2014.12.27_10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ___________________________________________________
FORM 10-Q
 ___________________________________________________
 
(Mark One)
S
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 27, 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 S No £
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer S
 
Accelerated filer £
 
 
 
Non-accelerated filer £
 
Smaller reporting company £
(do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £  No S
 
The number of shares outstanding of registrant’s common stock, par value $.01 per share, on January 30, 2015 was 24,731,941.



Table of Contents

COHERENT, INC.

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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Table of Contents

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



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Table of Contents

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

 
Three Months Ended
 
 
December 27,
2014
 
December 28,
2013
 
Net sales
$
200,615

 
$
193,556

 
Cost of sales
118,296

 
116,010

 
Gross profit
82,319

 
77,546

 
Operating expenses:
 

 
 

 
Research and development
19,173

 
20,937

 
Selling, general and administrative
38,141

 
39,891

 
Amortization of intangible assets
696

 
934

 
Total operating expenses
58,010

 
61,762

 
Income from operations
24,309

 
15,784

 
Other income (expense):
 

 
 
 
Interest income
96

 
59

 
Interest expense
(11
)
 
(23
)
 
Other—net
(770
)
 
(256
)
 
Total other expense, net
(685
)
 
(220
)
 
Income before income taxes
23,624

 
15,564

 
Provision for income taxes
6,194

 
3,861

 
Net income
$
17,430

 
$
11,703

 
 
 
 
 
 
Net income per share:
 

 
 

 
Basic
$
0.70

 
$
0.48

 
Diluted
$
0.69

 
$
0.47

 
 
 
 
 
 
Shares used in computation:
 

 
 

 
Basic
24,936

 
24,542

 
Diluted
25,197

 
24,915

 
 
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
 
 
December 27,
2014
 
December 28,
2013
 
 
 
 
 
 
Net income
$
17,430

 
$
11,703

 
Other comprehensive income (loss): (1)
 
 
 
 
Translation adjustment, net of taxes (2)
(14,519
)
 
1,148

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

375

 

 
Changes in unrealized losses on available-for-sale securities, net of taxes (4)
(73
)
 
(11
)
 
Other comprehensive income (loss), net of taxes
(14,217
)
 
1,137

 
Comprehensive income
$
3,213

 
$
12,840

 

(1)
Reclassification adjustments were not significant during the three months ended December 27, 2014 and December 28, 2013.

(2)
Tax expense (benefit) of $(752) and $1,186 was provided on translation adjustments during the three months ended December 27, 2014 and December 28, 2013, respectively. 

(3)
Tax expense of $217 was provided on net gain (loss) on derivative instruments during the three months ended December 27, 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)
 
December 27,
2014
 
September 27,
2014
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
129,420

 
$
91,217

Short-term investments
193,531

 
227,058

Accounts receivable—net of allowances of $1,090 and $1,155, respectively
130,461

 
137,324

Inventories
161,993

 
170,483

Prepaid expenses and other assets
34,021

 
27,839

Deferred tax assets
23,765

 
27,134

Total current assets
673,191

 
681,055

Property and equipment, net
103,978

 
107,424

Goodwill
106,602

 
109,513

Intangible assets, net
28,481

 
31,666

Other assets
65,755

 
69,717

Total assets
$
978,007

 
$
999,375

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
27,040

 
$
32,784

Income taxes payable
1,262

 
2,029

Other current liabilities
87,856

 
82,506

Total current liabilities
116,158

 
117,319

Other long-term liabilities
54,223

 
62,407

Commitments and contingencies (Note 10)


 


Stockholders’ equity:
 

 
 

Common stock, par value $.01 per share:
 

 
 

Authorized—500,000 shares
 

 
 

Outstanding—24,865 shares and 24,950 shares, respectively
248

 
248

Additional paid-in capital
168,806

 
184,042

Accumulated other comprehensive income
20,465

 
34,682

Retained earnings
618,107

 
600,677

Total stockholders’ equity
807,626

 
819,649

Total liabilities and stockholders’ equity
$
978,007

 
$
999,375


See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
Three Months Ended
 
December 27,
2014
 
December 28,
2013
Cash flows from operating activities:
 

 
 

Net income
$
17,430

 
$
11,703

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

Depreciation and amortization
6,210

 
6,699

Amortization of intangible assets
2,180

 
2,445

Deferred income taxes
6,988

 
(1,621
)
Stock-based compensation
4,390

 
4,868

Other non-cash (income) expense
360

 
(32
)
Changes in assets and liabilities, net of effect of acquisitions:
 

 
 

Accounts receivable
2,760

 
19,754

Inventories
4,715

 
(2,297
)
Prepaid expenses and other assets
(8,650
)
 
(9,256
)
Other assets
(658
)
 
(2,118
)
Accounts payable
(5,358
)
 
(5,658
)
Income taxes payable/receivable
(7,277
)
 
(4,361
)
Other current liabilities
7,145

 
5,250

Other long-term liabilities
816

 
3,301

Net cash provided by operating activities
31,051

 
28,677

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(5,138
)
 
(6,792
)
Proceeds from dispositions of property and equipment
568

 
182

Purchases of available-for-sale securities
(43,780
)
 
(47,224
)
Proceeds from sales and maturities of available-for-sale securities
77,370

 
51,605

Net cash provided by (used in) investing activities
29,020

 
(2,229
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
11,542

 
21,154

Repayments of short-term borrowings
(11,542
)
 
(21,154
)
Net change in capital lease obligations

 
(2
)
Repurchase of common stock
(17,298
)
 

Issuance of common stock under employee stock option and purchase plans
3,437

 
6,810

Net settlement of restricted common stock
(5,200
)
 
(7,658
)
Net cash used in financing activities
(19,061
)
 
(850
)
Effect of exchange rate changes on cash and cash equivalents
(2,807
)
 
2,333

Net increase in cash and cash equivalents
38,203

 
27,931

Cash and cash equivalents, beginning of period
91,217

 
110,444

Cash and cash equivalents, end of period
$
129,420

 
$
138,375


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 September 27, 2014. 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 first fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal year 2015 includes 53 weeks and fiscal 2014 includes 52 weeks.
 
2.    RECENT ACCOUNTING STANDARDS
 
Adoption of New Accounting Pronouncements

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 have adopted the FASB’s amended guidance prospectively for our fiscal year beginning September 28, 2014 in accordance with the new standard. As a result of this adoption, both long-term income taxes payable and noncurrent deferred tax assets decreased by approximately $7.9 million on our condensed consolidated balance sheet as of December 27, 2014.

