2013.12.29_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 29, 2012
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 February 4, 2013 was 24,222,144.



Table of Contents

COHERENT, INC.

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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


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

 
Three Months Ended
 
 
December 29,
2012
 
December 31,
2011
 
Net sales
$
183,202

 
$
190,767

 
Cost of sales
105,567

 
110,408

 
Gross profit
77,635

 
80,359

 
Operating expenses:
 

 
 

 
Research and development
19,301

 
18,779

 
Selling, general and administrative
36,982

 
34,631

 
Amortization of intangible assets
854

 
1,636

 
Total operating expenses
57,137

 
55,046

 
Income from operations
20,498

 
25,313

 
Other income (expense):
 

 
 
 
Interest and dividend income
50

 
202

 
Interest expense
(12
)
 
(2
)
 
Other—net
(1,475
)
 
318

 
Total other income (expense), net
(1,437
)
 
518

 
Income before income taxes
19,061

 
25,831

 
Provision for income taxes
4,908

 
8,780

 
Net income
$
14,153

 
$
17,051

 
 
 
 
 
 
Net income per share:
 

 
 

 
Basic
$
0.60

 
$
0.73

 
Diluted
$
0.58

 
$
0.71

 
 
 
 
 
 
Shares used in computation:
 

 
 

 
Basic
23,770

 
23,462

 
Diluted
24,222

 
23,961

 
 
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 29,
2012
 
December 31,
2011
 
 
 
 
 
 
Net income
$
14,153

 
$
17,051

 
Other comprehensive income (loss):
 
 
 
 
Translation adjustment
4,120

 
(10,321
)
 
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes
1

 
16

 
Other comprehensive income (loss), net of tax
4,121

 
(10,305
)
 
Comprehensive income
$
18,274

 
$
6,746

 

(1)
Tax expense (benefit) of $(19) and $104 was provided on translation adjustments during the three months ended December 29, 2012 and December 31, 2011, respectively.  Tax expense (benefit) on changes in unrealized gains (losses) on available-for-sale securities was insignificant.


See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except par data)
 
December 29,
2012
 
September 29,
2012
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
87,996

 
$
67,761

Short-term investments
91,781

 
157,168

Accounts receivable—net of allowances of $1,769 and $1,443, respectively
126,010

 
144,345

Inventories
169,002

 
160,113

Prepaid expenses and other assets
55,611

 
61,730

Deferred tax assets
21,083

 
23,368

Total current assets
551,483

 
614,485

Property and equipment, net
116,574

 
115,096

Goodwill
111,624

 
77,689

Intangible assets, net
50,127

 
9,473

Other assets
67,296

 
64,029

Total assets
$
897,104

 
$
880,772

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term obligations
$
15

 
$
17

Accounts payable
29,396

 
29,088

Income taxes payable
27,621

 
33,944

Other current liabilities
101,539

 
90,739

Total current liabilities
158,571

 
153,788

Long-term obligations

 
2

Other long-term liabilities
67,269

 
55,326

Commitments and contingencies (Note 11)


 


Stockholders’ equity:
 

 
 

Common stock, par value $.01 per share:
 

 
 

Authorized—500,000 shares
 

 
 

Outstanding—24,041 shares and 23,746 shares, respectively
240

 
237

Additional paid-in capital
137,079

 
131,708

Accumulated other comprehensive income
44,576

 
40,455

Retained earnings
489,369

 
499,256

Total stockholders’ equity
671,264

 
671,656

Total liabilities and stockholders’ equity
$
897,104

 
$
880,772


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 29,
2012
 
December 31,
2011
Cash flows from operating activities:
 

 
 

Net income
$
14,153

 
$
17,051

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

Depreciation and amortization
6,108

 
5,828

Amortization of intangible assets
1,181

 
1,636

Deferred income taxes
(275
)
 
(527
)
Stock-based compensation
4,994

 
4,022

Excess tax benefit from stock-based compensation arrangements

 
(1,681
)
Other non-cash (income) expense
522

 
1,151

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

 
 

Accounts receivable
19,452

 
9,161

Inventories
2,113

 
2,671

Prepaid expenses and other assets
(4,281
)
 
(7,321
)
Other assets
(666
)
 
(497
)
Accounts payable
(445
)
 
(4,715
)
Income taxes payable/receivable
(410
)
 
(8,210
)
Other current liabilities
4,056

 
(3,110
)
Other long-term liabilities
821

 
676

Net cash provided by operating activities
47,323

 
16,135

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(3,901
)
 
(8,139
)
Proceeds from dispositions of property and equipment

 
26

Purchases of available-for-sale securities
(63,630
)
 
(12,593
)
Proceeds from sales and maturities of available-for-sale securities
128,526

 
30,188

Acquisition of businesses, net of cash acquired
(67,289
)
 

Net cash (used in) provided by investing activities
(6,294
)
 
9,482

 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings

 
4,786

Repayments of short-term borrowings

 
(4,786
)
Net change in capital lease obligations
(4
)
 
(4
)
Issuance of common stock under employee stock option and purchase plans
4,712

 
4,568

Cash dividend paid on common stock
(24,040
)
 

Repurchase of common stock

 
(20,665
)
Net settlement of restricted common stock
(4,046
)
 
(4,413
)
Excess tax benefits from stock-based compensation arrangements

 
1,681

Net cash used in financing activities
(23,378
)
 
(18,833
)
Effect of exchange rate changes on cash and cash equivalents
2,584

 
(6,183
)
Net increase in cash and cash equivalents
20,235

 
601

Cash and cash equivalents, beginning of period
67,761

 
167,061

Cash and cash equivalents, end of period
$
87,996

 
$
167,662

Supplemental disclosure of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
12

 
$
3

Income taxes
$
6,150

 
$
25,818

Cash received during the period for:
 

 
 

Income taxes
$
405

 
$
9,662

 
 
 
 
Non-cash investing and financing activities:
 

 
 

Unpaid property and equipment
$
1,000

 
$
1,933


See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    BASIS OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes thereto should be read in conjunction with the Coherent, Inc. (referred to herein as the “Company,” “we,” “our,” “us” or “Coherent”) consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended September 29, 2012. In the opinion of management, all adjustments necessary for a fair presentation of financial condition and results of operation as of and for the periods presented have been made and include only normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year or any other interim periods presented therein. Our fiscal year ends on the Saturday closest to September 30 and our first fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal years 2013 and 2012 each include 52 weeks.
 
2.    RECENT ACCOUNTING STANDARDS
 
Adoption of New Accounting Pronouncements

In July 2012, the Financial Accounting Standards Board (“FASB”) amended existing guidance related to goodwill and other intangible assets by giving an entity testing an indefinite-lived intangible asset for impairment the option to first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of an intangible asset is less than its carrying amount. If the entity determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is not more likely than not impaired, the entity would not need to calculate the fair value of the asset. The guidance does not revise the requirement to test indefinite-lived intangible assets annually for impairment or to test these assets for impairment between annual tests if there is a change in events or circumstances. This amended guidance was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. We adopted this authoritative guidance in the first quarter of fiscal 2013. As we did not have any indefinite-lived intangible assets recorded in our consolidated balance sheet, the implementation of this authoritative guidance did not have a material impact on our consolidated financial position, results of operations and cash flows in connection with our impairment testing.

Recently Issued Accounting Pronouncement

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

On December 20, 2012, we acquired privately held Lumera Laser GmbH (Kaiserslautern, Germany) ("Lumera") for approximately $51.5 million, excluding transaction costs. Lumera manufactures ultrafast solid state lasers for

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microelectronics, OEM medical and materials processing applications. Lumera has been included in our Specialty Lasers and Systems segment.

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

Tangible assets
$
14,820

 Goodwill
24,628
Intangible assets:
 
  Existing technology
20,300
  In-process R&D
1,800
  Trade name
200
  Customer lists
6,500
  Backlog
1,000
Deferred tax liabilities
(8,994)
Liabilities assumed
(8,793)
Total
$
51,461


Results of operations for the business have been included in our consolidated financial statements subsequent to the date of acquisition and pro forma results of operations in accordance with authoritative guidance for prior periods have not been presented because the effect of the acquisition was not material to our prior period consolidated financial results.

None of the goodwill from this purchase is deductible for tax purposes.

The identifiable intangible assets are being amortized over their respective useful lives of less than one to six years.
        
