Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the Quarterly Period Ended January 2, 2010

 

or

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to          

 

Commission File Number: 001-33962

 

COHERENT, INC.

 

Delaware

 

94-1622541

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

5100 Patrick Henry Drive, Santa Clara, California 95054
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (408) 764-4000

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

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 o No o

 

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 o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(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 o  No x

 

The number of shares outstanding of registrant’s common stock, par value $.01 per share, on January 29, 2010 was 24,646,738.

 

 

 



Table of Contents

 

COHERENT, INC.

 

INDEX

 

 

 

 

Page

Part I.

Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations Three months ended January 2, 2010 and December 27, 2008

 

4

 

 

 

 

 

Condensed Consolidated Balance Sheets January 2, 2010 and October 3, 2009

 

5

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows Three months ended January 2, 2010 and December 27, 2008

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

22

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

35

 

 

 

 

Item 4.

Controls and Procedures

 

36

 

 

 

 

Part II.

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

37

 

 

 

 

Item 1A.

Risk Factors

 

38

 

 

 

 

Item 6.

Exhibits

 

52

 

 

 

 

Signatures

 

53

 

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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,” “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 events.

 

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Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in thousands, except per share data)

 

 

 

Three Months Ended

 

 

 

January 2,
2010

 

December 27,
2008

 

 

 

 

 

 

 

Net sales

 

$

122,815

 

$

124,388

 

Cost of sales

 

71,783

 

73,999

 

Gross profit

 

51,032

 

50,389

 

Operating expenses:

 

 

 

 

 

Research and development

 

15,410

 

14,778

 

Selling, general and administrative

 

27,979

 

23,628

 

Impairment of goodwill

 

 

19,286

 

Amortization of intangible assets

 

1,961

 

1,943

 

Total operating expenses

 

45,350

 

59,635

 

Income (loss) from operations

 

5,682

 

(9,246

)

Other income (expense) (net)

 

792

 

(4,230

)

Income (loss) before income taxes

 

6,474

 

(13,476

)

Provision for income taxes

 

2,295

 

1,203

 

Net income (loss)

 

$

4,179

 

$

(14,679

)

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

Basic

 

$

0.17

 

$

(0.61

)

Diluted

 

$

0.17

 

$

(0.61

)

 

 

 

 

 

 

Shares used in computation:

 

 

 

 

 

Basic

 

24,469

 

24,145

 

Diluted

 

24,678

 

24,145

 

 

See Accompanying Notes to Condensed Consolidated Financial Statements

 

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COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; in thousands, except par value)

 

 

 

January 2,
2010

 

October 3,
2009

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

199,760

 

$

199,950

 

Short-term investments

 

40,866

 

43,685

 

Accounts receivable—net of allowances of $2,150 and $2,147, respectively

 

76,136

 

74,235

 

Inventories

 

98,924

 

97,767

 

Prepaid expenses and other assets

 

51,827

 

38,969

 

Deferred tax assets

 

18,948

 

28,164

 

Total current assets

 

486,461

 

482,770

 

Property and equipment, net

 

100,062

 

98,792

 

Goodwill

 

68,916

 

66,967

 

Intangible assets, net

 

23,064

 

19,738

 

Other assets

 

92,202

 

85,337

 

Total assets

 

$

770,705

 

$

753,604

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term obligations

 

$

21

 

$

9

 

Accounts payable

 

24,359

 

21,639

 

Income taxes payable

 

1,617

 

1,953

 

Other current liabilities

 

71,911

 

62,741

 

Total current liabilities

 

97,908

 

86,342

 

Long-term obligations

 

44

 

6

 

Other long-term liabilities

 

92,054

 

91,685

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, par value $.01 per share:

 

 

 

 

 

Authorized—500,000 shares

 

 

 

 

 

Outstanding—24,644 shares and 24,455 shares, respectively

 

246

 

244

 

Additional paid-in capital

 

193,096

 

188,918

 

Accumulated other comprehensive income

 

77,038

 

80,269

 

Retained earnings

 

310,319

 

306,140

 

Total stockholders’ equity

 

580,699

 

575,571

 

Total liabilities and stockholders’ equity

 

$

770,705

 

$

753,604

 

 

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

 

 

 

January 2,
2010

 

December 27,
2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

4,179

 

$

(14,679

)

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

5,752

 