Recently Issued Accounting Pronouncement

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 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; early adoption is not permitted. We are currently evaluating the new guidance and have not determined the impact this standard may have on our financial statements nor have we decided upon the method of adoption.
3.     FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES
 
We measure our cash equivalents and marketable securities at fair value. The fair values of our financial assets and liabilities are determined using quoted market prices of identical assets or quoted market prices of similar assets from active markets. Level 1 valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 valuations are obtained from quoted market prices in active markets involving similar assets; these instruments, which mature within two years and are issued by counterparties with high credit ratings, include U.S. Treasury and international government obligations, investment-grade corporate bonds, certificates of deposit and commercial paper. Level 3 valuations would be based on unobservable inputs to a valuation model and include our own data about assumptions market participants would use in pricing the asset or liability based on the best information available under the circumstances. As of December 27, 2014 and September 27, 2014, we did not have any assets or liabilities valued based on Level 3 valuations.

Financial assets and liabilities measured at fair value as of December 27, 2014 and September 27, 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
 
December 27, 2014
 
September 27, 2014
 
(Level 1)
 
(Level 2)
 
(Level 1)
 
(Level 2)
Money market fund deposits(1)
$
14,516

 
$

 
$
5,975

 
$

Certificates of deposit(1)

 
37,396

 

 
12,084

U.S. and international government obligations(3)(8)

 
141,456

 

 
150,088

Corporate notes and obligations(2)(8)

 
52,853

 

 
52,987

Commercial paper(4)(8)

 
7,999

 

 
25,383

Equity Securities (5)

 
130

 

 

Foreign currency contracts(6)(9)

 
(1,316
)
 

 
(1,830
)
Mutual funds — Deferred comp and supplemental plan(7)(10)
15,225

 

 
15,000

 

 ___________________________________________________
(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)
December 27, 2014: $8,905 recorded in cash and cash equivalents and $132,551 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

September 27, 2014: Included in short-term investments on the Condensed Consolidated Balance Sheet.

(4)
December 27, 2014: Included in short-term investments on the Condensed Consolidated Balance Sheet.

September 27, 2014: Includes $1,400 recorded in cash and cash equivalents and $23,983 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(5)
December 27, 2014: Includes $2 recorded in cash and cash equivalents and $128 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(6)          December 27, 2014: Includes $398 and $360 recorded in prepaid expenses and other assets on the Condensed Consolidated Balance Sheet for non-designated forward contracts and cash flow contracts, respectively. Includes $1,414 and $660 recorded in other current liabilities on the Condensed Consolidated Balance Sheet for non-designated forward contracts and cash flow contracts, respectively. (See Note 4).

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September 27, 2014: Includes $303 and $63 recorded in prepaid expenses and other assets on the Condensed Consolidated Balance Sheet for non-designated forward contracts and cash flow contracts, respectively. Includes $1,246 and $950 both recorded in other current liabilities on the Condensed Consolidated Balance Sheet for non-designated forward contracts and cash flow contracts, respectively. (See Note 4).

(7)
December 27, 2014: Includes $1,560 recorded in prepaid expenses and other assets and $13,665 recorded in other assets on the Condensed Consolidated Balance Sheet.

September 27, 2014: Includes $1,515 recorded in prepaid expenses and other assets and $13,485 recorded in other assets on the Condensed Consolidated Balance Sheet.

(8)
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.

(9)
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.

(10)
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 market and listed securities for which no sale was reported on that date are stated as the last quoted bid price.
 
4.     DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
All derivatives, whether designated in hedging relationships or not, are recorded on the Condensed Consolidated Balance Sheet at fair value. We enter into foreign exchange forwards to minimize the risks of foreign currency fluctuation of specific assets and liabilities on the balance sheet; these are not designated as hedging instruments. Our derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by us or the counterparties.

We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, Japanese Yen (JPY), 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 four 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 Other Comprehensive Income ("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 December 27, 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

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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 amounts of non-designated hedge contracts, with maximum maturity of four months, are as follows (in thousands):
 
 
U.S. Notional Contract Value
 
U.S. Fair Value
 
December 27, 2014
 
September 27, 2014
 
December 27, 2014
 
September 27, 2014
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
48,113

 
$
31,926

 
$
(1,240
)
 
$
(1,153
)
  Sell
$
(2,624
)
 
$

 
$
(12
)
 
$

Japanese Yen currency hedge contracts
 
 
 
 
 
 
 
  Purchase
$
307

 
$
471

 
$

 
(3
)
  Sell
$
(8,369
)
 
$
(15,084
)
 
$
368

 
$
169

 
 
 
 
 
 
 
 
Korean Won currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(4,235
)
 
$
(2,991
)
 
$
(68
)
 
$
72

 
 
 
 
 
 
 
 
Chinese RMB currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(9,035
)
 
$
(15,678
)
 
$
(57
)
 
$
(56
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
2,445

 
$
1,899

 
$
(25
)
 
$
(35
)
Sell
$
(5,447
)
 
$
(3,515
)
 
$
18

 
$
63

 
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. Fair Value
 
December 27, 2014
 
September 27, 2014
 
December 27, 2014
 
September 27, 2014
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
5,574

 
$
11,149

 
$
(660
)
 
$
(950
)
 
 
 
 
 
 
 
 
Japanese Yen currency hedge contracts

 
 
 
 
 
 
 
Sell
$
(5,859
)
 
$
(12,091
)
 
$
360

 
$
63


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 US 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

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 (see Note 3); such amounts were not material as of December 27, 2014 and September 27, 2014.

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
 
 
 
December 27, 2014
 
December 28, 2013
 
Derivatives designated as hedging instruments
 
 
 

 
 

 
Gains(losses) in AOCI on derivatives (effective portion), after tax
AOCI
 
$
375

 
$

 
Gains(losses) reclassified from AOCI into income (effective portion)
Revenue
 
$
300

 
$

 
Gains(losses) reclassified from AOCI into income (effective portion)
Cost of sales
 
$
(614
)
 
$

 
Gains(losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Other income(expense)
 
$
35

 
$

 
Derivatives not designated as hedging instruments

 
 


 


 
Gains(losses) recognized in income
Other income(expense)
 
$
(712
)
 
$
(38
)
 


The amounts that will be reclassified from AOCI to earnings will generally be 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 December 27, 2014 and September 27, 2014 (in thousands):


 
 
 
 
 
 
 
 
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 December 27, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
758

 
$

 
$
758

 
$
(88
)
 
$

 
670

 
As of September 27, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
367

 
$

 
$
367

 
$
(367
)
 
$

 
$

 
(1) The balances at December 27, 2014 and September 27, 2014 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with the master netting agreements.

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Table of Contents


 
 
 
 
 
 
 
 
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 December 27, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(2,074
)
 
$

 
$
(2,074
)
 
$
88

 
$

 
(1,986
)
 
As of September 27, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
(2,197
)
 
$

 
$
(2,197
)
 
$
367

 
$

 
$
(1,830
)
 
(1) The balances at December 27, 2014 and September 27, 2014 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with the master netting agreements.