In-process research and development (“IPR&D”) consists of two projects that have not yet reached technological feasibility. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. The value assigned to IPR&D was determined by considering the value of the products under development to the overall development plan, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. During the development period, these assets will not be amortized as charges to earnings; instead these assets will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPR&D projects, the assets would then be considered finite-lived intangible assets and amortization of the assets will commence. None of the projects have been completed as of December 29, 2012.

We expensed $0.3 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in the three months ended December 29, 2012 and expensed $0.3 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in fiscal 2012.

Innolight Innovative Laser and Systemtechnik GmbH

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

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


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Tangible assets
$
2,510

 Goodwill
8,253

Intangible assets:
 
  Existing technology
8,500

  In-process R&D
430

  Trade name
100

  Customer lists
2,800

Deferred tax liabilities
(3,777
)
Liabilities assumed
(480
)
Total
$
18,336


Results of operations for the business have been included in our consolidated financial statements subsequent to the date of acquisition and pro forma results of operations in accordance with authoritative guidance for prior periods have not been presented because the effect of the acquisition was not material to our prior period consolidated financial results.

None of the goodwill from this purchase is deductible for tax purposes.

The identifiable intangible assets are being amortized over their respective useful lives of six to seven years.

IPR&D consists of two projects that have not yet reached technological feasibility. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. The value assigned to IPR&D was determined by considering the value of the products under development to the overall development plan, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. During the development period, these assets will not be amortized as charges to earnings; instead these assets will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPR&D projects, the assets would then be considered finite-lived intangible assets and amortization of the assets will commence. The projects have not been completed as of December 29, 2012.

We expensed $0.1 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in the three months ended December 29, 2012 and expensed $0.1 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in fiscal 2012.

Fiscal 2012 and Fiscal 2011 acquisitions

As more fully described in our Annual Report on Form 10-K for our fiscal year ended September 29, 2012, we acquired two companies in fiscal 2012 and fiscal 2011:

We acquired MiDAZ Lasers Ltd. ("Midaz") in the fourth quarter of fiscal 2012 for approximately $3.8 million in cash and recorded goodwill and intangible assets of approximately $4.6 million.

We acquired Hypertronics Pte Ltd (“Hypertronics”) in the second quarter of fiscal 2011 for approximately $14.5 million in cash and recorded goodwill and intangible assets of approximately $11.8 million.

Both businesses have been included in our Specialty Lasers and Systems segment. Results of operations for these businesses have been included in our consolidated financial statements subsequent to the date of their acquisition and pro forma results of operations in accordance with authoritative guidance for prior periods have not been presented because the effect of these acquisitions was not material to our prior period consolidated financial results.

During the second quarter of fiscal 2012, we determined that one of the hardware projects classified as IPR&D acquired from Hypertronics would not be completed.  As a result, $0.2 million was expensed in the second fiscal quarter for that project.  During the fourth quarter of fiscal 2012, we decided to no longer pursue orders of Hypertronics' legacy products and thus determined that an impairment review of the intangible assets was required. As a result of our analysis, we determined that the intangible assets were fully impaired and that the remaining hardware projects classified as IPR&D acquired from Hypertronics would not be completed.  As a result, we recorded a $4.0 million charge in amortization

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expense in the fourth quarter of fiscal 2012. We also wrote off $0.3 million of inventory unique to these products that were not expected to be resold.


4.     FAIR VALUES
 
We measure our cash equivalents and marketable securities at fair value. The fair values of our financial assets and liabilities are determined using quoted market prices of identical assets or quoted market prices of similar assets from active markets. Level 1 valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 valuations are obtained from quoted market prices in active markets involving similar assets; these instruments, which mature within one year 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 29, 2012 and September 29, 2012, 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 29, 2012 are summarized below (in thousands):
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Total Fair
Value
 
(Level 1)
 
(Level 2)
 
 
Money market fund deposits (1)
$
20,932

 
$

 
$
20,932

Certificates of deposit (2)(7)

 
7,299

 
7,299

U.S. government obligations (3)(7)

 
86,647

 
86,647

Corporate notes and obligations (4)(7)

 
8,129

 
8,129

Commercial paper (1)(7)

 
1,999

 
1,999

Foreign currency contracts (5)(8)

 
1,092

 
1,092

Mutual funds — Deferred comp and supplemental plan (6)(9)
6,770

 

 
6,770

 ___________________________________________________
(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)        
Includes $5,278 recorded in cash and cash equivalents and $2,021 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(3)
Includes $5,016 recorded in cash and cash equivalents and $81,631 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(4)
Included in short-term investments on the Condensed Consolidated Balance Sheet.

(5) 
Includes $1,240 recorded in prepaid expenses and other assets and $148 recorded in other current liabilities on the Condensed Consolidated Balance Sheet (see Note 5).

(6)          Includes $2,940 recorded in prepaid expenses and other assets and $3,830 recorded in other assets on the Condensed Consolidated Balance Sheet.

(7)
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.


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(8)
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.

(9)
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.
 
Financial assets and liabilities measured at fair value as of September 29, 2012 are summarized below (in thousands):
 
 
Quoted Prices in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Total Fair
Value
 
(Level 1)
 
(Level 2)
 
 
Money market fund deposits(1)
$
10,340

 
$

 
$
10,340

Certificates of deposit(2)(7)

 
31,253

 
31,253

U.S. and international government obligations(3)(7)

 
110,967

 
110,967

Corporate notes and obligations(4)(7)

 
43,406

 
43,406

Commercial paper (3)(7)

 
2,000

 
2,000

Foreign currency contracts(5)(8)

 
(21
)
 
(21
)
Mutual funds—Deferred comp and supplemental plan(6)(9)
6,400

 

 
6,400

 ___________________________________________________
(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)
Includes $29,234 recorded in cash and cash equivalents and $2,019 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(3)
Included in short-term investments on the Condensed Consolidated Balance Sheet.

(4)
Includes $1,223 recorded in cash and cash equivalents and $42,183 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(5)
Includes $626 recorded in prepaid expenses and other assets and $645 recorded in other current liabilities on the Condensed Consolidated Balance Sheet.

(6)
Includes $2,891 recorded in prepaid expenses and other assets and $3,509 recorded in other assets on the Condensed Consolidated Balance Sheet.

(7)
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.

(8)
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.

(9)
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.


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5.     DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
All derivatives, whether designated in hedging relationships or not, are recorded on the Condensed Consolidated Balance Sheet at fair value. We enter into foreign exchange forwards to minimize the risks of foreign currency fluctuation of specific assets and liabilities on the balance sheet; these are not designated as hedging instruments. Our derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by us or the counterparties.

We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Japanese Yen, the Euro and the Korean Won. As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading purposes. If a financial counterparty to any of our hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, we may experience material financial losses.
 
For derivative instruments that are not designated as hedging instruments, gains and losses are recognized in other income (expense).
 
The outstanding notional contract and fair value amounts of hedge contracts, with maximum maturity of two months, are as follows (in thousands):
 
 
U.S. Notional Contract Value
 
U.S. Notional Fair Value
 
December 29, 2012
 
September 29, 2012
 
December 29, 2012
 
September 29, 2012
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
65,490

 
$
61,779

 
$
66,543

 
$
62,404

 
 
 
 
 
 
 
 
Korean Won currency hedge contracts
 
 
 
 
 
 
 
  Sell
$
(26,058
)
 
$
(39,039
)
 
$
(26,106
)
 
$
(39,559
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Sell
$
(24,323
)
 
$
(20,452
)
 
$
(24,235
)
 
$
(20,578
)
 
The fair value of our derivative instruments are included in prepaid expenses and other assets and in other current liabilities in our Condensed Consolidated Balance Sheets; such amounts were not material as of December 29, 2012 and September 29, 2012.
 