4,729

 

Amortization of intangible assets

 

1,961

 

1,943

 

Deferred income taxes

 

6,921

 

(4,859

)

Loss on disposal of property and equipment

 

100

 

155

 

Stock-based compensation

 

1,874

 

1,753

 

Excess tax benefit from stock-based compensation arrangements

 

(100

)

(8

)

Impairment of goodwill

 

 

19,286

 

Non-cash restructuring and other charges (recoveries)

 

230

 

(244

)

Other non-cash expense (income)

 

(32

)

4

 

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

 

 

 

 

 

Accounts receivable

 

(716

)

2,892

 

Inventories

 

1,207

 

(875

)

Prepaid expenses and other assets

 

(8,252

)

(3,482

)

Other assets

 

(1,089

)

6,722

 

Accounts payable

 

1,752

 

(4,826

)

Income taxes payable/receivable

 

(4,792

)

(4,252

)

Other current liabilities

 

7,409

 

(7,057

)

Other long-term liabilities

 

1,196

 

(6,600

)

Net cash provided by (used in) operating activities

 

17,600

 

(9,398

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(3,266

)

(8,911

)

Proceeds from dispositions of property and equipment

 

478

 

826

 

Purchases of available-for-sale securities

 

(19,632

)

(14,459

)

Proceeds from sales and maturities of available-for-sale securities

 

22,506

 

4,112

 

Acquisition of a business

 

(15,000

)

 

Change in restricted cash

 

 

2,521

 

Net cash used in investing activities

 

(14,914

)

(15,911

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of capital lease obligations

 

(6

)

(2

)

Cash overdrafts decrease

 

 

(470

)

Issuance of common stock under employee stock option and purchase plans

 

2,833

 

3,543

 

Net settlement of restricted common stock

 

(519

)

 

Excess tax benefits from stock-based compensation arrangements

 

100

 

8

 

Net cash provided by financing activities

 

2,408

 

3,079

 

Effect of exchange rate changes on cash and cash equivalents

 

(5,284

)

(6,361

)

Net decrease in cash and cash equivalents

 

(190

)

(28,591

)

Cash and cash equivalents, beginning of period

 

199,950

 

213,826

 

Cash and cash equivalents, end of period

 

$

199,760

 

$

185,235

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

38

 

$

75

 

Income taxes

 

$

3,279

 

$

10,443

 

Cash received during the period for:

 

 

 

 

 

Income taxes

 

$

812

 

$

14

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

Unpaid property and equipment

 

$

654

 

$

1,554

 

 

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 October 3, 2009. 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 quarter includes 13 weeks of operations. Fiscal years 2010 and 2009 include 52 and 53 weeks, respectively.

 

2.            RECENT ACCOUNTING STANDARDS

 

Adoption of New Accounting Pronouncements

 

In December 2007 the FASB revised the authoritative guidance for business combinations. The revised guidance retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations, however these rules, (including additional guidance issuance after December 2007), change certain elements of accounting for business combinations such as:

 

·                  The acquisition date is the date that the acquirer achieves control.

·                  Acquisition related costs are recognized separately from the acquisition and recorded as an expense.

·                  Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can be reasonably estimated; if fair value cannot be reasonably estimated during the measurement period, the contingent asset or liability is recognized in accordance with the guidance on contingencies.

 

We adopted this guidance for acquisitions completed after October 4, 2009, the beginning of our fiscal year 2010. The impact of adoption will be largely dependent on the size and nature of the business combinations completed after the adoption of this statement.

 

In February 2008, the FASB issued guidance which delayed the effective date regarding fair value measurements and disclosures of nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. We adopted this update for our fiscal year beginning October 4, 2009. The adoption of this standard did not have a material impact on our consolidated financial position, results of operations and cash flows.

 

In 2008, the FASB issued new requirements regarding the determination of the useful lives of intangible assets and accounting for acquired defensive assets. This guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible; an entity needs to consider its own historical experience adjusted for entity specific factors. In the absence of that experience, an entity shall consider the assumptions that market participants would use about renewal or extension options.  Defensive assets should be assigned useful lives based on the period during which the asset would diminish in value.  We adopted this guidance for our fiscal year beginning October 4, 2009 and it will be applied prospectively to intangible assets acquired.

