 
20,355

 

 
16,478

 
16,478

 

Prepaid and other assets:
 
 
 


 


 


 


 


Foreign currency contracts (3)
 
290

 

 
290

 
258

 

 
258

Mutual funds — Deferred comp and supplemental plan (4)
 
13,838

 
13,838

 

 
13,891

 
13,891

 

Total
 
$
282,172

 
$
63,305

 
$
218,867

 
$
217,354

 
$
38,666

 
$
178,688

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency contracts (3)
 
$
(3,750
)
 
$

 
$
(3,750
)
 
$
(239
)
 
$

 
$
(239
)
Total
 
$
278,422

 
$
63,305

 
$
215,117

 
$
217,115

 
$
38,666

 
$
178,449


 ___________________________________________________
(1)
Valuations are based upon quoted market prices.

(2)
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.

(3)
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. At July 2, 2016, prepaid expenses and other assets include $290 non-designated forward contracts; other current liabilities include $3,750 non-designated forward contracts. At October 3, 2015, prepaid expenses and other assets include $217 non-designated forward contracts and $41 foreign currency contracts designated for cash flow hedges, respectively; other current liabilities include $239 non-designated forward contracts and $0 foreign currency contracts designated for cash flow hedges, respectively. See Note 6, "Derivative Instruments and Hedging Activities".

(4)
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.              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):
 
 
July 2, 2016
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
139,407

 
$

 
$

 
$
139,407

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
48,318

 
$

 
$

 
$
48,318

U.S. Treasury and agency obligations
145,222

 
533

 
(3
)
 
145,752

Corporate notes and obligations
19,676

 
105

 
(1
)
 
19,780

Equity securities
15,269

 
5,086

 

 
20,355

Total short-term investments
$
228,485

 
$
5,724

 
$
(4
)
 
$
234,205

 
 
October 3, 2015
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
130,607

 
$

 
$

 
$
130,607

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
9,740

 
$

 
$

 
$
9,740

       U.S. Treasury and agency obligations
149,708

 
1,040

 

 
150,748

Corporate notes and obligations
17,892

 
52

 
(2
)
 
17,942

Equity securities
15,269

 
1,209

 

 
16,478

Total short-term investments
$
192,609

 
$
2,301

 
$
(2
)
 
$
194,908


None of the unrealized losses as of July 2, 2016 or October 3, 2015 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 July 2, 2016 and October 3, 2015 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):

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July 2, 2016
 
October 3, 2015
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year
$
211,327

 
$
211,951

 
$
148,088

 
$
149,100

Investments in available-for-sale debt securities due in one to five years (1)
$
1,889

 
$
1,899

 
$
29,252

 
$
29,330

(1) Classified as short-term investments because these securities are highly liquid and can be sold at any time.
 
During the three and nine months ended July 2, 2016, we received proceeds totaling $15.5 million and $44.1 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 July 4, 2015, we received proceeds totaling $44.6 million and $122.5 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.
 
6.     DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, Japanese Yen, South Korean Won and Chinese Renminbi (RMB). As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading purposes. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency or interest rates at each respective date.
 
For derivative instruments that are not designated as hedging instruments, gains and losses are recognized in other income (expense).

Non-Designated Derivatives

The outstanding notional contract and fair value asset (liability) amounts of non-designated hedge contracts, with maximum maturity of two months, are as follows (in thousands):

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Table of Contents

 
 
U.S. Notional Contract Value
 
U.S. Fair Value
 
July 2, 2016
 
October 3, 2015
 
July 2, 2016
 
October 3, 2015
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
64,730

 
$
52,699

 
$
(143
)
 
$
33

Sell
$
(307
)
 
$

 
$
6

 
$

 
 
 
 
 
 
 
 
Japanese Yen currency hedge contracts
 
 
 
 
 
 
 
Purchase
$

 
$
558

 
$

 
$
8

Sell
$
(40,182
)
 
$
(15,804
)
 
$
(2,604
)
 
$
(84
)
 
 
 
 
 
 
 
 
South Korean Won currency hedge contracts
 
 
 
 
 
 
 
Purchase
$

 
$
253

 
$

 
$

  Sell
$
(21,763
)
 
$
(17,747
)
 
$
(921
)
 