The amount of non-designated derivative instruments’ gain in the Condensed Consolidated Statements of Operations included in other income (expense) for the three months ended December 29, 2012 and December 31, 2011 is as follows (in thousands):
 
 
 
Amount of Gain or (Loss) Recognized in
 
 
Income on Derivatives
 
 
Three Months Ended
 
 
December 29, 2012
Derivatives not designated as hedging instruments
 
 
Foreign exchange contracts
 
$
1,900



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Amount of Gain or (Loss) Recognized in
 
 
Income on Derivatives
 
 
Three Months Ended
 
 
December 31, 2011
Derivatives not designated as hedging instruments
 
 
Foreign exchange contracts
 
$
1,982


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

Cash, cash equivalents and short-term investments consist of the following (in thousands):
 
 
December 29, 2012
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
87,980

 
$
16

 
$

 
$
87,996

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Certificates of deposit
$
2,008

 
$
13

 
$

 
$
2,021

U.S. Treasury and agency obligations
81,272

 
359

 

 
81,631

Corporate notes and obligations
8,048

 
82

 
(1
)
 
8,129

Total short-term investments
$
91,328

 
$
454

 
$
(1
)
 
$
91,781

 
 
September 29, 2012
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
67,752

 
$
9

 
$

 
$
67,761

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Certificates of deposit
$
2,017

 
$
2

 
$

 
$
2,019

       U.S. Treasury and agency obligations
108,284

 
666

 
(2
)
 
108,948

International government obligations
2,004

 
14

 

 
2,018

Corporate notes and obligations
41,912

 
272

 
(1
)
 
42,183

Commercial paper
2,000

 

 

 
2,000

Total short-term investments
$
156,217

 
$
954

 
$
(3
)
 
$
157,168

 
At December 29, 2012, gross unrealized losses on our investments with unrealized losses that are not deemed to be other-than-temporarily impaired were $2,000 on corporate notes and obligations of $6.7 million.

The amortized cost and estimated fair value of available-for-sale investments in debt securities as of December 29, 2012 and September 29, 2012 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):
 

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December 29, 2012
 
September 29, 2012
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year
$
89,320

 
$
89,760

 
$
154,200

 
$
155,149

 
During the three months ended December 29, 2012, we received proceeds totaling $56.6 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 31, 2011, we received proceeds totaling $27.5 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million.
 
At December 29, 2012, gross unrealized losses on our investments with unrealized losses that are not deemed to be other-than-temporarily impaired were $2,000 on corporate notes and obligations of $6.7 million.
 
7.    GOODWILL AND INTANGIBLE ASSETS
 
Goodwill is tested for impairment on an annual basis and between annual tests if events or circumstances indicate that an impairment loss may have occurred, and we write down these assets when impaired. We perform our annual impairment tests during the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.
 
We evaluate long-lived assets and amortizable intangible assets whenever events or changes in business circumstances or our planned use of assets indicate that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. Reviews are performed to determine whether the carrying values of assets are impaired based on comparison to the undiscounted expected future cash flows identifiable to such long-lived and amortizable intangible assets. If the comparison indicates that impairment exists, the impaired asset is written down to its fair value.
 
During the three months ended December 29, 2012, 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 29, 2012 to December 29, 2012 are as follows (in thousands):
 
Specialty
Lasers and
Systems
 
Commercial
Lasers and
Components
 
Total
Balance as of September 29, 2012
$
71,326

 
$
6,363

 
$
77,689

Additions (See Note 3)
32,881

 

 
32,881

Translation adjustments and other
1,054

 

 
1,054

Balance as of December 29, 2012
$
105,261

 
$
6,363

 
$
111,624

 
Components of our amortizable intangible assets are as follows (in thousands):
 
 
December 29, 2012
 
September 29, 2012
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
80,517

 
$
(45,497
)
 
$
35,020

 
$
51,346

 
$
(44,457
)
 
$
6,889

Customer lists
17,254

 
(5,936
)
 
11,318

 
7,849

 
(5,666
)
 
2,183

Trade name
3,405

 
(2,878
)
 
527

 
3,050

 
(2,749
)
 
301

Order backlog (1)
1,000

 

 
1,000

 

 

 

Non-compete agreement
691

 
(668
)
 
23

 
689

 
(661
)
 
28

Production know-how (1)

 

 

 
910

 
(838
)
 
72

In-process research & development
2,239

 

 
2,239

 

 

 

Total
$
105,106

 
$
(54,979
)
 
$
50,127

 
$
63,844

 
$
(54,371
)
 
$
9,473

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

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Amortization expense for intangible assets for the three months ended December 29, 2012 and December 31, 2011 was $1.2 million and $1.6 million, respectively, which includes $0.9 million and $1.2 million, respectively, for amortization of existing technology and production know-how.

At December 29, 2012, estimated amortization expense for the remainder of fiscal 2013, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):
 
Estimated
Amortization
Expense
2013 (remainder)
$
8,644

2014
9,461

2015
8,983

2016
8,583

2017
7,587

2018
4,449

Thereafter
2,420

Total
$
50,127


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
December 29,
2012
 
September 29,
2012
Purchased parts and assemblies
$
48,660

 
$
46,526

Work-in-process
65,403

 
60,171

Finished goods
54,939

 
53,416

Total inventories
$
169,002

 
$
160,113

 
Prepaid expenses and other assets consist of the following (in thousands):
 
December 29,
2012
 
September 29,
2012
Prepaid and refundable income taxes
$
9,994

 
$
20,634

Other taxes receivable
28,609

 
25,607

Prepaid expenses and other
17,008

 
15,489

Total prepaid expenses and other assets
$
55,611

 
$
61,730

 
Other assets consist of the following (in thousands):
 
December 29,
2012
 
September 29,
2012
Assets related to deferred compensation arrangements
$
22,450

 
$
21,990

Deferred tax assets
39,189

 
37,160

Other assets
5,657

 
4,879

Total other assets
$
67,296

 
$
64,029

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

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December 29,
2012
 
September 29,
2012
Accrued payroll and benefits
$
28,013

 
$
28,100

Deferred income
17,027

 
17,465

Reserve for warranty
18,510

 
17,442

Accrued expenses and other
11,613

 
10,445

Other taxes payable
22,673

 
15,457

Customer deposits
3,703

 
1,830

Total other current liabilities
$
101,539

 
$
90,739

 
There were no restructuring plans or activities in the three months ended December 29, 2012. There were no new restructuring charges during fiscal 2012. The closure of our Finland site was completed in the third quarter of fiscal 2011, with the last payments and other reductions completed during fiscal 2012.

We provide warranties on certain of our product sales and reserves for estimated warranty costs are recorded during the period of sale. The determination of such reserves requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. The weighted average warranty period covered is approximately 15 months. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to cost of sales may be required in future periods.
 
Components of the reserve for warranty costs during the first three months of fiscal 2013 and 2012 were as follows (in thousands):
 
Three Months Ended
 
December 29,
2012
 
December 31,
2011
Beginning balance
$
17,442

 
$
16,704

Additions related to current period sales
5,777

 
6,374

Warranty costs incurred in the current period
(6,040
)
 
(7,249
)
Accruals resulting from acquisitions
1,735

 

Adjustments to accruals related to foreign exchange and other
(404
)
 
206

Ending balance
$
18,510

 
$
16,035

 
Other long-term liabilities consist of the following (in thousands):
 
December 29,
2012
 
September 29,
2012
Long-term taxes payable
$
19,695

 
$
21,281

Deferred compensation
23,286

 
22,816

Deferred tax liabilities
13,676

 
726

Deferred income
2,303

 
2,191

Asset retirement obligations liability
2,021

 
2,029

Other long-term liabilities
6,288

 
6,283

Total other long-term liabilities
$
67,269

 
$
55,326

 
9.     SHORT-TERM BORROWINGS
 
We have several lines of credit which allow us to borrow in the applicable local currency. We have a total of $15.8 million of unsecured foreign lines of credit as of December 29, 2012.  At December 29, 2012, we had used $2.3 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe during the first fiscal quarter of 2013.  In addition, our domestic line of credit consists of a $50.0 million unsecured revolving credit account with Union Bank of California. The agreement will expire on May 31, 2014. The line of credit is subject to covenants related to

17

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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 29, 2012.

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10.  STOCK-BASED COMPENSATION
 
Fair Value of Stock Compensation
 
We recognize compensation expense for all share based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis over the respective requisite service period of the awards.
 
Determining Fair Value
 
The fair values of shares purchased under the Employee Stock Purchase Plan (“ESPP”) for the three months ended December 29, 2012 and December 31, 2011, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
Three Months Ended
 
 
 
December 29,
2012
 
December 31,
2011
 
Expected life in years
 
0.5

 
0.5

 
Expected volatility
 
34.8
%
 
49.3
%
 
Risk-free interest rate
 
0.2
%
 
0.1
%
 
Expected dividend yield
 
1.0
%
 

 
Weighted average fair value per share
 
$
10.60

 
$
14.93

 

    
There were no stock options granted during the three months ended December 29, 2012 and December 31, 2011.
 