 

Recently Issued Accounting Pronouncements

 

In September 2009, the FASB amended revenue recognition guidance for arrangements with multiple deliverables. This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements, such as product, software, services or support, to a customer at different times as part of a single revenue generating transaction and provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables. The standard also expands the

 

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disclosure requirements for multiple deliverable revenue arrangements. This standard should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt this standard on a retrospective basis. We are currently evaluating the potential impact and timing of the adoption of this update on our consolidated financial position and results of operations.

 

3.              BUSINESS COMBINATION

 

On October 13, 2009, we acquired all the assets and certain liabilities of StockerYale, Inc. (“StockerYale”)’s laser module product line in Montreal and its specialty fiber product line in Salem, New Hampshire for $15.0 million in cash. StockerYale designs, develops and manufactures low power laser modules, light emitting (LED) systems and specialty optical fiber products.  These assets and liabilities have been included in our Commercial Lasers and Components segment.

 

We adopted the new authoritative guidance on business combinations during the first quarter of fiscal 2010 and the acquisition was accounted for in accordance with this guidance; therefore, the tangible and intangible assets acquired were recorded at fair value on the acquisition date.

 

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

 

Tangible assets

 

$

9,770

 

Goodwill

 

2,580

 

Intangible assets:

 

 

 

Existing technology

 

610

 

Production know-how

 

910

 

Customer lists

 

3,170

 

Non-compete agreements

 

60

 

Order backlog

 

600

 

Liabilities assumed

 

(2,700

)

Total

 

$

15,000

 

 

The goodwill recognized from this acquisition resulted primarily from anticipated increases in market share and synergies of combining these entities and was included in our Commercial Lasers and Components segment.  None of the goodwill from this purchase is deductible for tax purposes.

 

Goodwill, which represents the excess of the purchase price over the fair value of tangible and identified intangible assets acquired, is not being amortized but will be reviewed annually for impairment, or more frequently if impairment indicators arise, in accordance with authoritative guidance. The identifiable intangible assets are being amortized over their respective useful lives of one to seven years.

 

In accordance with authoritative guidance, we expensed $0.2 million of acquisition-related costs incurred as selling, general and administrative expenses in our consolidated statements of operations for the quarter ended January 2, 2010.

 

Results of operations for the acquired product lines have been included in our consolidated financial statements subsequent to the date of acquisition, and have not been presented on a pro forma basis as the revenue and income from operations are not material to our consolidated results. 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.

 

4.              FAIR VALUES

 

Cash Equivalents and Marketable Securities

 

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. 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 and during the three months ended January 2, 2010, we did not have any assets or liabilities valued based on Level 3 valuations.

 

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Financial assets and liabilities measured at fair value as of January 2, 2010 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)

 

$

17,227

 

$

 

$

17,227

 

Certificates of deposit (2)

 

 

149,451

 

149,451

 

U.S. Treasury and agency obligations (3)

 

 

45,875

 

45,875

 

Corporate notes and obligations (4)

 

 

37

 

37

 

Commercial paper (5)

 

 

2,150

 

2,150

 

Foreign currency contracts (6)

 

 

(170

)

(170

)

Total net assets measured at fair value

 

$

17,227

 

$

197,343

 

$

214,570

 

 


(1)          Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet.

(2)          Includes $148,698 recorded in cash and cash equivalents and $753 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(3)          Includes $5,799 recorded in cash and cash equivalents and $40,076 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

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

(5)          Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet.

(6)          Includes $112 recorded in prepaid expenses and other assets and $282 recorded in other current liabilities on the Condensed Consolidated Balance Sheet.

 

Financial assets and liabilities measured at fair value as of October 3, 2009 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)

 

$

16,481

 

$

 

$

16,481

 

Certificates of deposit (2)

 

 

143,886

 

143,886

 

U.S. Treasury and agency obligations (3)

 

 

47,770

 

47,770

 

Corporate notes and obligations (4)

 

 

51

 

51

 

Commercial paper (5)

 

 

8,598

 

8,598

 

Foreign currency contracts (6)

 

 

(4

)

(4

)

Total net assets measured at fair value

 

$

16,481

 

$

200,301

 

$

216,782

 

 


(1)          Included in cash and cash equivalents on the Condensed Consolidated Balance Sheet.