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):
 
 
December 27, 2014
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
129,415

 
$
6

 
$
(1
)
 
$
129,420

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
7,999

 
$

 
$

 
$
7,999

U.S. Treasury and agency obligations
131,888

 
732

 
(69
)
 
132,551

Equity Securities
99

 
29

 

 
128

Corporate notes and obligations
52,617

 
319

 
(83
)
 
52,853

Total short-term investments
$
192,603

 
$
1,080

 
$
(152
)
 
$
193,531

 

12

Table of Contents

 
September 27, 2014
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
91,217

 
$

 
$

 
$
91,217

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
23,983

 
$

 
$

 
$
23,983

       U.S. Treasury and agency obligations
149,260

 
831

 
(3
)
 
150,088

Corporate notes and obligations
52,834

 
195

 
(42
)
 
52,987

Total short-term investments
$
226,077

 
$
1,026

 
$
(45
)
 
$
227,058

 
None of the unrealized losses as of December 27, 2014 or September 27, 2014 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 December 27, 2014 and September 27, 2014, classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):
 
 
December 27, 2014
 
September 27, 2014
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year
$
152,248

 
$
153,139

 
$
178,329

 
$
179,223

Investments in available-for-sale debt securities due in one to five years (1)
$
40,256

 
$
40,264

 
$
47,748

 
$
47,835

(1) Classified as short-term investments because these securities are highly liquid and can be sold at any time. 

During the three months ended December 27, 2014, we received proceeds totaling $29.6 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million. During the three months ended December 28, 2013, we received proceeds totaling $7.0 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million.

6.    GOODWILL AND INTANGIBLE ASSETS
 
Goodwill is tested for impairment on an annual basis and between annual tests if events or circumstances indicate that an impairment loss may have occurred, and we write down these assets when impaired. We perform our annual impairment tests during the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.

During the three months ended December 27, 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 27, 2014 to December 27, 2014 are as follows (in thousands):
 
Specialty
Lasers and
Systems
 
Commercial
Lasers and
Components
 
Total
Balance as of September 27, 2014
$
103,150

 
$
6,363

 
$
109,513

Additions

 

 

Translation adjustments and other
(2,911
)
 

 
(2,911
)
Balance as of December 27, 2014
$
100,239

 
$
6,363

 
$
106,602

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

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Table of Contents

 
 
December 27, 2014
 
September 27, 2014
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
80,063

 
$
(58,792
)
 
$
21,271

 
$
81,551

 
$
(57,827
)
 
$
23,724

Customer lists
16,238

 
(9,508
)
 
6,730

 
16,632

 
(9,199
)
 
7,433

Trade name
421

 
(349
)
 
72

 
431

 
(346
)
 
85

In-process research & development
408

 

 
408

 
424

 

 
424

Total
$
97,130

 
$
(68,649
)
 
$
28,481

 
$
99,038

 
$
(67,372
)
 
$
31,666

     ** 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 December 27, 2014 and December 28, 2013 was $2.2 million and $2.4 million, respectively, which includes $1.7 million and $1.9 million, respectively, for amortization of existing technology.

At December 27, 2014, estimated amortization expense for the remainder of fiscal 2015, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):
 
Estimated
Amortization
Expense
2015 (remainder)
$
6,438

2016
8,210

2017
7,086

2018
4,170

2019
2,232

2020
201

Thereafter
144

Total
$
28,481


7.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
December 27,
2014
 
September 27,
2014
Purchased parts and assemblies
$
49,454

 
$
51,091

Work-in-process
65,238

 
70,486

Finished goods
47,301

 
48,906

Total inventories
$
161,993

 
$
170,483

 
Prepaid expenses and other assets consist of the following (in thousands):
 
December 27,
2014
 
September 27,
2014
Prepaid and refundable income taxes
$
8,887

 
$
11,001

Other taxes receivable
11,068

 
5,184

Prepaid expenses and other
14,066

 
11,654

Total prepaid expenses and other assets
$
34,021

 
$
27,839

 
Other assets consist of the following (in thousands):

14

Table of Contents

 
December 27,
2014
 
September 27,
2014
Assets related to deferred compensation arrangements
$
26,888

 
$
26,484

Deferred tax assets
33,289

 
37,616

Other assets
5,578

 
5,617

Total other assets
$
65,755

 
$
69,717

 
Other current liabilities consist of the following (in thousands):
 
December 27,
2014
 
September 27,
2014
Accrued payroll and benefits
$
28,986

 
$
29,228

Deferred income
15,668

 
15,536

Warranty Reserve
16,604

 
16,961

Accrued expenses and other
13,411

 
13,410

Other taxes payable
9,057

 
5,036

Customer deposits
4,130

 
2,335

Total other current liabilities
$
87,856

 
$
82,506

 

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 three months of fiscal 2015 and 2014 were as follows (in thousands):
 
Three Months Ended
 
December 27,
2014
 
December 28,
2013
Beginning balance
$
16,961

 
$
18,508

Additions related to current period sales
5,608

 
6,708

Warranty costs incurred in the current period
(5,135
)
 
(6,815
)
Adjustments to accruals related to foreign exchange and other
(830
)
 

Ending balance
$
16,604

 
$
18,401

 
Other long-term liabilities consist of the following (in thousands):
 
December 27,
2014
 
September 27,
2014
Long-term taxes payable
$
7,864

 
$
15,776

Deferred compensation
28,402

 
27,858

Deferred tax liabilities
6,046

 
6,511

Deferred income
3,229

 
3,448

Asset retirement obligations liability
2,151

 
2,222

Other long-term liabilities
6,531

 
6,592

Total other long-term liabilities
$
54,223

 
$
62,407

 
8.     SHORT-TERM BORROWINGS
 

15

Table of Contents

We have several lines of credit which allow us to borrow in the applicable local currency. We have a total of $13.7 million of unsecured foreign lines of credit as of December 27, 2014.  At December 27, 2014, we had used $3.0 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe, Japan and China during the first quarter of fiscal 2015.  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 December 27, 2014.

9.  STOCK-BASED COMPENSATION
 
Fair Value of Stock-based compensation
 
We recognize compensation expense for all share based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis over the respective requisite service period of the awards.
 
Determining Fair Value
 
The fair values of shares purchased under the Employee Stock Purchase Plan (“ESPP”) for the three months ended December 27, 2014 and December 28, 2013, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
 
Three Months Ended
 
 
 
December 27,
2014
 
December 28,
2013
 
Expected life in years
 
0.5

 
0.5

 
Expected volatility
 
24.8
%
 
24.8
%
 
Risk-free interest rate
 
0.1
%
 
0.1
%
 
Expected dividend yield
 
%
 
%
 
Weighted average fair value per share
 
$
13.97

 
$
13.49

 

    
There were no stock options granted during the three months ended December 27, 2014 and December 28, 2013.
 