Restricted stock awards and restricted stock units are independent of option grants and are typically subject to vesting restrictions—either time-based or performance-based conditions for vesting. Until restricted stock vests, shares (including those issuable upon vesting of the applicable restricted stock unit) are subject to forfeiture if employment terminates prior to the release of restrictions and cannot be transferred.
The service based restricted stock unit awards are generally subject to annual vesting over two to three years from the date of grant.
The automatic annual grants of restricted stock units for non-employee members of the board of directors vest on February 15 of the calendar year following the grant, which is made following our annual meeting of shareholders.
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 units to officers and certain employees. The performance stock unit agreements provide for the award of performance stock units with each unit representing the right to receive one share of our common stock to be issued after the applicable award period. The final number of units awarded for this grant will be determined as of the vesting dates, based upon our total shareholder return over the performance period compared to the Russell 2000 Index and could range from a minimum of no units to a maximum of twice the initial award. The weighted average fair value for these performance units was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
 
 
Three Months Ended
 
December 29, 2012
 
December 31, 2011
Risk-free interest rate
0.33
%
 
0.39
%
Volatility
37.9
%
 
41.8
%
Weighted average fair value
$48.48
 
$71.59

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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 29, 2012 and December 31, 2011 (in thousands):
 
Three Months Ended
 
 
December 29, 2012
 
December 31, 2011
 
Cost of sales
$
435

 
$
369

 
Research and development
476

 
393

 
Selling, general and administrative
4,083

 
3,260

 
Income tax benefit
(1,483
)
 
(1,328
)
 
 
$
3,511

 
$
2,694

 

During the three months ended December 29, 2012, $0.6 million was capitalized into inventory for all stock plans, $0.4 million was amortized to cost of sales and $0.7 million remained in inventory at December 29, 2012. During the three months ended December 31, 2011, $0.5 million was capitalized into inventory for all stock plans, $0.4 million was amortized to cost of sales and $0.5 million remained in inventory at December 31, 2011.  Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.
 
At December 29, 2012, 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 $26.2 million, net of estimated forfeitures of $1.3 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.3 years and will be adjusted for subsequent changes in estimated forfeitures.

At December 29, 2012, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.6 million, which will be recognized over the six month offering period.
 
The stock option exercise tax benefits reported in the statement of cash flows results from the excess tax benefits arising from tax deductions in excess of the stock-based compensation cost recognized, determined on a grant-by-grant basis. During the first three months of fiscal 2013 and fiscal 2012, we recorded $0.0 and $1.7 million, respectively, of excess tax benefits as cash flows from financing activities.
 
Stock Options & Awards Activity
 
The following is a summary of option activity for our Stock Option Plans (in thousands, except per share amounts and weighted average remaining contractual term in years):

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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 29, 2012
641

 
$
27.86

 
 
 
 

Granted

 

 
 
 
 

Exercised
(68
)
 
26.96

 
 
 
 

Forfeitures

 

 
 
 
 

Expirations

 

 
 
 
 

Outstanding at December 29, 2012
573

 
$
27.97

 
3.2 years
 
$
12,168

Vested and expected to vest at December 29, 2012
573

 
$
27.97

 
3.2 years
 
$
12,168

Exercisable at December 29, 2012
556

 
$
27.47

 
3.0 years
 
$
12,083

 
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and the quoted price of our common stock at the end of the reporting period.  There were approximately 0.6 million outstanding options that were in-the-money as of December 29, 2012.  The aggregate intrinsic value of options exercised under the Company’s stock plans for the three months ended December 29, 2012 and December 31, 2011 were $1.2 million and $1.6 million, respectively, determined as of the date of option exercise.
 
The following table summarizes the activity of our time based and market- performance based restricted stock units for the first three months of fiscal 2013 (in thousands, except per share amounts):

 
Time Based Restricted Stock Units
 
Market-Based Performance Restricted Stock Units
 
Number of
Shares(1)
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares(2)
 
Weighted
Average
Grant Date
Fair Value
Nonvested stock at September 29, 2012
440

 
$
47.81

 
152

 
$
57.55

Granted
242

 
42.28

 
97

 
48.48

Vested
(217
)
 
42.35

 
(28
)
 
49.50

Forfeited

 

 
(5
)
 
49.23

Nonvested stock at December 29, 2012
465

 
$
47.48

 
216

 
$
54.73


__________________________________________
(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.



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

 
12.       ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive income (net of tax) at December 29, 2012 and September 29, 2012 are substantially comprised of accumulated translation adjustments of $44.6 million and $40.4 million, respectively.
 

13.  EARNINGS PER SHARE
 
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
 
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data): 
 
Three Months Ended
 
 
December 29,
2012
 
December 31,
2011
 
Weighted average shares outstanding —basic
23,770

 
23,462

 
Dilutive effect of employee stock awards
452

 
499

 
Weighted average shares outstanding—diluted
24,222

 
23,961

 
 
 
 
 
 
Net income
$
14,153

 
$
17,051

 
 
 
 
 
 
Net income per basic share
$
0.60

 
$
0.73

 
Net income per diluted share
$
0.58

 
$
0.71

 
 
A total of 73,146 and 207,517 potentially dilutive securities have been excluded from the diluted share calculation for the three months ended December 29, 2012 and December 31, 2011, respectively, as their effect was anti-dilutive.
 

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14.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 
 
Three Months Ended
 
 
December 29,
2012
 
December 31,
2011
 
Foreign exchange gain (loss)
$
(1,769
)
 
$
313

 
Gain (loss) on deferred compensation investments, net
294

 
(54
)
 
Other—net

 
59

 
Other income (expense), net
$
(1,475
)
 
$
318

 


15.  STOCK REPURCHASES AND DIVIDENDS
 
On October 4, 2012, the Board of Directors authorized a buyback program whereby we are authorized to repurchase up to $25.0 million of our common stock. The program was authorized for 12 months from the date of authorization. No shares have been purchased under this program as of December 29, 2012.

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

16.  INCOME TAXES
 
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discrete to the period. Our estimated effective tax rate for the three months ended December 29, 2012 was 25.7%. Our effective tax rate for the three months ended December 29, 2012 was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of foreign tax credits and the benefit of releasing foreign tax reserves accrued under ASC 740-10 (formerly FASB Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes") and related interest. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

Determining the consolidated provision for income taxes, income tax liabilities and deferred tax assets and liabilities involves judgment. We calculate and provide for income taxes in each of the tax jurisdictions in which we operate, which involves estimating current tax exposures as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.
 
As of December 29, 2012, the total amount of gross unrecognized tax benefits was $25.8 million including gross interest and penalties of $1.3 million, of which $16.3 million, if recognized, would affect our effective tax rate. Our total gross unrecognized tax benefits, net of certain deferred tax assets, were classified as other long-term liabilities in the condensed consolidated balance sheets.
 
Our policy is to include interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 29, 2012, the total amount of gross interest and penalties accrued was $1.3 million, which is classified as other long-term liabilities in the condensed consolidated balance sheets.
 
We are subject to taxation and file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2009 are closed to examination. In our major state jurisdiction and our major foreign jurisdictions, the years prior to 2008 and 2006, respectively, are closed to examination. In December 2011 and January 2012, our three German subsidiaries received notices of tax audits for the fiscal years 2006 through 2010. These audits are currently in process.



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Management believes that it has adequately provided for any adjustments that may result from tax examinations. The Company regularly engages in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign and state tax matters may be concluded in the next 12 months. Although the timing of the resolution and/or closure of audits is highly uncertain, it is reasonably possible that the balance of net unrecognized tax benefits including interest and penalties at December 29, 2012 could be reduced by approximately $0.2 million to $2.4 million in the next 12 months.

The American Taxpayer Relief Act of 2012 (“the Act”), was enacted on January 2, 2013.  Under the Act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 through December 31, 2013.  The look-through treatment of payments between related controlled foreign corporations under the Subpart F rule was also retroactively extended for the same time period. The effects of the change in the tax law will be recognized in our second quarter of fiscal 2013, which is the quarter that the law was enacted.  Accordingly, we anticipate that prior period research and development credits of approximately $1.0 million to $2.5 million from the last three quarters of fiscal 2012 and the first quarter of fiscal 2013 will be recognized in the second quarter of fiscal 2013. In addition, we also anticipate a reduction in the tax impact of the Subpart F income inclusion of up to approximately $0.5 million.