(2)          Includes $141,423 recorded in cash and cash equivalents and $2,463 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(3)          Includes $9,599 recorded in cash and cash equivalents and $38,171recorded in short-term investments on the Condensed Consolidated Balance Sheet.

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

(5)          Includes $5,598 recorded in cash and cash equivalents and $3,000 recorded in short-term investments on the Condensed Consolidated Balance Sheet.

(6)          Includes $217 recorded in prepaid expenses and other assets and $221 recorded in other current liabilities on the Condensed Consolidated Balance Sheet.

 

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.

 

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We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro and the Japanese Yen. As a result, our earnings and cash flows 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 U.S. Dollar notional amounts of hedge contracts, with maximum maturity of 2 months, are as follows (in thousands):

 

 

 

January 2,
2010

 

October 3,
2009

 

Foreign currency hedge contracts

 

 

 

 

 

Purchase

 

$

9,291

 

$

23,199

 

Sell

 

(7,148

)

(7,779

)

Net

 

$

2,143

 

$

15,420

 

 

The location and fair value amounts of our derivative instruments reported in our Condensed Consolidated Balance Sheets as of January 2, 2010 and October 3, 2009were as follows (in thousands):

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

January 2, 2010

 

January 2, 2010

 

 

 

Balance Sheet

 

 

 

Balance Sheet

 

 

 

 

 

Location

 

Fair Value

 

Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Prepaid expenses and other assets

 

$

112

 

Other current liabilities

 

$

282

 

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

October 3, 2009

 

October 3, 2009

 

 

 

Balance Sheet

 

 

 

Balance Sheet

 

 

 

 

 

Location

 

Fair Value

 

Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Prepaid expenses and other assets

 

$

217

 

Other current liabilities

 

$

221

 

 

The location and amounts of non-designated derivative instruments’ gains and losses in the Condensed Consolidated Statements of Operations for the three months ended January 2, 2010 are as follows (in thousands):

 

 

 

 

 

Amount of (Loss) Recognized in

 

 

 

Location of Gain

 

Income on Derivatives

 

 

 

(Loss) Recognized in
Income on Derivatives

 

Three Months Ended
January 2, 2010

 

Derivatives not designated as hedging instruments

 

 

 

 

 

Foreign exchange contracts

 

Other income (expense)

 

$

(31

)

 

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Table of Contents

 

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):

 

 

 

January 2, 2010

 

 

 

Cost Basis

 

Unrealized
Gains

 

Unrealized
Losses

 

Fair Value

 

Cash and cash equivalents

 

$

 199,758

 

$

2

 

$

 

$

199,760

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

 

$

 

$

 

$

 

Certificates of deposit

 

750

 

2

 

 

752

 

U.S. Treasury and agency obligations

 

40,008

 

73

 

(4

)

40,077

 

Corporate notes and obligations

 

38

 

 

(1

)

37

 

Total short-term investments

 

$

40,796

 

$

75

 

$

(5

)

$

40,866

 

 

 

 

October 3, 2009

 

 

 

Cost Basis

 

Unrealized
Gains

 

Unrealized
Losses

 

Fair Value

 

Cash and cash equivalents

 

$

199,949

 

$

1

 

$

 

$

199,950

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

3,000

 

$

 

$

 

$

3,000

 

Certificates of deposit

 

2,451

 

12

 

 

2,463

 

U.S. Treasury and agency obligations

 

38,152

 

19

 

 

38,171

 

Corporate notes and obligations

 

53

 

 

(2

)

51

 

Total short-term investments

 

$

43,656

 

$

31

 

$

(2

)

$

43,685

 

 

The amortized cost and estimated fair value of available-for-sale investments in debt securities as of January 2, 2010 and October 3, 2009 classified as short-term investments on our consolidated balance sheet were as follows (in thousands):

 

 

 

January 2, 2010

 

October 3, 2009

 

 

 

Amortized Cost

 

Estimated Fair Value

 

Amortized Cost

 

Estimated Fair Value

 

Due in less than 1 year

 

$

40,006

 

$

40,077

 

$

41,151

 

$

41,171

 

Due in 1 to 5 years

 

 

 

 

 

Due in 5 to 10 years

 

 

 

 

 

Due beyond 10 years

 

38

 

37

 

54

 

51

 

Total investments in available-for-sale debt securities

 

$

40,044

 

$

40,114

 

$

41,205

 

$

41,222

 

 

During the first fiscal quarter of 2010, we received proceeds totaling $8.7 million from the sale of available-for-sale securities and realized gross losses of less than $0.1 million. During the first fiscal quarter of 2009, we received proceeds totaling $1.1 million from the sale of available-for-sale securities and realized gross losses of less than $0.1 million.