Restricted stock awards and restricted stock units are typically subject to vesting restrictions—either time-based or performance-based market 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 target award. The weighted average fair value for these performance units was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
 

16

Table of Contents

 
Three Months Ended
 
December 27, 2014
 
December 28, 2013
Risk-free interest rate
0.96
%
 
0.62
%
Volatility
28.7
%
 
36.9
%
Weighted average fair value
$
70.57

 
$
77.10


 
We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period, with no adjustment in future periods based upon the actual shareholder return over the performance period.
 
Stock-Based Compensation Expense
 
The following table shows total stock-based compensation expense and related tax benefits included in the condensed consolidated statements of operations for the three months ended December 27, 2014 and December 28, 2013 (in thousands):
 
Three Months Ended
 
 
December 27, 2014
 
December 28, 2013
 
Cost of sales
$
597

 
$
538

 
Research and development
330

 
522

 
Selling, general and administrative
3,463

 
3,808

 
Income tax benefit
(430
)
 
(1,339
)
 
 
$
3,960

 
$
3,529

 

During the three months ended December 27, 2014, $0.7 million was capitalized into inventory for all stock plans, $0.6 million was amortized to cost of sales and $0.8 million remained in inventory at December 27, 2014. During the three months ended December 28, 2013, $0.7 million was capitalized into inventory for all stock plans, $0.5 million was amortized to cost of sales and $0.8 million remained in inventory at December 28, 2013.  Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.
 
At December 27, 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 $27.7 million, net of estimated forfeitures of $1.0 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.8 years and will be adjusted for subsequent changes in estimated forfeitures.

At December 27, 2014, total compensation cost related to options to purchase common shares under the ESPP but not yet recognized 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 three months of fiscal 2015 and fiscal 2014, 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):

17

Table of Contents

 
Number of
Shares
 
Weighted
Average
Exercise Price
Per Share
 
Weighted
Average
Remaining
Contractual
Term in Years
 
Aggregate
Intrinsic Value
Outstanding at September 27, 2014
107

 
$
29.20

 
 
 
 

Granted

 

 
 
 
 

Exercised
(4
)
 
23.16

 
 
 
 

Forfeitures

 

 
 
 
 

Expirations

 

 
 
 
 

Outstanding at December 27, 2014
103

 
$
29.46

 
3.8 years
 
$
3,395

Vested and expected to vest at December 27, 2014
103

 
$
29.46

 
3.8 years
 
$
3,395

Exercisable at December 27, 2014
103

 
$
29.46

 
3.8 years
 
$
3,395

 
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 for in-the money options. The aggregate intrinsic value of options exercised under the Company’s stock plans for the three months ended December 27, 2014 and December 28, 2013 were $0.2 million and $5.8 million, respectively, determined as of the date of option exercise.
 
The following table summarizes the activity of our time based and market- performance based restricted stock units for the first three months of fiscal 2015 (number of shares in thousands):

 
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 27, 2014
390

 
$
58.66

 
229

 
$
61.46

Granted
214

 
64.82

 
51

 
70.57

Vested
(194
)
 
51.99

 
(38
)
 
53.46

Forfeited
(2
)
 
60.81

 
(43
)
 
53.46

Nonvested stock at December 27, 2014
408

 
$
65.07

 
199

 
$
67.09


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





18

Table of Contents

10.      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 matter described below. On May 14, 2013, IMRA America (“Imra”) filed a complaint for patent infringement against two of the Company’s 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 of the amount which is reasonably estimable and probable 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.  We are currently under audit in South Korea for customs duties and value added tax for the period March 2009 to March 2014.  At this time, management has not made an accrual of an amount related to this matter since it has determined that such accrual is neither probable nor reasonably estimable.  Although we do not expect that the audit will ultimately have a material adverse effect on our condensed consolidated financial position, results of operations or cash flows, an adverse result in this matter could negatively affect our results in the period in which they occur.

 
11. STOCK REPURCHASE

On July 25, 2014, the Board of Directors authorized a buyback program whereby we are 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 300,441 shares of outstanding common stock at an average price of $57.55 per share for a total of $17.3 million, excluding expenses. During the month of January 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.


12.  EARNINGS PER SHARE
 
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
 
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data): 
 
Three Months Ended
 
 
December 27,
2014
 
December 28,
2013
 
Weighted average shares outstanding —basic
24,936

 
24,542

 
Dilutive effect of employee stock awards
261

 
373

 
Weighted average shares outstanding—diluted
25,197

 
24,915

 
 
 
 
 
 
Net income
$
17,430

 
$
11,703

 
 
 
 
 
 
Net income per basic share
$
0.70

 
$
0.48

 
Net income per diluted share
$
0.69

 
$
0.47

 
 
A total of 159,618 and 29,916 potentially dilutive securities have been excluded from the diluted share calculation for the three months ended December 27, 2014 and December 28, 2013, respectively, as their effect was anti-dilutive.
 
13.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 


19

Table of Contents

 
Three Months Ended
 
 
December 27,
2014
 
December 28,
2013
 
Foreign exchange loss
$
(1,161
)
 
$
(2,124
)
 
Gain on deferred compensation investments, net
384

 
1,877

 
Other—net
7

 
(9
)
 
Other expense, net
$
(770
)
 
$
(256
)
 

14.  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 rate for the three months ended December 27, 2014 was 26.2%. Our effective tax rate for the three months ended December 27, 2014 was 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. statutory tax rates including 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 2011 are closed. In our major foreign jurisdictions and our major state jurisdictions, the years prior to 2006 and 2010, 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.

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 foreign tax matters may be concluded in the next 12 months.

The Tax Increase Prevention Act of 2014 (“the Act”), was enacted on December 19, 2014. Under the Act, the federal research and development tax credit was retroactively extended for amounts paid or incurred after December 31, 2013
through December 31, 2014. The effects of the change in the tax law are recognized in our first quarter of fiscal 2015, which is the quarter that the law was enacted. Accordingly, prior year research and development tax credits of approximately $1.3 million less appropriate reserves are recognized in the first quarter of fiscal 2015.

15.  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 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 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.


20

Table of Contents

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 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 from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain research and development, management, finance, legal and human resources) and are included in the results below under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.

The following table provides net sales and income from operations for our operating segments (in thousands):
 
 
Three Months Ended
 
December 27,
2014
 
December 28,
2013
Net sales:
 
 
 
Specialty Laser Systems
$
145,091

 
$
136,823

Commercial Lasers and Components
55,524

 
56,733

Total net sales
$
200,615

 
$
193,556

 
 
 
 
Income from operations:
 
 
 
Specialty Laser Systems
$
34,554

 
$
28,632

Commercial Lasers and Components
703

 
306

Corporate and other
(10,948
)
 
(13,154
)
Total income from operations
$
24,309

 
$
15,784


    
The following table provides a reconciliation of our total income from operations to net income (in thousands):
 
 
Three Months Ended
 Reconciliation of Income From Operations to Net Income
December 27,
2014
 
December 28,
2013
Total income from operations
$
24,309

 
$
15,784

Total other income, net
(685
)
 
(220
)
Income before income taxes
23,624

 
15,564

Provision for income taxes
6,194

 
3,861

Net Income
$
17,430

 
$
11,703


Major Customers

We had one major customer during the three months ended December 27, 2014 who accounted for 18.6% and 13.8% of consolidated revenue during the three months ended December 27, 2014 and the three months ended December 28, 2013, respectively. The customer purchased primarily from our SLS segment.