$
30

 
 
 
 
 
 
 
 
Chinese RMB currency hedge contracts
 
 
 
 
 
 
 
Sell
$
(14,864
)
 
$
(10,900
)
 
$
128

 
$
(106
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
6,225

 
$
3,283

 
$
156

 
$
(49
)
Sell
$
(1,883
)
 
$
(5,835
)
 
$
(82
)
 
$
146


Designated Derivatives

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. We had no cash flow hedges outstanding at July 2, 2016. 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 since we do not designate our cash flow hedges as investing or financing activities.
The outstanding notional contract and fair value asset (liability) amounts of designated cash flow hedge contracts, with maximum maturity of thirteen months, are as follows (in thousands):
 
U.S. Notional Contract Value
 
U.S. Fair Value
 
July 2, 2016
 
October 3, 2015
 
July 2, 2016
 
October 3, 2015
Japanese Yen currency hedge contracts
 
 
 
 
 
 
 
Sell
$

 
$
(2,093
)
 
$

 
$
41

 
We have entered into certain derivative forward contracts to sell Japanese Yen and buy Euro to hedge revenue exposures related to our photonics-based solutions in Asia. In order to facilitate the hedge, we transact with counterparties in the U.S. directly and then allocate the hedge contracts to our affiliates through a back-to-back relationship with our German subsidiary. The German subsidiary designates these hedge contracts as cash flow hedges under ASC 815, none of which were outstanding at July 2, 2016.
The fair value of our derivative instruments is included in prepaid expenses and other assets and in other current liabilities in our Condensed Consolidated Balance Sheets (See 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):

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Location in financial statements
 
Three Months Ended
 
Nine Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
Derivatives designated as hedging instruments
 
 
 

 
 

 
 

 
 

Gains(losses) in OCI on derivatives (effective portion), after tax
OCI
 
$

 
$
77

 
$
(28
)
 
$
627

Losses reclassified from OCI into income (effective portion)
Cost of sales
 
$

 
$

 
$

 
$
(1,720
)
Gains(losses) reclassified from OCI into income (effective portion)
Revenue
 
$

 
$

 
$
(58
)
 
$
208

Gains(losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Other income(expense)
 
$
1

 
$

 
$
(29
)
 
$
(112
)
Derivatives not designated as hedging instruments

 
 
 
 
 
 
 
 
 
Losses recognized in income
Other income(expense)
 
$
(4,926
)
 
$
(29
)
 
$
(7,437
)
 
$
(6,154
)

During the first quarter of fiscal 2016 we recognized a loss of $31,000 in other income (expense) as ineffectiveness related to a portion of an anticipated hedged transaction that failed to occur within the original hedge period plus two months. During the nine months ended July 4, 2015 we recognized a loss of $0.1 million in other income (expense) as ineffectiveness related to a portion of an anticipated hedged transaction that failed to occur within the original hedge period plus two months. The remainder of the hedged transaction occurred as expected and effective amounts were recognized in revenue as disclosed in the above table.

The amounts that are reclassified from OCI to earnings are generally offset by the recognition of the hedged transactions (e.g., anticipated cost of 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 our condensed 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 July 2, 2016 and October 3, 2015 (in thousands):


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Table of Contents

 
 
 
 
 
 
 
 
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 July 2, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
290

 
$

 
$
290

 
$
(290
)
 
$

 
$

 
As of October 3, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
258

 
$

 
$
258

 
$
(116
)
 
$

 
$
142

 
(1) The balances at July 2, 2016 and October 3, 2015 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 July 2, 2016:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(3,750
)
 
$

 
$
(3,750
)
 
$
290

 
$

 
$
(3,460
)
 
As of October 3, 2015:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(239
)
 
$

 
$
(239
)
 
$
116

 
$

 
$
(123
)
 
(1) The balances at July 2, 2016 and October 3, 2015 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with the master netting agreements.

7.    GOODWILL AND INTANGIBLE ASSETS 

During the nine months ended July 2, 2016, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment. We will conduct our annual goodwill testing during the fourth fiscal quarter.
 