Deferred Income Taxes
 
As of December 29, 2012, our condensed consolidated balance sheet included net deferred tax assets, before valuation allowance, of approximately $55.2 million, which consists of tax credits carryovers, accruals and reserves, competent authority offset to transfer pricing tax reserves, employee stock-based compensation expenses and certain other liabilities. Management periodically evaluates the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is solely dependent on our ability to generate sufficient future taxable income in the applicable jurisdictions during periods prior to the expiration of tax statutes to fully utilize these assets.  After evaluating all available evidence, we have determined that it is “more likely than not” that a portion of the deferred tax assets would not be realized and we have a total valuation allowance of $9.1 million as of December 29, 2012.  We intend to maintain the valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance.

17.  SEGMENT INFORMATION
 
We are organized into two reportable operating segments: Specialty Lasers and Systems (“SLS”) and Commercial Lasers and Components (“CLC”). This segmentation reflects the go-to-market strategies for various products and markets.  SLS develops and manufactures configurable, advanced-performance products largely serving the microelectronics, scientific research and government programs and original equipment manufacturer (“OEM”) components and instrumentation markets. The size and complexity of many of the SLS products generally require service to be performed at the customer site by factory-trained field service engineers. While both segments work to deliver cost-effective solutions, CLC focuses on higher volume products that are offered in set configurations. The product architectures are designed for easy exchange at the point of use such that product service and repairs are generally based upon advanced replacement and depot (i.e., factory) repair. CLC’s primary markets include materials processing, OEM components and instrumentation and microelectronics. 

We have identified SLS and CLC as operating segments for which discrete financial information is available. Both units have dedicated engineering, manufacturing, product business management and product line management functions. A small portion of our outside revenue is attributable to projects and recently developed products for which a segment has not yet been determined. The associated direct and indirect costs are presented in the category of Corporate and other, along with other corporate costs as described below.
 
Our Chief Executive Officer has been identified as the chief operating decision maker (CODM) as he assesses the performance of the segments and decides how to allocate resources to the segments. Income (loss) from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. As assets are not a measure used to assess the performance of the company by the CODM, asset information is not tracked or compiled by segment and is not available to be reported in our disclosures. Income (loss) from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain research and development, management, finance, legal and human resources) and are included in the results below

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under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.
 
The following table provides net sales and income (loss) from operations for our operating segments (in thousands):
 
 
Three Months Ended
 
December 29,
2012
 
December 31,
2011
Net sales:
 
 
 
Specialty Laser Systems
$
131,460

 
$
135,617

Commercial Lasers and Components
51,742

 
55,150

Total net sales
$
183,202

 
$
190,767

 
 
 
 
Income (loss) from operations:
 
 
 
Specialty Laser Systems
$
30,334

 
$
31,030

Commercial Lasers and Components
1,825

 
4,020

Corporate and other
(11,661
)
 
(9,737
)
Total income from operations
$
20,498

 
$
25,313



Major Customers

We had two major customers during the three months ended December 29, 2012 who accounted for 10.9% and 10.2%, respectively, of consolidated revenue; both customers purchased primarily from our SLS segment. There was one major customer who accounted for 15.6% of consolidated revenue for the three months ended December 31, 2011, who purchased primarily from our SLS segment.

We had one major customer who accounted for 12.0% of accounts receivable at December 29, 2012. There were two major customers who accounted for 14.9% and 14.8%, respectively, of accounts receivable at September 29, 2012.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
COMPANY OVERVIEW
 
BUSINESS BACKGROUND
 
We are one of the world’s leading suppliers of photonics-based solutions in a broad range of commercial and scientific research applications. We design, manufacture, service and market lasers and related accessories for a diverse group of customers. Since
inception in 1966, we have grown through internal expansion and through strategic acquisitions of complementary businesses, technologies, intellectual property, manufacturing processes and product offerings.
 
We are organized into two operating segments: Specialty Lasers and Systems (“SLS”) and Commercial Lasers and Components (“CLC”). This segmentation reflects the go-to-market strategies for various products and markets. 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. While both segments deliver cost-effective photonics solutions, CLC focuses on higher volume products that are offered in set configurations. The product architectures are designed for easy exchange at the point of use such that substantially all product service and repairs are based upon advanced replacement and depot (i.e., factory) repair. CLC’s primary markets include materials processing, original equipment manufacturer (“OEM”) components and instrumentation and microelectronics.
 
Income (loss) from operations is the measure of profit and loss that our chief operating decision maker (“CODM”) uses to assess performance and make decisions. Income (loss) from operations represents the sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses, which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain advanced research and development, management, finance, legal and human resources) and are included in Corporate and other. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.

MARKET APPLICATIONS
 
Our products address a broad range of applications that we group into the following markets: Microelectronics, Scientific Research and Government Programs, OEM Components and Instrumentation and Materials Processing.
 
OUR STRATEGY
We strive to develop innovative and proprietary products and solutions that meet the needs of our customers and that are based on our core expertise in lasers and optical technologies. In pursuit of our strategy, we intend to:
Leverage our technology portfolio and application engineering to lead the proliferation of photonics into broader markets—We will continue to identify opportunities in which our technology portfolio and application engineering can be used to offer innovative solutions and gain access to new markets. We plan to utilize our expertise to increase our market share in the mid to high power material processing applications.
Optimize our leadership position in existing markets—There are a number of markets where we have historically been at the forefront of technological development and product deployment and from which we have derived a substantial portion of our revenues. We plan to optimize our financial returns from these markets.
Maintain and develop additional strong collaborative customer and industry relationships—We believe that the Coherent brand name and reputation for product quality, technical performance and customer satisfaction will help us to further develop our loyal customer base. We plan to maintain our current customer relationships and develop new ones with customers who are industry leaders and work together with these customers to design and develop innovative product systems and solutions as they develop new technologies.
Develop and acquire new technologies and market share—We will continue to enhance our market position through our existing technologies and develop new technologies through our internal research and development efforts, as well as through the acquisition of additional complementary technologies, intellectual property, manufacturing processes and product offerings.

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Streamline our manufacturing structure and improve our cost structure—We will focus on optimizing the mix of products that we manufacture internally and externally. We will utilize vertical integration where our internal manufacturing process is considered proprietary and seek to leverage external sources when the capabilities and cost structure are well developed and on a path towards commoditization.
Focus on long-term improvement of adjusted EBITDA, in dollars and as a percentage of net sales—We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock compensation expenses, major restructuring costs and certain other non-operating income and expense items. Key initiatives to reach our goals for EBITDA improvements include utilization of our Asian manufacturing locations, rationalizing our supply chain and continued leveraging of our infrastructure.

 
APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, accounting for long-lived assets (including goodwill and intangible assets), inventory valuation, warranty reserves, stock-based compensation and accounting for income taxes. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for our fiscal year ended September 29, 2012.
 

KEY PERFORMANCE INDICATORS
 
Below is a summary of some of the quantitative performance indicators (as defined below) that are evaluated by management to assess our financial performance. Some of the indicators are non-GAAP measures and should not be considered as an alternative to any other measure for determining operating performance or liquidity that is calculated in accordance with generally accepted accounting principles.
 
Three Months Ended
 
 
 
 
 
December 29, 2012
 
December 31, 2011
 
Change
 
% Change
 
(Dollars in thousands)
 
 
 
 
 
 
 
 
Bookings
$
175,973

 
$
201,848

 
$
(25,875
)
 
(12.8
)%
Book-to-bill ratio
0.96

 
1.06

 
(0.10
)
 
(9.4
)%
Net sales—Specialty Lasers and Systems
$
131,460

 
$
135,617

 
$
(4,157
)
 
(3.1
)%
Net sales—Commercial Lasers and Components
$
51,742

 
$
55,150

 
$
(3,408
)
 
(6.2
)%
Gross profit as a percentage of net sales—
Specialty Lasers and Systems
44.8
%
 
43.8
%
 
1.0
 %
 
2.3
 %
Gross profit as a percentage of net sales—Commercial Lasers and Components
37.4
%
 
39.0
%
 
(1.6
)%
 
(4.1
)%
Research and development as a percentage of net sales
10.5
%
 
9.8
%
 
0.7
 %
 
7.1
 %
Income before income taxes
$
19,061

 
$
25,831

 
$
(6,770
)
 
(26.2
)%
Net cash provided by operating activities
$
47,323

 
$
16,135

 
$
31,188

 
193.3
 %
Days sales outstanding in receivables
61.9

 
61.6

 
0.3

 
0.5
 %
Annualized first quarter inventory turns
2.5

 
3.0

 
(0.5
)
 
(16.7
)%
Capital spending as a percentage of net sales
2.1
%
 
4.3
%
 
(2.2
)%
 
(51.2
)%
Adjusted EBITDA as a percentage of net sales
18.1
%
 
19.3
%
 
(1.2
)%
 
(6.2
)%
 
Definitions and analysis of these performance indicators are as follows:
 

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Bookings and Book-to-Bill Ratio
 
Bookings represent orders expected to be shipped within 12 months and services to be provided pursuant to service contracts. While we generally have not experienced a significant rate of cancellation, bookings are generally cancelable by our customers without substantial penalty and, therefore, we cannot assure all bookings will be converted to net sales.
 