21

Table of Contents

We had one major customer who accounted for 18.3% and 15.2% of accounts receivable at December 27, 2014 and September 27, 2014, respectively. There was one additional major customer who accounted for 11.6% of accounts receivable at September 27, 2014. Both customers purchased primarily from our SLS segment.

22


16.  SUBSEQUENT EVENT
 
On January 21, 2015, our board of directors authorized an additional stock repurchase program to repurchase up to $25.0 million of the Company's outstanding common stock from time to time through January 31, 2016.

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, Materials Processing, OEM Components and Instrumentation and Scientific Research and Government Programs.
 
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.


Table of Contents

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, 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 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 September 27, 2014.
 
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.

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Table of Contents

 
Three Months Ended
 
 
 
 
 
December 27, 2014
 
December 28, 2013
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
162,524

 
$
201,462

 
$
(38,938
)
 
(19.3
)%
Book-to-bill ratio
0.81

 
1.04

 
(0.23
)
 
(22.1
)%
Net sales—Specialty Lasers and Systems
$
145,091

 
$
136,823

 
$
8,268

 
6.0
 %
Net sales—Commercial Lasers and Components
$
55,524

 
$
56,733

 
$
(1,209
)
 
(2.1
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
44.0
%
 
43.1
%
 
0.9
 %
 
2.1
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
34.7
%
 
34.1
%
 
0.6
 %
 
1.8
 %
Research and development as a percentage of net sales
9.6
%
 
10.8
%
 
(1.2
)%
 
(11.1
)%
Income before income taxes
$
23,624

 
$
15,564

 
$
8,060

 
51.8
 %
Net cash provided by operating activities
$
31,051

 
$
28,677

 
$
2,374

 
8.3
 %
Days sales outstanding in receivables
58.5

 
53.8

 
4.7

 
8.7
 %
Annualized first quarter inventory turns
2.9

 
2.7

 
0.2

 
7.4
 %
Capital spending as a percentage of net sales
2.6
%
 
3.5
%
 
(0.9
)%
 
(25.7
)%
Net income as a percentage of net sales
8.7
%
 
6.0
%
 
2.7
 %
 
45.0
 %
Adjusted EBITDA as a percentage of net sales
18.7
%
 
16.4
%
 
2.3
 %
 
14.0
 %
 
Definitions and analysis of these performance indicators are as follows:
 
Bookings and Book-to-Bill Ratio
 
Bookings represent orders received during the current period for products and services to be provided pursuant to service contracts. While we generally have not experienced a significant rate of cancellation, bookings are generally cancelable by our customers without substantial penalty and, therefore, we cannot assure all bookings will be converted to net sales.
 
The book-to-bill ratio is calculated as quarterly bookings divided by quarterly net sales.  This is an indication of the strength of our business but can sometimes be impacted by a single large order. A ratio of greater than 1.0 indicates that demand for our products is greater than what we supply in the quarter whereas a ratio of less than 1.0 indicates that demand for our products is less than what we supply in the quarter.
 
Bookings decreased 19.3% in the first quarter of fiscal 2015 compared to the same quarter one year ago, with decreases in all four markets led by a significant decrease in the OEM components and instrumentation market. Compared to the fourth quarter of fiscal 2014, bookings decreased 11.0% with decreases in the OEM components and instrumentation, materials processing and microelectronics markets partially offset by an increase in the scientific and government programs market. The book-to-bill ratio was 0.81 in the first quarter of fiscal 2015. Bookings in the first quarter of fiscal 2015 were lower due to the timing of orders placed by customers following large, multi-quarter bookings in the second half of fiscal 2014.
 
Microelectronics
 
Microelectronics bookings decreased 10% compared to the same quarter one year ago and decreased 7% from bookings in the fourth quarter of fiscal 2014. The book-to-bill ratio for the first quarter of fiscal 2015 was 0.73.
 
Flat panel display orders in the first quarter of fiscal 2015 decreased 36% both from orders in the first and fourth quarters of fiscal 2014 due to timing of order placement by customers as we had record bookings in the first three quarters of fiscal 2014, as well as reduced service bookings as customers manage their inventory levels. We expect continued fluctuations in order volumes on a quarterly basis. The drivers for flat panel display are unchanged and include higher smartphone share, larger screen sizes, lower display unit costs and the emergence of flexible displays. We believe these factors favor larger format annealing systems in excess of one meter. In addition, flexible displays have enabled wearable devices and may be poised for a role in automotive applications, such as in digital instrument panels. We shipped the first Triple Vyper™ Linebeam 1500

25

Table of Contents

system in the first quarter of fiscal 2015. We are planning to ship the remaining two systems in the order during fiscal 2015, pursuant to the customer’s requested delivery schedule.
Orders in the advanced packaging (API) market increased 38% from orders in the first quarter of fiscal 2014 and 2% from orders in the fourth quarter of fiscal 2014. We expect bookings in the API market to increase over the course of fiscal 2015. We have broadened our customer set in microvia applications with greater emphasis on Chinese and Korean integrators. We believe this strategy will be beneficial in areas like flip-chip packaging. Additionally, the laser direct imaging market has posted good utilization numbers supporting service demand, slow capacity expansion and a shift to UV diode based imagers for the lower end of the market.
Orders from semiconductor capital equipment OEMs decreased 3% from the first quarter of fiscal 2014 but increased 35% from the fourth quarter of fiscal 2014. Industry trade groups project a record-setting year for capital expenditure investment. While we have seen a very modest increase in orders, we are starting to receive longer-term scheduling inquiries. These requests have historically correlated with an upturn in orders, but we believe it is too early to increase manufacturing levels.
Micro materials processing using short pulse lasers is the most dynamic part of microelectronics, with much of the business tied to consumer electronics, predominantly mobile devices, and is very project driven. We are actively engaged on a number of projects where our newer products like the Rapid NX, Avia NX, and Monaco offer process and performance advantages to the customer.
Materials Processing
 
Materials processing orders decreased 17% compared to the same quarter one year ago and decreased 22% from the fourth quarter of fiscal 2014. The book-to-bill ratio for the first quarter of fiscal 2015 was 0.83. First quarter of fiscal 2015 orders were lower following an exceptionally strong fourth quarter of fiscal 2014 as well as exhibiting some seasonal effects. Nonetheless, demand for our new J-Series CO2 lasers was strong with high sequential and year-over-year growth. We also released a redesigned laser manufacturing workstation, the META™ 10C, equipped with a kilowatt CO2 laser for the job shop market. The metal cutting market is very active. At the Fabtech tradeshow, some of the larger integrators were showing early homegrown fiber lasers or discussing plans to introduce them, driven by desires of differentiation and cost control. If successful, the trend will drive more top-down and bottom-up vertical integration. The additive manufacturing market is also showing positive trends which resulted in orders for CO2 and UV lasers in polymer processes; this market also appears to be driving demand for mid-power (500W-1kW) fiber lasers and direct diode systems.