The changes in the carrying amount of goodwill by segment for the period from October 3, 2015 to July 2, 2016 are as follows (in thousands):
 
Specialty
Lasers and
Systems
 
Commercial
Lasers and
Components
 
Total
Balance as of October 3, 2015
$
95,454

 
$
6,363

 
$
101,817

Translation adjustments and other
(509
)
 

 
(509
)
Balance as of July 2, 2016
$
94,945

 
$
6,363

 
$
101,308

 

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Table of Contents

Components of our amortizable intangible assets are as follows (in thousands):
 
 
July 2, 2016
 
October 3, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
70,601

 
$
(59,714
)
 
$
10,887

 
$
71,365

 
$
(55,452
)
 
$
15,913

Customer lists
15,933

 
(11,135
)
 
4,798

 
16,099

 
(9,661
)
 
6,438

Trade name
385

 
(349
)
 
36

 
399

 
(349
)
 
50

In-process research & development
371

 

 
371

 
375

 

 
375

Total
$
87,290

 
$
(71,198
)
 
$
16,092

 
$
88,238

 
$
(65,462
)
 
$
22,776


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

Amortization expense for intangible assets for the three months ended July 2, 2016 and July 4, 2015 was $2.0 million and $2.0 million, respectively, which includes $1.4 million and $1.5 million, respectively, for amortization of existing technology. The change in the accumulated amortization also includes $0.4 million and $0.2 million of foreign exchange impact for the three months ended July 2, 2016 and July 4, 2015, respectively.

Amortization expense for intangible assets for the nine months ended July 2, 2016 and July 4, 2015 was $6.2 million and $6.2 million, respectively, which includes $4.6 million and $4.8 million, respectively, for amortization of existing technology. The change in the accumulated amortization also includes $0.5 million and $3.3 million of foreign exchange impact for the nine months ended July 2, 2016 and July 4, 2015, respectively.

At July 2, 2016, estimated amortization expense for the remainder of fiscal 2016, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):
 
Estimated
Amortization
Expense
2016 (remainder)
$
1,875

2017
6,952

2018
4,248

2019
2,168

2020
685

2021
55

Thereafter
109

Total
$
16,092


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
July 2,
2016
 
October 3,
2015
Purchased parts and assemblies
$
54,569

 
$
50,182

Work-in-process
81,865

 
56,225

Finished goods
63,737

 
50,207

Total inventories
$
200,171

 
$
156,614

 
Prepaid expenses and other assets consist of the following (in thousands):

17

Table of Contents

 
July 2,
2016
 
October 3,
2015
Prepaid and refundable income taxes
$
10,715

 
$
8,846

Other taxes receivable
11,155

 
6,574

Prepaid expenses and other assets
14,479

 
12,874

Total prepaid expenses and other assets
$
36,349

 
$
28,294

 
Other assets consist of the following (in thousands):
 
July 2,
2016
 
October 3,
2015
Assets related to deferred compensation arrangements
$
25,357

 
$
25,131

Deferred tax assets
60,921

 
60,254

Other assets
6,578

 
3,841

Total other assets
$
92,856

 
$
89,226


For our $750.0 million debt financing commitment with certain lenders (See Note 9 "Short-term Borrowings"), we paid $2.5 million of debt issuance costs in the second and third quarters of fiscal 2016 and recorded it to other assets.

Other current liabilities consist of the following (in thousands):
 
July 2,
2016
 
October 3,
2015
Accrued payroll and benefits
$
35,782

 
$
35,504

Deferred revenue
18,909

 
16,474

Warranty reserve
15,151

 
15,308

Accrued expenses and other
14,484

 
10,965

Other taxes payable
5,302

 
4,888

Customer deposits
2,433

 
1,793

Total other current liabilities
$
92,061

 
$
84,932

 
Components of the reserve for warranty costs during the first nine months of fiscal 2016 and 2015 were as follows (in thousands):
 
Nine Months Ended
 
July 2,
2016
 
July 4,
2015
Beginning balance
$
15,308

 
$
16,961

Additions related to current period sales
15,298

 
16,605

Warranty costs incurred in the current period
(15,059
)
 
(15,065
)
Adjustments to accruals related to foreign exchange and other
(396
)
 