The book-to-bill ratio is calculated as quarterly bookings divided by quarterly net sales.  This is an indication of the strength of our business but can sometimes be impacted by a single large order. A ratio of greater than 1.0 indicates that demand for our products is greater than what we supply in the quarter.
 
Bookings decreased 12.8% in the first quarter of fiscal 2013 compared to the same quarter one year ago, with decreases in the microelectronics, scientific and government programs and OEM components and instrumentation markets partially offset by an increase in the materials processing market. Compared to the fourth quarter of fiscal 2012, bookings increased 3.9% led by a significant increase in the advanced packaging market. The book-to-bill ratio was 0.96 in the first quarter of fiscal 2013.
 
Microelectronics
 
Microelectronics bookings decreased 21% compared to the same quarter one year ago but increased 19% from bookings in the fourth quarter of fiscal 2012. The book-to-bill ratio for the first quarter of fiscal 2013 was 0.89.
 
Flat panel display orders in the first quarter of fiscal 2013 increased 10% from orders in the fourth quarter of fiscal 2012 primarily due to higher service orders and upgrades for existing systems. The market remains strong for liquid crystal display (LCD) and active-matrix organic light emitting diode (AMOLED) production from integrators for flat panel display manufacturers in Japan, Korea and China and we expect follow-on orders and continued fluctuations in order volumes on a quarterly basis.

Orders in the advanced packaging (API) market increased 47% from orders in the fourth quarter of fiscal 2012 largely driven by holiday demand for certain smartphones and tablets, leading to increases in high density interconnect (HDI) and flex printed circuit board (PCB) capacity. While a positive development, we believe a broader API segment recovery is still a second half, calendar 2013 event. Products and technologies from Innolight and Lumera will play important roles in advanced packaging applications.

Orders from semiconductor capital equipment OEMs increased 11% from the fourth quarter of fiscal 2012 reflecting strong orders for inspection applications and strong service orders.

Materials Processing
 
Materials processing orders increased 17% compared to the same quarter one year ago and decreased 6% from the fourth quarter of fiscal 2012. The book-to-bill ratio for the first quarter of fiscal 2013 was 1.01. The first fiscal quarter is typically a seasonally soft quarter in materials processing applications as year-end production needs have already been addressed. Design wins in marking and engraving for consumer electronics manufacturing led to strong bookings for low-power CO2 lasers and bookings increased for packaging applications in China, again for CO2 lasers.

We believe the outlook for the next few quarters has improved both due to projected actions by the new Chinese government to stimulate business and the stabilization of the Euro zone. Since the official launch of the Highlight™ 1000FL fiber laser in September 2012, we have received a significant number of inquiries from different OEM customers.

OEM Components and Instrumentation
 
OEM Components and Instrumentation orders decreased 5% compared to the same quarter one year ago and decreased 19% from the fourth quarter of fiscal 2012. The book-to-bill ratio for the first quarter of fiscal 2013 was 0.93. The decrease from the fourth fiscal quarter was due, in part, to the timing of annual orders in the light show market.

Instrumentation orders were flat compared to the fourth quarter of fiscal 2012 that included a number of large OEM orders. Flow cytometry provided a majority of the bookings and we also received key development orders for gene sequencing applications.

Orders for medical OEM products were 32% lower in the first quarter of fiscal 2013 following strong orders in the fourth quarter of fiscal 2012 for lasers used in refractive surgery. The outlook in this market is strong, with customers signaling

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increased demand. We have also broadened our opportunity through recent acquisitions as Lumera gives us immediate entry into the fast evolving cataract market. The combination of an Innolight product with some of our optical expertise creates a new, low-cost platform for microkeratome work, which has the potential to displace much more complex and costly competitive offerings.

Scientific and Government Programs
 
Scientific and government programs orders decreased 16% compared to the same quarter one year ago and increased 10% from the fourth quarter of fiscal 2012. The book-to-bill for the first quarter of fiscal 2013 was 1.16.
 
Record Chameleon™ orders in North America and record amplifier orders in the Pacific Rim led the way for first quarter fiscal 2013 bookings, with Chameleon orders in the U.S. benefitting from a large order from a multi-user R&D center and an order from a manufacturer of multiphoton microscopes. The amplifier orders from the Pacific Rim, which included carryovers from the fourth quarter of fiscal 2012, were geographically diverse and dominated by our Libra™ platform. The Libra is a hands-free system favored by researchers seeking leading performance with minimal user support.

Bookings from European scientific customers were lower than we typically see at the end of the calendar year due to lower spending in Germany and austerity effects in various countries. With respect to one of our recent European acquisitions, Innolight products will modestly contribute to future scientific orders for lasers used in a variety of applications including atom trapping and optical metrology.

Net Sales
 
Net sales include sales of lasers, laser tools, related accessories and service contracts. Net sales for the first fiscal quarter decreased 3.1% in our SLS segment from the same quarter one year ago and decreased 6.2% 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 43.8% to 44.8% in our SLS segment and decreased from 39.0% to 37.4% 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 increased to 10.5% from 9.8% 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

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quarter of fiscal 2013 increased 0.3 days from the same quarter one year ago primarily due to the acquisition of Lumera Laser at the end of the first quarter of fiscal 2013 partially offset by improved collections.
 
Annualized Inventory Turns
 
We calculate annualized inventory turns as the cost of sales during the quarter annualized and divided by net inventories at the end of the period. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. The more money we have tied up in inventory, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our annualized inventory turns for the first quarter of fiscal 2013 decreased by 0.5 turns from the same quarter one year ago primarily due to increased long lead-time materials to support a sizable backlog of flat panel laser annealing systems, the impact of decreased sales volumes in relation to inventory levels in certain businesses and the acquisition of Lumera Laser at the end of the first quarter of fiscal 2013.

Capital Spending as a Percentage of Net Sales
 
Capital spending as a percentage of net sales (“capital spending percentage”) is calculated as capital expenditures for the period divided by net sales for the period.  Capital spending percentage indicates the extent to which we are expanding or improving our operations, including investments in technology and equipment.  Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage decreased to 2.1% from 4.3% for the first quarter of fiscal 2013 compared to the same period one year ago primarily due to building improvements and purchases of production-related assets to support our expansion in Asia in fiscal 2012.
 
Adjusted EBITDA as a Percentage of Net Sales

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

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 29,
2012
 
December 31,
2011
Net income as a percentage of net sales
7.7
%
 
8.9
 %
Income tax expense
2.7
%
 
4.6
 %
Interest and other income (expense), net
1.0
%
 
(0.2
)%
Depreciation and amortization
4.0
%
 
3.9
 %
Stock based compensation
2.7
%
 
2.1
 %
Adjusted EBITDA as a percentage of net sales
18.1
%
 
19.3
 %

SIGNIFICANT EVENTS
 
On October 30, 2012, we acquired all of the outstanding shares of Innolight Innovative Laser and Systemtechnik GmbH ("Innolight") for approximately $18.3 million, excluding transaction costs. Innolight provides a core technology building block for an emerging class of commercial, sub-nanosecond lasers for microelectronics manufacturing and its semiconductor-based

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architecture delivers pulsed output that can be amplified by conventional or fiber amplifiers to ultimately deliver infrared, green or ultraviolet light capable of processing a range of materials.

On December 20, 2012, we acquired all of the outstanding shares of Lumera Laser GmbH ("Lumera") for approximately $51.5 million, excluding transaction costs. Lumera is a recognized leader in ultrafast solid state lasers for microelectronics, OEM medical and materials processing applications.