OEM Components and Instrumentation
 
OEM Components and Instrumentation orders decreased 41% compared to the same quarter one year ago and decreased 21% from the fourth quarter of fiscal 2014. The book-to-bill ratio for the first quarter of fiscal 2015 was 0.77.

Orders for medical OEM products were 65% lower in the first quarter of fiscal 2015 compared to the same quarter one year ago and 48% lower than orders in the fourth quarter of fiscal 2014. The decreases predominantly reflect the timing of large medical OEM orders, rather than easing of demand in medical applications as medical OEM customers report stable to increasing demand. We have also launched a new product for the cataract market that supports a broader procedure window which is relevant because research shows not all cataracts are treated similarly. The more stubborn variety of cataracts occurs in populations closer to the equator due to increased sun exposure. Ability to vary the laser performance, as our new product does, allows for process optimization.
Instrumentation orders decreased 27% compared to the first quarter of fiscal 2014 but increased 11% compared to the fourth quarter of fiscal 2014. The growth was skewed towards emerging customers in China, North America and Europe for cytometry and sequencing applications.
Scientific and Government Programs
 
Scientific and government programs orders decreased 9% compared to the same quarter one year ago but increased 2% from the fourth quarter of fiscal 2014. The book-to-bill for the first quarter of fiscal 2015 was 1.11.
 
While overall research funding remains flat, there were some notable market and regional factors during the first quarter of fiscal 2015. The increase in life sciences research in Asia is continuing and led to record Chameleon™ orders from the region. Combined with traditional physical sciences, Asia also produced record scientific orders, with activity especially strong in China and Korea. North America and Europe were in-line with expectations and Japan orders were up modestly.

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Table of Contents

The biological imaging market continues to be the largest opportunity in the research market. Our Chameleon product line is a key contributor in this area and we recently released the newest version at the Neuroscience Conference in November 2014. The Chameleon Discovery is a different architect than earlier Ti:Sapphire-based Chameleons and is an Ytterbium laser with a tunable optical parametric oscillator (OPO) to provide very broad tuning with leading power performance. The combination allows investigators to target reagents and reactions not easily accessible with Ti:Sapphire. While we have offered OPOs with earlier versions of Chameleon, they were purchased from a vendor. The unit paired with Discovery is a Coherent-developed device, which should be beneficial to costs.
Net Sales
 
Net sales include sales of lasers, laser tools, related accessories and service. Net sales for the first fiscal quarter increased 6.0% in our SLS segment from the same quarter one year ago and decreased 2.1% in our CLC segment from the same quarter one year ago. For a description of the reasons for changes in net sales refer to the “Results of Operations” section of this quarterly report.

Gross Profit as a Percentage of Net Sales
 
Gross profit as a percentage of net sales (“gross profit percentage”) is calculated as gross profit for the period divided by net sales for the period.  Gross profit percentage in the first quarter increased from 43.1% to 44.0% in our SLS segment and increased from 34.1% to 34.7% in our CLC segment from the same quarter one year ago. For a description of the reasons for changes in gross profit refer to the “Results of Operations” section of this quarterly report.
 
Research and Development as a Percentage of Net Sales
 
Research and development as a percentage of net sales (“R&D percentage”) is calculated as research and development expense for the period divided by net sales for the period.  Management considers R&D percentage to be an important indicator in managing our business as investing in new technologies is a key to future growth.  R&D percentage decreased to 9.6% from 10.8% in our first fiscal quarter compared to the same period one year ago.  For a description of the reasons for changes in R&D spending refer to the “Results of Operations” section of this quarterly report.
 
Net Cash Provided by Operating Activities
 
Net cash provided by operating activities as reflected on our Condensed Consolidated Statements of Cash Flows primarily represents the excess of cash collected from billings to our customers and other receipts over cash paid to our vendors for expenses and inventory purchases to run our business.  We believe that cash flows from operations is an important performance indicator because cash generation over the long term is essential to maintaining a healthy business and providing funds to help fuel growth.  For a description of the reasons for changes in Net Cash Provided by Operating Activities refer to the “Liquidity and Capital Resources” section of this quarterly report.
 
Days Sales Outstanding in Receivables
 
We calculate days sales outstanding (“DSO”) in receivables as net receivables at the end of the period divided by net sales during the period and then multiplied by the number of days in the period, using 90 days for quarters.  DSO in receivables indicates how well we are managing our collection of receivables, with lower DSO in receivables resulting in higher working capital availability.  The more money we have tied up in receivables, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business.  Our DSO in receivables for the first quarter of fiscal 2015 increased 4.7 days from the same quarter one year ago primarily due to a higher concentration of sales in the last month of the fiscal quarter and timing of collections, particularly in Europe.
 
Annualized First Quarter Inventory Turns
 
We calculate annualized first quarter inventory turns as the cost of sales during the first quarter annualized and divided by net inventories at the end of the first quarter. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. The more money we have tied up in inventory, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our annualized inventory turns for the first quarter of fiscal 2015 increased by 0.2 turns from the same quarter one year ago primarily due to the impact of lower levels of service inventory.

Capital Spending as a Percentage of Net Sales

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Table of Contents

 
Capital spending as a percentage of net sales (“capital spending percentage”) is calculated as capital expenditures for the period divided by net sales for the period.  Capital spending percentage indicates the extent to which we are expanding or improving our operations, including investments in technology and equipment.  Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage decreased to 2.6% from 3.5% for the first quarter of fiscal 2015 compared to the same period one year ago primarily due to lower purchases of production-related assets to support new product introductions.
 
Adjusted EBITDA as a Percentage of Net Sales

We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock-based compensation, major restructuring costs and certain other non-operating income and expense items. Key initiatives to reach our goals for EBITDA improvements include utilization of our Asian manufacturing locations, rationalizing our supply chain and continued leveraging of our infrastructure.

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

Below is the reconciliation of our net income as a percentage of net sales to our adjusted EBITDA as a percentage of net sales:

 
Three Months Ended
 
December 27,
2014
 
December 28,
2013
Net income as a percentage of net sales
8.7
%
 
6.0
%
Income tax expense
3.1
%
 
2.0
%
Interest and other (income) expense, net
0.6
%
 
1.1
%
Depreciation and amortization
4.1
%
 
4.8
%
Stock based compensation
2.2
%
 
2.5
%
Adjusted EBITDA as a percentage of net sales
18.7
%
 
16.4
%

SIGNIFICANT EVENTS

Stock Repurchases

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 300,441 shares of outstanding common stock under this plan at an average price of $57.55 per share for a total of $17.3 million. During the month of January 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, which concluded this program. For information regarding our new buyback program, please see Note 16 "Subsequent Event" to our condensed consolidated financial statements.