(2,822
)
Ending balance
$
15,151

 
$
15,679

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

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Table of Contents

 
July 2,
2016
 
October 3,
2015
Long-term taxes payable
$
1,109

 
$
7,651

Deferred compensation
27,166

 
26,691

Deferred tax liabilities
1,634

 
2,717

Deferred revenue
4,147

 
3,149

Asset retirement obligations liability
2,771

 
2,654

Other long-term liabilities
8,158

 
7,077

Total other long-term liabilities
$
44,985

 
$
49,939

 
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 $14.1 million of unsecured foreign lines of credit as of July 2, 2016. At July 2, 2016, we had used $1.8 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe and Japan during the first nine months of 2016. In addition, our domestic line of credit consists of a $50.0 million unsecured revolving credit account. 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. We have an outstanding balance of $20.0 million and have used $1.1 million for letters of credit against our domestic line of credit as of July 2, 2016.

On March 16, 2016, we entered into a debt commitment letter with Barclays Bank PLC ("Barclays") and on April 5, 2016, entered into an amended and restated debt commitment letter with Barclays and both Bank of America, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (together, "BAML"). Pursuant to the commitment letter, among other things, Barclays and BAML have committed to provide us with debt financing including a term loan (denominated in Euros) in an amount of the Euro equivalent of $750.0 million and, along with The Bank of Tokyo-Mitsubishi UFJ, Ltd. (“MUFG”), which was added by a joinder agreement with Barclays and BAML (and consented to by us), a $100.0 million revolving facility (denominated in U.S. dollars) to finance the acquisition of Rofin. The obligations of the lenders under the commitment letter are subject to certain conditions, including the consummation of the acquisition in accordance with the terms and conditions of the definitive agreement and other customary closing obligations. For our debt financing commitment, we paid $2.5 million of debt issuance costs in the second and third quarters of fiscal 2016 and recorded it to other assets on our condensed consolidated balance sheets. The debt issuance cost will be reclassified when there is an outstanding debt.

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 July 2, 2016 and July 4, 2015, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Expected life in years
 
0.5

 
0.5

 
0.5

 
0.5

 
Expected volatility
 
38.5
%
 
30.8
%
 
31.6
%
 
26.8
%
 
Risk-free interest rate
 
0.37
%
 
0.06
%
 
0.28
%
 
0.06
%
 
Expected dividend yield
 
%
 
%
 
%
 
%
 
Weighted average fair value per share
 
$
21.35

 
$
14.58

 
$
16.08

 
$
14.27

 

There were no stock options granted during the three and nine months ended July 2, 2016 and July 4, 2015.

19

Table of Contents


We grant performance restricted stock units to officers and certain employees. The performance restricted stock unit agreements provide for the award of performance restricted stock units with each unit representing the right to receive one share of our common stock to be issued after the applicable award vesting period. The final number of units awarded, if any, for these performance grants 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 no units to a maximum of twice the initial award units. 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
 
 
July 2, 2016
 
July 4, 2015
Risk-free interest rate
 
1.20
%
 
0.96
%
Volatility
 
27.0
%
 
28.7
%
Weighted average fair value
 
$74.48
 
$70.57

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 July 2, 2016 and July 4, 2015 (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
 
July 2, 2016
 
July 4, 2015
 
July 2, 2016
 
July 4, 2015
 
Cost of sales
$
677

 
$
664

 
$
1,876

 
$
1,937

 
Research and development
610

 
529

 
1,646

 
1,415

 
Selling, general and administrative
4,402

 
3,372

 
11,299

 
10,385

 
Income tax benefit
(1,588
)
 
(1,272
)
 
(3,450
)
 
(3,005
)
 
 
$
4,101

 
$
3,293

 
$
11,371

 
$
10,732

 

During the three and nine months ended July 2, 2016, $0.7 million and $2.0 million was capitalized into inventory for all stock plans, $0.7 million and $1.9 million was amortized to cost of sales and $0.8 million remained in inventory at July 2, 2016. During the three and nine months ended July 4, 2015, $0.6 million and $1.9 million was capitalized into inventory for all stock plans, $0.7 million and $1.9 million was amortized to cost of sales and $0.7 million remained in inventory at July 4, 2015
 
At July 2, 2016, 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 $27.1 million, net of estimated forfeitures of $0.9 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.4 years and will be adjusted for subsequent changes in estimated forfeitures.