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


RESULTS OF OPERATIONS
 
CONSOLIDATED SUMMARY
 
The following table sets forth, for the periods indicated, the percentage of total net sales represented by the line items reflected in our condensed consolidated statements of operations:
 
 
Three Months Ended
 
 
December 29,
2012
 
December 31,
2011
 
Net sales
100.0
 %
 
100.0
%
 
Cost of sales
57.6
 %
 
57.9
%
 
Gross profit
42.4
 %
 
42.1
%
 
Operating expenses:
 
 
 
 
Research and development
10.5
 %
 
9.8
%
 
Selling, general and administrative
20.2
 %
 
18.2
%
 
Amortization of intangible assets
0.5
 %
 
0.9
%
 
Total operating expenses
31.2
 %
 
28.9
%
 
Income from operations
11.2
 %
 
13.2
%
 
Other income (net)
(0.8
)%
 
0.3
%
 
Income before income taxes
10.4
 %
 
13.5
%
 
Provision for income taxes
2.7
 %
 
4.6
%
 
Net income
7.7
 %
 
8.9
%
 

Net income for the first quarter of fiscal 2013 was $14.2 million ($0.58 per diluted share) including $3.5 million of after-tax stock-related compensation expense. Net income for the first quarter of fiscal 2012 was $17.1 million ($0.71 per diluted share) including $2.7 million of after-tax stock-related compensation expense.
 
NET 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):

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Three Months Ended
 
December 29, 2012
 
December 31, 2011
 
Amount
 
Percentage
of total
 net sales
 
Amount
 
Percentage
 of total
 net sales
Consolidated:
 
 
 
 
 
 
 
Microelectronics
$
89,030

 
48.6
%
 
$
92,892

 
48.7
%
OEM components and instrumentation
36,290

 
19.8
%
 
35,940

 
18.8
%
Materials processing
26,519

 
14.5
%
 
23,379

 
12.3
%
Scientific and government programs
31,363

 
17.1
%
 
38,556

 
20.2
%
   Total
$
183,202

 
100.0
%
 
$
190,767

 
100.0
%

Net sales for the first quarter of fiscal 2013 decreased by $7.6 million, or 4%, including a decrease of $2.0 million due to the impact of foreign currency exchange rates, compared to the first quarter of fiscal 2012.  Sales decreases in the scientific and government programs and microelectronics markets were partially offset by increases in the materials processing and OEM components and instrumentation markets.
 
Sales in the scientific and government programs market decreased $7.2 million, or 19%, primarily due to lower demand for advanced research applications used by university and government research groups partly due to lower U.S. and global stimulus funding. We expect that this lower funding level will continue as government policy. The decrease in the microelectronics market of $3.9 million, or 4%, was due to lower shipments for advanced packaging and solar applications partially offset by higher sales in flat panel display applications. Sales in the materials processing market increased $3.1 million, or 13%, primarily due to higher shipments for marking and non-metal cutting applications. The increase in the OEM components and instrumentation market of $0.4 million, or 1%, was due primarily to higher shipments for military and bio-instrumentation applications partially offset by lower shipments for medical applications.

Backlog represents orders which we expect to be shipped within 12 months. 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 continue to have a sizable backlog of orders, $348.1 million at December 29, 2012, including a significant concentration in the flat panel display market (43%).

The timing for shipments of our higher average selling price excimer products in the flat panel display market can 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 revenue 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 29, 2012
 
December 31, 2011
 
Amount
 
Percentage
of total
net sales
 
Amount
 
Percentage
of total
net sales
Consolidated:
 
 
 
 
 
 
 
Specialty Lasers and Systems (SLS)
$
131,460

 
71.8
%
 
$
135,617

 
71.1
%
Commercial Lasers and Components (CLC)
51,742

 
28.2
%
 
55,150

 
28.9
%
   Total
$
183,202

 
100.0
%
 
$
190,767

 
100.0
%


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Net sales for the first quarter of fiscal 2013 decreased by $7.6 million, or 4%, compared to the first quarter of fiscal 2012, with decreases of $4.2 million, or 3%, in our SLS segment and decreases of $3.4 million, or 6%, in our CLC segment.
 
The decrease in our SLS segment sales was primarily due to lower shipments for scientific and government programs, solar and medical applications partially offset by higher revenue for flat panel display and materials processing applications. The decrease in our CLC segment sales was primarily due to lower advanced packaging and certain flat panel display application sales partially offset by higher instrumentation and military application sales. 

GROSS PROFIT
 
Consolidated
 
Our gross profit rate increased to 42.4% in the first quarter of fiscal 2013 from 42.1% in the first quarter of fiscal 2012. The increase in the gross profit rate was primarily due to favorable product margins (0.8%) resulting from favorable product mix in the microelectronics market and the favorable impact of foreign exchange rates net of the impact of lower volumes in several business units serving the advanced packaging, semiconductor and scientific markets. The favorable product margin was partially offset by higher other costs (0.5%) primarily due to higher inventory provisions.

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, 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 Japanese Yen.
 
Specialty Lasers and Systems
 
The gross profit rate in our SLS segment increased to 44.8% in the first quarter of fiscal 2013 from 43.8% in the first quarter of fiscal 2012 primarily due to favorable product costs (2.5%) resulting from favorable product mix in the microelectronics market and the favorable impact of foreign exchange rates partially offset by the impact of lower volumes in several business units serving the advanced packaging, semiconductor and scientific markets. The favorable product costs were partially offset by higher other costs (0.9%) due to higher inventory provisions and higher warranty costs (0.6%).

Commercial Lasers and Components

The gross profit rate in our CLC segment decreased to 37.4% in the first quarter of fiscal 2013 from 39.0% in the first quarter of fiscal 2012 primarily due to unfavorable product costs (3.4%) resulting from lower volumes in several business units serving particularly the advanced packaging and components markets and unfavorable product mix within instrumentation and semiconductor markets partially offset by lower warranty costs due to fewer warranty events (1.5%) and lower other costs (0.3%).


OPERATING EXPENSES:
 
 
Three Months Ended
 
December 29, 2012
 
December 31, 2011
 
Amount
 
Percentage of
total net sales
 
Amount
 
Percentage of
total net sales
 
(Dollars in thousands)
Research and development
$
19,301

 
10.5
%
 
$
18,779

 
9.8
%
Selling, general and administrative
36,982

 
20.2
%
 
34,631

 
18.2
%
Amortization of intangible assets
854

 
0.5
%
 
1,636

 
0.9
%
Total operating expenses
$
57,137

 
31.2
%
 
$
55,046

 
28.9
%

Research and development

Research and development (“R&D”) expenses increased $0.5 million, or 3%, during the first fiscal quarter ended December 29, 2012 compared to the same quarter one year ago.  The increase was primarily due to lower net reimbursements from customers

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for development projects ($0.4 million), higher other spending on headcount and projects ($0.4 million) and higher stock-related compensation expense ($0.1 million) partially offset by the impact of foreign exchange rates ($0.4 million). On a segment basis as compared to the prior year period, SLS research and development spending increased $0.5 million primarily due to lower net reimbursements from customers for development projects and higher other spending on headcount and projects partially offset by the impact of foreign exchange rates. Both CLC spending and Corporate and other spending were flat.

Selling, general and administrative

Selling, general and administrative (“SG&A”) expenses increased $2.4 million or 7%, during the first fiscal quarter ended December 29, 2012 compared to the same quarter one year ago.  The increase was primarily due to $1.4 million higher payroll spending due to higher headcount and increased salaries and commissions due to mix, $0.8 million higher stock-related compensation expense, $0.5 million higher consulting and legal costs related to acquisitions and $0.3 million higher other variable spending partially offset by the impact of foreign exchange rates ($0.6 million). On a segment basis as compared to the prior year period, SLS segment expenses increased $0.3 million primarily due to higher payroll spending and higher other variable spending partially offset by the impact of foreign exchange rates. CLC spending increased $0.3 million primarily due to higher payroll spending.   Spending for Corporate and other increased $1.8 million primarily due to higher stock-related compensation expense, higher consulting and legal costs related to acquisitions and higher other variable spending.

Amortization of intangible assets
 
Amortization of intangible assets decreased $0.8 million during the first three months of fiscal 2013 compared to the same period last year primarily due to the completion of amortization of certain intangibles from prior acquisitions partially offset by amortization of intangibles from the acquisition of Innolight in the first quarter of fiscal 2013.
 
OTHER INCOME (EXPENSE) — NET
 
Other income, net of other expense, decreased $2.0 million during the three months ended December 29, 2012 compared to the same period one year ago. The decrease was primarily due to higher net foreign exchange losses ($2.1 million) due to the significant movement in the Japanese Yen in the last few weeks of the first quarter of fiscal 2013.
 