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

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Table of Contents

 
Three Months Ended
 
 
December 27,
2014
 
December 28,
2013
 
Net sales
100.0
 %
 
100.0
 %
 
Cost of sales
59.0
 %
 
59.9
 %
 
Gross profit
41.0
 %
 
40.1
 %
 
Operating expenses:
 
 
 
 
Research and development
9.6
 %
 
10.8
 %
 
Selling, general and administrative
19.0
 %
 
20.6
 %
 
Amortization of intangible assets
0.3
 %
 
0.5
 %
 
Total operating expenses
28.9
 %
 
31.9
 %
 
Income from operations
12.1
 %
 
8.2
 %
 
Other income (expense), net
(0.3
)%
 
(0.2
)%
 
Income before income taxes
11.8
 %
 
8.0
 %
 
Provision for income taxes
3.1
 %
 
2.0
 %
 
Net income
8.7
 %
 
6.0
 %
 

Net income for the first quarter of fiscal 2015 was $17.4 million ($0.69 per diluted share) including $4.0 million of after-tax stock-based compensation expense, $1.6 million after-tax amortization of intangible assets and a benefit of $1.1 million related to the renewal of the federal research and development tax credits for fiscal 2014. Net income for the first quarter of fiscal 2014 was $11.7 million ($0.47 per diluted share) including $3.5 million of after-tax stock-based compensation expense and $1.8 million amortization of intangible assets.
 
NET SALES
 
Market Application
 
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands):
 
Three Months Ended
 
December 27, 2014
 
December 28, 2013
 
Amount
 
Percentage
of total
 net sales
 
Amount
 
Percentage
 of total
 net sales
Consolidated:
 
 
 
 
 
 
 
Microelectronics
$
99,311

 
49.5
%
 
$
92,303

 
47.7
%
OEM components and instrumentation
41,289

 
20.6
%
 
40,003

 
20.7
%
Materials processing
28,758

 
14.3
%
 
27,970

 
14.4
%
Scientific and government programs
31,257

 
15.6
%
 
33,280

 
17.2
%
   Total
$
200,615

 
100.0
%
 
$
193,556

 
100.0
%

Net sales for the first quarter of fiscal 2015 increased by $7.1 million, or 4%, compared to the first quarter of fiscal 2014.  Sales increases in the microelectronics, OEM components and instrumentation and materials processing markets were partially offset by decreases in the scientific and government programs market.
 
The increase in the microelectronics market of $7.0 million, or 8%, was due to higher shipments of flat panel display annealing systems net of lower flat panel display tube replacement sales partially offset by lower shipments for semiconductor and advanced packaging applications. The increase in the OEM components and instrumentation market of $1.3 million, or 3%, was due primarily to higher shipments for medical applications partially offset by lower shipments for bio-instrumentation and military applications. Sales in the materials processing market increased $0.8 million, or 3%, primarily due to higher shipments of non-metal cutting and automotive manufacturing applications. Sales in the scientific and government programs market decreased $2.0 million, or 6%, primarily due to the timing of shipments to customers in Europe, particularly compared to the record level of shipments in the fourth quarter of fiscal 2014.

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Table of Contents


Backlog represents orders which we expect to be shipped within 12 months and the current portion of service contracts. Orders used to compute backlog are generally cancelable and subject to rescheduling by our customers without substantial penalties. Historically, we have not experienced a significant rate of cancellation or rescheduling outside the 12 month period, though we cannot guarantee that the rate of cancellations or rescheduling will not increase in the future. We have a backlog of orders shippable within 12 months of $295.9 million at December 27, 2014, including a significant concentration in the flat panel display market (34%) for customers which are primarily in Asia.

The timing for shipments of our higher average selling price excimer products in the flat panel display market have historically fluctuated and are in the future expected to fluctuate from quarter-to-quarter due to customer scheduling, our ability to manufacture these products and/or availability of supplies.  As a result, the timing to convert orders for these products to net sales will likely fluctuate from quarter-to-quarter.

Segments
 
We are organized into two reportable operating segments: Specialty Lasers and Systems (“SLS”) and Commercial Lasers and Components (“CLC”). SLS develops and manufactures configurable, advanced-performance products largely serving the microelectronics, scientific research and government programs and OEM components and instrumentation markets. CLC focuses on higher volume products that are offered in set configurations. CLC’s primary markets include materials processing, OEM components and instrumentation and microelectronics.
 
The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands):
 
Three Months Ended
 
December 27, 2014
 
December 28, 2013
 
Amount
 
Percentage
of total
net sales
 
Amount
 
Percentage
of total
net sales
Consolidated:
 
 
 
 
 
 
 
Specialty Lasers and Systems (SLS)
$
145,091

 
72.3
%
 
$
136,823

 
70.7
%
Commercial Lasers and Components (CLC)
55,524

 
27.7
%
 
56,733

 
29.3
%
   Total
$
200,615

 
100.0
%
 
$
193,556

 
100.0
%

Net sales for the first quarter of fiscal 2015 increased by $7.1 million, or 4%, compared to the first quarter of fiscal 2014, with increases of $8.3 million, or 6%, in our SLS segment and decreases of $1.2 million, or 2%, in our CLC segment.
 
The increase in our SLS segment sales was primarily due to higher shipments of flat panel display annealing systems partially offset by lower shipments for semiconductor applications and scientific and government research programs. The decrease in our CLC segment sales was primarily due to lower advanced packaging application sales partially offset by higher medical application sales. 

GROSS PROFIT
 
Consolidated
 
Our gross profit rate increased to 41.0% in the first quarter of fiscal 2015 from 40.1% in the first quarter of fiscal 2014. The increase in the gross profit rate was primarily due to lower other costs (0.9%) primarily due to improved inventory management, lower duty and freight charges and lower warranty costs (0.8%) partially offset by unfavorable product margins (0.8%) resulting from a less favorable product mix, unfavorable yields and the impact of lower volumes in certain business units net of the favorable impact from foreign currency fluctuations.

Our gross profit rate has been and will continue to be affected by a variety of factors including market mix, pricing on volume orders, our ability to manufacture advanced and more complex products, manufacturing efficiencies, excess and obsolete inventory write-downs, warranty costs, amortization of intangibles, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, commodity prices and foreign currency fluctuations, particularly the recent weakening of the Euro and Japanese Yen.
 