At July 2, 2016, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.8 million, which will be recognized over the six month offering period.
 
Stock Awards Activity

The following table summarizes the activity of our time-based and performance restricted stock units for the first nine months of fiscal 2016 (in thousands, except per share amounts):


20

Table of Contents

 
Time Based Restricted Stock Units
 
Performance Restricted Stock Units
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Nonvested stock at October 3, 2015
394

 
$
65.17

 
199

 
$
67.09

Granted
269

 
64.42

 
65

 
74.48

Vested(1)
(191
)
 
61.12

 
(57
)
 
48.48

Forfeited
(12
)
 
63.82

 
(38
)
 
48.48

Nonvested stock at July 2, 2016
460

 
$
66.45

 
169

 
$
74.10


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

21

Table of Contents

For Controlling Configuration of Laser Induced Breakdown and Ablation,” issued November 5, 1997. The patent, now expired in all jurisdictions, 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. Following the filing of the infringement suit, our subsidiaries filed a separate nullity action with the Federal Patent Court in Munich, Germany requesting that the court hold that the Patent was invalid based on prior art. On October 1, 2015, the Federal Patent Court ruled that the German portion of the Patent was invalid. Imra has filed a notice to appeal this decision to the Federal Court of Justice, the highest civil jurisdiction court in Germany. The infringement action is currently stayed pending the outcome of such appeal. 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 condensed 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.

The United States and many foreign governments impose tariffs and duties on the import and export of certain products we sell. From time to time our duty calculations and payments are audited by government agencies. During the second quarter of fiscal 2016, we concluded an audit in South Korea for customs duties and value added tax for the period March 2009 to March 2014. We paid $1.6 million related to this matter in the second quarter of fiscal 2016 and have no remaining accrual at July 2, 2016.

On March 16, 2016, we entered into a debt commitment letter with Barclays Bank PLC ("Barclays") and on April 5, 2016, entered into an amended and restated debt commitment letter with Barclays and both Bank of America, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (together, "BAML"). See Note 9 "Short-term Borrowings".

We have an agreement with a financial advisor, Barclays, in relation to the pending acquisition of Rofin. We have agreed to pay Barclays a fee of approximately $10.5 million, $1.0 million of which was paid upon delivery of the fairness opinion in the second quarter of fiscal 2016, and was recorded in the selling, general and administrative line of the condensed consolidated statements of operations, and the remaining portion of which will be paid upon, and subject to, consummation of the acquisition. We have also agreed to pay to Barclays approximately $17.0 million and $7.5 million for underwriting and upfront fees, respectively, upon the close of the financing. In addition, the acquisition agreement contains certain termination rights for Coherent and further provides that we may be required to pay a termination fee of $65.0 million to Rofin and $2.4 million to Barclays.

12.  STOCK REPURCHASE
 
On July 25, 2014, the Board of Directors authorized a buyback program whereby we were authorized to repurchase up to $25.0 million of our common stock from time to time through July 31, 2015. During the first quarter of fiscal 2015, we repurchased and retired 300,441shares of outstanding common stock at an average price of $57.55 per share for a total of $17.3 million, excluding expenses. During the second quarter of fiscal 2015, we repurchased and retired 133,673 shares of outstanding common stock under this plan at an average price of $57.66 per share for a total of $7.7 million, completing the repurchase program.

On January 21, 2015, our Board of Directors authorized an additional stock repurchase program to repurchase up to $25.0 million of our outstanding common stock from time to time through January 31, 2016. During the fourth quarter of fiscal 2015, we repurchased and retired 430,675 shares of outstanding common stock under this plan at an average price of $58.05 per share for a total of $25.0 million.


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On August 25, 2015, our Board of Directors authorized an additional stock repurchase program to repurchase up to $25.0 million of our outstanding common stock from time to time through August 31, 2016. During the fourth quarter of fiscal 2015, we repurchased and retired 437,534 shares of outstanding common stock under this plan at an average price of $57.14 per share for a total of $25.0 million.