 

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Table of Contents

 

The following table shows the gross unrealized losses and fair values of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by the investment category and length of time that the individual securities have been in a continuous unrealized loss position at January 2, 2010 and October 3, 2009 (in thousands):

 

 

 

 

 

January 2, 2010

 

 

 

Description of

 

Less Than 12 Months

 

12 Months or Greater

 

Total

 

Securities

 

Fair Value

 

Unrealized Losses

 

Fair Value

 

Unrealized Losses

 

Fair Value

 

Unrealized Losses

 

U.S. Treasury and agency obligations

 

$

11,550

 

$

(4

)

$

 

$

 

$

11,550

 

$

(4

)

Corporate notes and obligations

 

 

 

37

 

(1

)

37

 

(1

)

Total

 

$

11,550

 

$

(4

)

$

37

 

$

(1

)

$

11,587

 

$

(5

)

 

 

 

 

 

October 3, 2009

 

 

 

Description of

 

Less Than 12 Months

 

12 Months or Greater

 

Total

 

Securities

 

Fair Value

 

Unrealized Losses

 

Fair Value

 

Unrealized Losses

 

Fair Value

 

Unrealized Losses

 

U.S. Treasury and agency obligations

 

$

2,990

 

$

 

$

 

$

 

$

2,990

 

$

 

Corporate notes and obligations

 

 

 

52

 

(2

)

52

 

(2

)

Total

 

$

2,990

 

$

 

$

52

 

$

(2

)

$

3,042

 

$

(2

)

 

U.S. Treasury and agency obligations:  There were no unrealized losses on these investments.

 

Corporate notes and obligations:  The unrealized losses on our investments in corporate notes and obligations at January 2, 2010 and October 3, 2009 relate to a $0.1 million investment. The credit ratings of the investments in the notes and obligations range from AAA to A (S&P and Moody’s) and therefore the decline in the market value is attributable to change in interest rates and not credit quality.

 

7.    GOODWILL AND INTANGIBLE ASSETS

 

During the three months ended December 27, 2008, our stock price declined substantially, which combined with expectations of declines in forecasted operating results due to the slowdown in the global economy, led the Company to conclude that a triggering event for review for potential goodwill impairment had occurred.  Accordingly, as of December 27, 2008, we performed an interim goodwill impairment evaluation. Goodwill is tested for impairment first by comparing each reporting unit’s fair value to its respective carrying value. If such comparison indicates a potential impairment, then the impairment is determined as the difference between the recorded value of goodwill and its fair value. The performance of this test is a two-step process.

 

Step 1 of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform Step 2 of the goodwill impairment test to determine the amount of impairment loss. Step 2 of the goodwill impairment test involves comparing the fair value of the affected reporting unit’s goodwill against the carrying value of that goodwill.

 

The reporting units we evaluated for goodwill impairment have been determined to be the same as our operating segments and include Commercial Lasers and Components (“CLC”) and Specialty Lasers and Systems (“SLS”).  We determined the fair value of our reporting units for the Step 1 test using a weighting of the Income (discounted cash flow), Market and Transaction approach valuation methodologies. Management completed and reviewed the results of the Step 1 analysis and concluded that a Step 2 analysis was required only for the CLC reporting unit. Our preliminary analysis indicated that the entire balance of the goodwill in the CLC reporting unit at that date was impaired and we recorded a non-cash goodwill impairment charge of $19.3 million in the first quarter of fiscal 2009.  During the three months ended April 4, 2009, we completed the Step 2 analysis for the CLC reporting unit at December 27, 2008 and determined that the entire balance of goodwill in the CLC reporting unit at that date was impaired.  The estimated fair value of our SLS reporting unit exceeded its carrying value so no further impairment analysis was required for this reporting unit.

 

The non-cash impairment of goodwill of $19.3 million was recorded in the three months ended December 27, 2008.

 

During the three months ended January 2, 2010, 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.