INCOME TAXES
 
The effective tax rate on income before income taxes for the first quarter of fiscal 2013 of 25.7% was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of foreign tax credits and the benefit of releasing foreign tax reserves accrued under ASC 740-10 (formerly FASB Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”) and related interest. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).
 
The effective tax rate for the first quarter of fiscal 2012 of 34.0% was lower than the statutory rate of 35% primarily due to permanent differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates, the benefit of foreign tax credits and the benefit of releasing foreign tax reserves accrued under ASC 740-10 (formerly FASB Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”) and related interest. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

DEFERRED INCOME TAXES

As of December 29, 2012, our condensed consolidated balance sheet included net deferred tax assets, before valuation allowance, of approximately $55.2 million, which consists of tax credit carryovers, accruals and reserves, competent authority offset to transfer pricing tax reserves, employee stock-based compensation expenses, and certain other liabilities. Management periodically evaluates the realizability of our net deferred tax assets based on all available evidence, both positive and negative. The realization of net deferred tax assets is solely dependent on our ability to generate sufficient future taxable income in the applicable jurisdictions during periods prior to the expiration of tax statutes to fully utilize these assets.  After evaluating all available evidence, we have determined that it is “more likely than not” that a portion of the deferred tax assets would not be realized and we have a total valuation allowance of $9.1 million as of December 29, 2012. We intend to maintain the valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance.


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LIQUIDITY AND CAPITAL RESOURCES
 
At December 29, 2012, we had assets classified as cash and cash equivalents, as well as time deposits and fixed income securities classified as short-term investments, in an aggregate amount of $179.8 million, compared to $224.9 million at September 29, 2012. At December 29, 2012, approximately $119.1 million of this cash and securities was held in certain of our foreign subsidiaries, $48.7 million of which was denominated in currencies other than the U.S. dollar. We currently have approximately $103.5 million of the cash, including investments in U.S. Treasury securities, held by our 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.

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 cash dividend in the first quarter of fiscal 2013. Supplemental information pertaining 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 condensed consolidated financial statements:
 
 
Three Months Ended
 
December 29,
2012
 
December 31,
2011
 
(in thousands)
Net cash provided by operating activities
$
47,323

 
$
16,135

Sales of shares under employee stock plans
4,712

 
4,568

Repurchase of common stock

 
(20,665
)
Cash dividend paid on common stock
(24,040
)
 

Capital expenditures
(3,901
)
 
(8,139
)
Acquisition of businesses, net of cash acquired
(67,289
)
 

 
Net cash provided by operating activities increased by $31.2 million for the first three months of fiscal 2013 compared to the same period one year ago. The increase in cash provided by operating activities was primarily due to exceptionally high cash flows from accounts receivable, lower tax payments and lower payments related to other current liabilities and accounts payable. We do not expect favorable increases in cash flows from accounts receivable of this magnitude in the foreseeable future. We believe that our existing cash, cash equivalents and short term investments combined with cash to be provided by operating activities will be adequate to cover our working capital needs and planned capital expenditures for at least the next 12 months to the extent such items are known or are reasonably determinable based on current business and market conditions. However, we may elect to finance certain of our capital expenditure requirements through borrowings under our bank credit facilities or other sources of capital. We continue to follow our strategy to further strengthen our financial position by using available cash flow to fund operations.
 
We intend to continue pursuing acquisition opportunities at valuations we believe are reasonable based upon market conditions. However, we cannot accurately predict the timing, size and success of our acquisition efforts or our associated potential capital commitments. Furthermore, we cannot assure you that we will be able to acquire businesses on terms acceptable to us. We expect to fund future acquisitions through existing cash balances and cash flows from operations. If required, we will look for additional borrowings or consider the issuance of securities. The extent to which we will be willing or able to use our common stock to make acquisitions will depend on its market value at the time and the willingness of potential sellers to accept it as full or partial payment.

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On December 10, 2012, we announced that the Board of Directors approved a $1.00 per share special cash dividend on our outstanding common stock payable on December 27, 2012 to stockholders of record on December 19, 2012, resulting in a payment of $24.0 million in the first quarter of fiscal 2013. We do not expect to pay any additional dividends in the foreseeable future.

On August 25, 2011, the Board of Directors authorized the repurchase of up to $50.0 million of our common stock. The program was authorized for 12 months from the date of authorization. During fiscal 2011, we repurchased and retired 586,200 shares of outstanding common stock at an average price of $42.67 per share for a total of $25.0 million, excluding expenses. During the fiscal 2012, we repurchased and retired 543,200 shares of outstanding common stock at an average price of $45.99 per share for a total of $25.0 million, excluding expenses, completing the repurchase. On October 4, 2012, the Board of Directors authorized the repurchase of up to $25.0 million of our common stock. No repurchases were made in the first quarter of fiscal 2013.

Additional sources of cash available to us were domestic and international currency lines of credit and bank credit facilities totaling $65.8 million as of December 29, 2012, of which $63.5 million was unused and available. These unsecured credit facilities were used in Europe during the first three months of fiscal 2013. Our domestic line of credit consists of a $50 million unsecured revolving credit account with Union Bank of California, which expires on May 31, 2014 and is subject to covenants related to financial ratios and tangible net worth. No amounts have been drawn upon our domestic line of credit and $2.3 million of the international currency lines has been used as guarantees as of December 29, 2012.
 
Our ratio of current assets to current liabilities was 3.5:1 at December 29, 2012 compared to 4.0:1 at September 29, 2012. The decrease in our ratio is primarily due to decreases in cash and short-term investments and accounts receivable. Our cash and cash equivalents, short-term investments, working capital and debt obligations are as follows:
 
 
December 29, 2012
 
September 29, 2012
 
(in thousands)
Cash and cash equivalents
$
87,996

 
$
67,761

Short-term investments
91,781

 
157,168

Working capital
392,912

 
460,697

Total debt obligations
15

 
19

 
Contractual Obligations and Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements as defined under Regulation S-K of the Securities Act of 1933. Information regarding our long-term debt payments, operating lease payments, asset retirement obligations, purchase commitments with suppliers and purchase obligations is provided in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended September 29, 2012. There have been no material changes in contractual obligations outside of the ordinary course of business since September 29, 2012. Information regarding our other financial commitments at December 29, 2012 is provided in the notes to the condensed consolidated financial statements in this filing.
 
Changes in Financial Condition
 
Cash provided by operating activities during the first three months of fiscal 2013 was $47.3 million, which included cash provided by operating assets and liabilities of $20.6 million, net income of $14.2 million, depreciation and amortization of $7.3 million, stock-based compensation expense of $5.0 million and $0.2 million other.

Cash used in investing activities during the first three months of fiscal 2013 was $6.3 million, which included $67.3 million used to acquire Lumera and Innolight and $3.9 million used to acquire property and equipment and improve buildings partially offset by $64.9 million net sales of available-for-sale securities.
 
Cash used by financing activities during the first three months of fiscal 2013 was $23.4 million, which included a $24.0 million cash dividend on our common stock and $4.1 million other partially offset by $4.7 million generated from our employee stock option and stock purchase plans.
 

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Changes in exchange rates during the first three months of fiscal 2013 increased our cash balances by $2.6 million.
 
RECENT ACCOUNTING STANDARDS
 
See Note 2. “Recent Accounting Standards” in the Notes to Condensed Consolidated Financial Statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our condensed consolidated financial position, results of operations and cash flows.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Market risk disclosures
 
We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes.
 
Interest rate sensitivity
 
A portion of our investment portfolio is composed of fixed income securities. These securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately (whether due to changes in overall market rates or credit worthiness of the issuers of our individual securities) and uniformly by 10% from levels at December 29, 2012, the fair value of the portfolio, based on quoted market prices in active markets involving similar assets, would decline by an immaterial amount due to their short-term maturities. We have the ability to generally hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. If necessary, we may sell short-term investments prior to maturity to meet our liquidity needs.
 
At December 29, 2012, the fair value of our available-for-sale debt securities was $89.8 million, all of which were classified as short-term investments.  Gross unrealized gains and losses on available-for-sale debt securities were $441,000 and $(1,000), respectively, at December 29, 2012.
 
Foreign currency exchange risk
 
We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Japanese Yen, the Euro and the Korean Won. As a result, our earnings