30

Table of Contents

Specialty Lasers and Systems
 
The gross profit rate in our SLS segment increased to 44.0% in the first quarter of fiscal 2015 from 43.1% in the first quarter of fiscal 2014 primarily due to lower warranty costs (0.9%) due to fewer warranty events, lower other costs (0.6%) primarily due to improved inventory management and lower duty costs resulting from more favorable regional mix as well as lower intangibles amortization (0.1%). These improvements were partially offset by unfavorable product costs (0.7%) due to a less favorable product mix within the microelectronics and scientific markets partially offset by the favorable impact from foreign currency fluctuations.

Commercial Lasers and Components

The gross profit rate in our CLC segment increased to 34.7% in the first quarter of fiscal 2015 from 34.1% in the first quarter of fiscal 2014 primarily due to lower other costs (1.6%) from improved inventory management and lower warranty costs (0.6%) as a result of fewer warranty events. These improvements were partially offset by unfavorable product costs (1.6%) resulting from unfavorable yields and higher manufacturing costs primarily due to lower volumes in several business units.
OPERATING EXPENSES:
 
 
Three Months Ended
 
December 27, 2014
 
December 28, 2013
 
Amount
 
Percentage of
total net sales
 
Amount
 
Percentage of
total net sales
 
(Dollars in thousands)
Research and development
$
19,173

 
9.6
%
 
$
20,937

 
10.8
%
Selling, general and administrative
38,141

 
19.0
%
 
39,891

 
20.6
%
Amortization of intangible assets
696

 
0.3
%
 
934

 
0.5
%
Total operating expenses
$
58,010

 
28.9
%
 
$
61,762

 
31.9
%

Research and development

Research and development expenses decreased $1.8 million, or 8%, during the first fiscal quarter ended December 27, 2014 compared to the same quarter one year ago.  The decrease was primarily due to $1.4 million lower project spending as a result of higher customer reimbursements for development projects and lower spending on various projects and the impact of foreign exchange rates ($0.4 million). These customer reimbursements are expected to be at a lower rate beginning in our second fiscal quarter. Other variable spending increases were offset by lower charges for increases in deferred compensation plan liabilities and lower stock-based compensation expense. On a segment basis as compared to the prior year period, SLS research and development spending decreased $1.0 million primarily due to lower project spending as a result of higher customer reimbursements for development projects and the impact of foreign exchange rates partially offset by higher other variable spending. CLC spending decreased $0.3 million primarily due to lower project spending. Corporate and other spending decreased $0.5 million primarily due to lower charges for increases in deferred compensation plan liabilities and lower stock-based compensation expense.

Selling, general and administrative

Selling, general and administrative expenses decreased $1.8 million or 4%, during the first fiscal quarter ended December 27, 2014 compared to the same quarter one year ago. The decrease was primarily due to $1.4 million lower charges for increases in deferred compensation plan liabilities with the related income for increases in deferred compensation plan assets recorded in other income (expense), the favorable impact of foreign exchange rates ($1.0 million), $0.4 million lower stock-based compensation expense and $0.3 million lower other net variable spending partially offset by $1.3 million higher payroll spending primarily due to higher salaries, benefits and variable compensation. On a segment basis as compared to the prior year period, SLS segment expenses were flat with higher headcount related spending offset by the favorable impact of foreign exchange rates. CLC spending was flat with higher headcount related spending offset by lower other variable spending. Spending for Corporate and other decreased $1.8 million primarily due to lower charges for deferred compensation plan liabilities and lower stock-based compensation expense.

Amortization of intangible assets
 

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Amortization of intangible assets decreased $0.2 million during the first three months of fiscal 2015 compared to the same period one year ago primarily due to the completion of amortization in fiscal 2014 of certain intangibles from prior acquisitions.
 
OTHER INCOME (EXPENSE) — NET
 
Other income (expense), net, decreased $0.5 million during the three months ended December 27, 2014 compared to the same period one year ago. The decrease was primarily due to lower gains on our deferred compensation plan assets net of expenses ($1.5 million) partially offset by lower net foreign exchange losses ($1.0 million) due to less significant movement in certain foreign currencies in the first quarter of fiscal 2015 as compared to the first quarter of fiscal 2014.
 
INCOME TAXES
 
The effective tax rate on income before income taxes for the first quarter of fiscal 2015 of 26.2% was 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. statutory tax rates including 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).
 
The effective tax rate on income before income taxes for the first quarter of fiscal 2014 of 24.8% was 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. statutory 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-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

LIQUIDITY AND CAPITAL RESOURCES
 
At December 27, 2014, we had assets classified as cash and cash equivalents and short-term investments, in an aggregate amount of $323.0 million, compared to $318.3 million at September 27, 2014. At December 27, 2014, approximately $225.5 million of this cash and securities was held in certain of our foreign subsidiaries, $91.1 million of which was denominated in currencies other than the U.S. dollar, primarily the Euro. We currently have approximately $224.1 million of cash held by foreign subsidiaries where we intend to permanently reinvest our accumulated earnings in these entities and our current plans do not demonstrate a need for these funds to support our domestic operations. If, however, a portion of these funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes. The amount of the taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated. We actively monitor the third-party depository institutions that hold these assets, primarily focusing on the safety of principal and secondarily maximizing yield on these assets. We diversify our cash and cash equivalents and investments among various financial institutions, money market funds and sovereign debt in order to reduce our exposure should any one of these financial institutions or financial instruments fail or encounter difficulties. To date, we have not experienced any material loss or lack of access to our invested cash, cash equivalents or short-term investments. However, we can provide no assurances that access to our invested cash, cash equivalents or short-term investments will not be impacted by adverse conditions in the financial markets.

In the fourth quarter of fiscal 2014, we converted $62.7 million of cash and securities held in certain of our foreign subsidiaries to U.S. dollars and invested those funds within a European subsidiary whose functional currency is the U.S. dollar. At December 27, 2014, this subsidiary had $127.6 million of U.S. dollar denominated investments primarily in U.S. Treasury Securities, Corporate Notes and Commercial Paper. Accordingly, there is no translation expense arising from this entity holding U.S. dollar denominated investments. The converted funds are not intended to be repatriated to the U.S. and no U.S. tax was triggered on the transfer of these funds to the European subsidiary. See ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK below for more information about risks and trends related to foreign currencies.

Sources and Uses of Cash
 
Historically, our primary source of cash has been provided by operations. Other sources of cash in the past three fiscal years include proceeds received from the sale of our stock through our employee stock option and purchase plans. Our historical uses of cash have primarily been for the repurchase of our common stock, capital expenditures, acquisitions of businesses and technologies and the payment of a special cash dividend in the first quarter of fiscal 2013. Supplemental information pertaining

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to our historical sources and uses of cash is presented as follows and should be read in conjunction with our condensed consolidated statements of cash flows and the notes to our condensed consolidated financial statements:
 
 
Three Months Ended
 
December 27,
2014
 
December 28,
2013
 
(in thousands)
Net cash provided by operating activities
$
31,051

 
$
28,677

Sales of shares under employee stock plans
3,437

 
6,810

Repurchase of common stock
(17,298
)
 

Capital expenditures<