 

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Table of Contents

 

The changes in the carrying amount of goodwill by segment for the period from October 3, 2009 to January 2, 2010 are as follows (in thousands):

 

 

 

Commercial
Lasers and
Components

 

Specialty
Lasers and
Systems

 

Total

 

Balance as of October 3, 2009

 

$

 

$

66,967

 

$

66,967

 

Additions

 

2,580

 

 

 

2,580

 

Translation adjustments and other

 

 

(631

)

(631

)

Balance as of January 2, 2010

 

$

2,580

 

$

66,336

 

$

68,916

 

 

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

 

 

 

January 2, 2010

 

October 3, 2009

 

 

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Existing technology

 

$

54,829

 

$

(40,280

)

$

14,549

 

$

54,477

 

$

(39,220

)

$

15,257

 

Patents

 

10,309

 

(9,072

)

1,237

 

10,440

 

(8,975

)

1,465

 

Order backlog

 

5,544

 

(5,002

)

542

 

5,015

 

(5,002

)

13

 

Customer lists

 

8,555

 

(3,961

)

4,594

 

5,421

 

(3,763

)

1,658

 

Trade name

 

3,782

 

(2,533

)

1,249

 

3,833

 

(2,488

)

1,345

 

Production know-how

 

910

 

(63

)

847

 

 

 

 

Non-compete agreement

 

1,640

 

(1,594

)

46

 

1,590

 

(1,590

)

 

Total

 

$

85,569

 

$

(62,505

)

$

23,064

 

$

80,776

 

$

(61,038

)

$

19,738

 

 

Amortization expense for intangible assets for the three months ended January 2, 2010 and December 27, 2008 was $2.0 million and $1.9 million, respectively. At January 2, 2010, estimated amortization expense for the remainder of fiscal 2010, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):

 

 

 

Estimated
Amortization
Expense

 

2010 (remainder)

 

$

5,982

 

2011

 

6,355

 

2012

 

4,338

 

2013

 

2,525

 

2014

 

1,668

 

2015

 

1,252

 

Thereafter

 

944

 

Total

 

$

23,064

 

 

8.              BALANCE SHEET DETAILS

 

Inventories consist of the following (in thousands):

 

 

 

January 2,
2010

 

October 3,
2009

 

Purchased parts and assemblies

 

$

33,314

 

$

30,945

 

Work-in-process

 

31,811

 

30,680

 

Finished goods

 

33,799

 

36,142

 

Inventories

 

$

98,924

 

$

97,767

 

 

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Table of Contents

 

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

 

 

 

January 2,
2010

 

October 3,
2009

 

Prepaid and refundable income taxes

 

$

26,839

 

$

22,041

 

Prepaid expenses and other

 

24,988

 

16,928

 

Total prepaid expenses and other assets

 

$

51,827

 

$

38,969

 

 

Other assets consist of the following (in thousands):

 

 

 

January 2,
2010

 

October 3,
2009

 

Assets related to deferred compensation arrangements

 

$

22,598

 

$

21,629

 

Deferred tax assets

 

66,699

 

60,819

 

Other assets

 

2,905

 

2,889

 

Total other assets

 

$

92,202

 

$

85,337

 

 

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

 

 

 

January 2,
2010

 

October 3,
2009

 

Accrued payroll and benefits

 

$

20,521

 

$

19,967

 

Deferred income

 

13,694

 

14,424

 

Reserve for warranty

 

9,933

 

10,211

 

Accrued expenses and other

 

11,212

 

9,918

 

Other taxes payable

 

10,005

 

4,361

 

Accrued restructuring charges

 

1,965

 

1,652

 

Customer deposits

 

4,581

 

2,208

 

Total other current liabilities

 

$

71,911

 

$

62,741

 

 

On April 16, 2008, we announced that we entered into an agreement to sell certain assets of our Auburn Optics (“Auburn”) manufacturing operation to Research Electro-Optics, Inc. (“REO”), a privately held optics manufacturing and technology company. We also entered into a strategic supply agreement with REO. REO is providing optical manufacturing capabilities for us, including fabrication and coating of optical components. The transition of the optics manufacturing assets from Auburn to REO was completed in fiscal 2009. The transition has resulted in charges primarily for employee terminations, supplier qualification, moving costs for related equipment, and other exit related costs associated with a plan approved by management.