13.  EARNINGS PER SHARE
 
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
 
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data): 
 
Three Months Ended
 
Nine Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Weighted average shares outstanding —basic
24,192

 
24,737

 
24,108

 
24,794

 
Dilutive effect of employee stock awards
275

 
235

 
247

 
224

 
Weighted average shares outstanding—diluted
24,467

 
24,972

 
24,355

 
25,018

 
 
 
 
 
 
 
 
 
 
Net income
$
18,650

 
$
13,264

 
$
56,717

 
$
49,107

 
 
 
 
 
 
 
 
 
 
Net income per basic share
$
0.77

 
$
0.54

 
$
2.35

 
$
1.98

 
Net income per diluted share
$
0.76

 
$
0.53

 
$
2.33

 
$
1.96

 
 
A total of 214 and 71 potentially dilutive securities have been excluded from the diluted share calculation for the three and nine months ended July 2, 2016 as their effect was anti-dilutive. A total of 333 and 44,688 potentially dilutive securities have been excluded from the diluted share calculation for the three and nine months ended July 4, 2015 as their effect was anti-dilutive.
 
14.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 
 
Three Months Ended
 
Nine Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Foreign exchange loss
$
(1,261
)
 
$
(869
)
 
$
(2,781
)
 
$
(950
)
 
Gain on deferred compensation investments, net
1,796

 
121

 
795

 
1,176

 
Other
29

 
(39
)
 
90

 
60

 
Other - net
$
564

 
$
(787
)
 
$
(1,896
)
 
$
286

 

15.  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 July 2, 2016 were 31.3% and 27.7%, respectively. Our effective tax rates for the three and nine months ended July 2, 2016 were lower than the statutory rate of 35.0% primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including the Singapore tax exemption, the benefit of foreign tax credits and the benefit of federal research and development tax credits including renewal of the federal research and development tax credits for fiscal 2015. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules including an intercompany loan from Coherent Korea that will likely be repaid in fiscal 2017, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

Our effective tax rates for the three and nine months ended July 4, 2015 were 26.7% and 25.4%, respectively. Our effective tax rates for the three and nine months ended July 4, 2015 were lower than the statutory rate of 35.0% primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including South Korea and Singapore tax exemptions, the benefit of foreign tax credits and the benefit of the federal research and development tax credits including renewal of the federal research and development tax credits for fiscal 2014. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

Determining the consolidated provision for income taxes, income tax liabilities and deferred tax assets and liabilities involves judgment. We calculate and provide for income taxes in each of the tax jurisdictions in which we operate, which involves estimating current tax exposures as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.

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 fiscal 2011 are closed. In our major foreign jurisdictions and our major state jurisdictions, the years prior to fiscal 2011 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 March 2016, the Internal Revenue Service (IRS) issued an audit notice and Information Documentation Requests (IDRs) for fiscal year 2013. The audit is currently in progress.

In December 2011 and January 2012, three of our German subsidiaries received notices of tax audits for the fiscal years 2006 through 2010. The audits were completed in the third quarter of fiscal 2016. As a result of the settlement, our gross uncertain tax positions decreased by approximately $4.9 million. The net impact of the adjustments was immaterial to the condensed consolidated statement of operations.

In July 2015 and March 2016, Coherent Kaiserslautern GmbH (formerly Lumera Laser GmbH) received tax audit notices for the years 2010 to 2014. The audit began in August 2015. We acquired the shares of Lumera Laser GmbH in December 2012 and, pursuant to the terms of the acquisition agreement, we should not have responsibility for any assessments related to the pre-acquisition period. In March 2016, Coherent Japan KK received a tax audit notice for the years 2013 to 2015. The audit will begin in the fourth quarter of fiscal 2016. In June, 2016, Coherent Holding and Coherent Deutschland GmbH received a tax audit notice for the years 2011 to 2014. The audit will begin in the fourth quarter of fiscal 2016.

We regularly engage in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions and management believes that it has adequately provided reserves for any adjustments that may result from tax examinations.


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The Consolidated Appropriations Act of 2016 (“the Act”), was enacted on December 18, 2015. Under the Act, the federal research and development tax credit was retroactively extended for amounts paid or incurred after December 31, 2014
through December 31, 2015 and the credit was made permanent. The effects of the change in the tax law are recognized in our first quarter of fiscal 2016, which is the quarter that the law was enacted. Accordingly, prior year research and development tax credits of approximately $1.2 million, after netting with appropriate reserves, were recognized in the first quarter of fiscal 2016.

Coherent Korea received approval for an additional High-Tech tax exemption in April 2016 from the Korean authorities and must make a capital contribution for the exemption to be effective.

16.  SEGMENT INFORMATION
 
The following table provides net sales and income from operations for our operating segments and a reconciliation of our total income from operations to net income (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Net sales:
 
 
 
 
 
 
 
 
Specialty Laser Systems
$
161,140

 
$
123,341

 
$
440,444

 
$
408,448

 
Commercial Lasers and Components
57,627

 
65,161

 
168,480

 
184,390

 
Total net sales
$
218,767

 
$
188,502

 
$
608,924

 
$
592,838

 
 
 
 
 
 
 
 
 
 
Income (expense) from operations:
 
 
 
 
 
 
 
 
Specialty Laser Systems
$
44,306

 
$
24,760

 
$
117,736

 
$
91,392

 
Commercial Lasers and Components
(776
)
1,825

4,227

 
2,623

 
7,209

7,209

Corporate and other
(17,242
)
 
(10,293
)
 
(40,784
)
 
(33,466
)
 
Total income from operations
26,288

 
18,694

 
79,575

 
65,135

 
    Total other income (expense), net
852

 
(608
)
 
(1,150
)
 
697

 
Income before income taxes
27,140

 
18,086

 
78,425

 
65,832

 
    Provision for income taxes
8,490

 
4,822

 
21,708

 
16,725

 
Net Income
$
18,650

 
$
13,264

 
$
56,717

 
$
49,107

 
   
Major Customers

We had one major customer during the three and nine months ended July 2, 2016 who accounted for 15.8% and 16.8%, respectively, of consolidated revenue. This same customer accounted for 12.3% of consolidated revenue for the three months ended July 4, 2015. We had another major customer during the three and nine months ended July 2, 2016 who accounted for 11.3% and 10.6%, respectively, of consolidated revenue. This customer accounted for 15.4% of consolidated revenue for the nine months ended July 4, 2015. Both customers purchased primarily from our SLS segment.

We had one major customer who accounted for 13.9% of accounts receivable at July 2, 2016. We had another major customer who accounted for 12.0% and 21.4% of accounts receivable at July 2, 2016 and October 3, 2015, respectively. Both customers purchased primarily from our SLS segment.

17.  SUBSEQUENT EVENT
 
On August 1, 2016, we purchased forward contracts totaling 670.0 million Euro, with a value date of November 30, 2016, to limit our foreign exchange risk related to the commitment of our term loan (denominated in Euros) in an amount of the Euro equivalent of $750.0 million to finance the U.S. dollar payment for the acquisition of Rofin. The derivatives used to hedge our currency exposure do not qualify for hedge accounting treatment. These derivatives will be marked to market at the end of each reporting period with gains and losses recognized in other income (expense).

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 providers of lasers and laser-based technology in a broad range of scientific, commercial and industrial 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 original equipment manufacturer ("OEM")

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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, OEM components and instrumentation and microelectronics.
 
Income from operations is the measure of profit and loss that our chief operating decision maker (“CODM”) uses to assess performance and make decisions. Income 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.
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-based compensation expense, 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

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States of America and pursuant to the rules and regulations of the SEC. The preparation of these condensed 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 condensed 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 October 3, 2015.
 

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
 
 
 
 
 
July 2, 2016
 
July 4, 2015
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
390,814

 
$
176,665

 
$
214,149

 
121.2
 %
Book-to-bill ratio
1.79

 
0.94

 
0.85

 
90.4
 %
Net sales—Specialty Lasers and Systems
$
161,140

 
$
123,341

 
$
37,799

 
30.6
 %
Net sales—Commercial Lasers and Components
$
57,627

 
$
65,161

 
$
(7,534
)
 
(11.6
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
47.6
%
 
45.4
%
 
2.2
 %
 
4.8
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
32.2
%
 
35.8
%
 
(3.6
)%
 
(10.1
)%
Research and development as a percentage of net sales
9.8
%
 
11.3
%
 
(1.5
)%
 
(13.3
)%
Income before income taxes
$
27,140

 
$
18,086

 
$
9,054

 
50.1
 %
Net cash provided by (used in) operating activities