 

During fiscal 2008, we consolidated our German DPSS manufacturing into our Lübeck, Germany site. The transfer was completed in the fourth quarter of fiscal 2008. On October 13, 2008, we announced the consolidation of the remainder of our Munich facility into our Göttingen site. The transfer was completed in our third quarter of fiscal 2009. The consolidation and transfers have resulted in charges primarily for employee terminations, other exit related costs associated with a plan approved by management and a grant repayment liability.

 

During the second quarter of fiscal 2009, we announced our plans to close our facilities in Tampere, Finland and St. Louis, Missouri. The closure of St. Louis site was completed in the fourth quarter of fiscal 2009.  The closure of our Finland site is scheduled for completion by the end of fiscal 2010. These closure plans have resulted in charges primarily for employee termination and other exit related costs associated with a plan approved by management.

 

Restructuring charges in the first three months of fiscal 2010 and 2009 are recorded in cost of sales, research and development and selling, general and administrative expenses in our condensed consolidated statements of operations.

 

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Table of Contents

 

The following table presents our current liability as accrued on our balance sheet for restructuring charges.  The table sets forth an analysis of the components of the restructuring charges and payments and other deductions made against the accrual for the first three months of fiscal 2010 and 2009 (in thousands):

 

 

 

Severance
Related

 

Facilities-
related
Charges

 

Other
Restructuring
Costs

 

Total

 

Balance at September 27,008

 

$

2,581

 

$

19

 

$

987

 

$

3,587

 

Provisions

 

2,884

 

192

 

1,011

 

4,087

 

Payments and other

 

(2,921

)

(27

)

(1,383

)

(4,331

)

Balance at December 27, 2008

 

$

2,544

 

$

184

 

$

615

 

$

3,343

 

 

 

 

 

 

 

 

 

 

 

Balance at October 3, 2009

 

$

488

 

$

357

 

$

807

 

$

1,652

 

Provisions

 

434

 

17

 

607

 

1,058

 

Payments and other

 

(94

)

(235

)

(416

)

(745

)

Balance at January 2, 2010

 

$

828

 

$

139

 

$

998

 

$

1,965

 

 

The current year severance related costs are primarily comprised of severance pay, outplacement services, medical and other related benefits for employees being terminated due to the transition of activities out of Montreal, Canada, and Tampere, Finland. The remaining severance related restructuring accrual balance of approximately $0.8 million at January 2, 2010 is expected to result in cash expenditures through the fourth quarter of fiscal 2010. The other restructuring costs are primarily for a grant repayment liability and other exit related costs associated with a plan approved by management.

 

We provide warranties on certain of our product sales and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances 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 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 fiscal quarter of fiscal 2010 and 2009 were as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2,
2010

 

December 27,
2008

 

Beginning balance

 

$

10,211

 

$

13,214

 

Additions related to current period sales

 

3,082

 

3,651

 

Warranty costs incurred in the current period

 

(3,459

)

(4,476

)

Accruals resulting from acquisition

 

160

 

 

Adjustments to accruals related to prior period sales

 

(61

)

(328

)

Ending balance

 

$

9,933

 

$

12,061

 

 

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

 

 

 

January 2,
2010

 

October 3,
2009

 

Long-term taxes payable

 

$

51,879

 

$

51,483

 

Deferred compensation

 

23,906

 

22,723

 

Deferred tax liabilities

 

8,581

 

9,651

 

Deferred income

 

1,992

 

2,109

 

Asset retirement obligations liability

 

1,289

 

1,342

 

Other long-term liabilities

 

4,407

 

4,377

 

Total other long-term liabilities

 

$

92,054

 

$

91,685

 

 

The following table reconciles changes in our asset retirement obligations liability (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2,
2010

 

December 27,
2008

 

Beginning balance

 

$

1,679

 

$

1,464

 

Adjustment to asset retirement obligations recognized

 

(49

)

354

 

Accretion recognized

 

20

 

27

 

Changes due to foreign currency exchange

 

(29

)

35

 

Ending balance

 

$

1,621

 

$

1,880

 

 

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Table of Contents

 

At January 2, 2010, $332,000 of the asset retirement liability is reported in other current liabilities and $1,289,000 is reported in other long-term liabilities on our condensed consolidated balance sheets.  At December 27, 2008, $250,000 of the asset retirement liability is reported in other current liabilities and $1,630,000 is reported in other long-term liabilities on our condensed consolidated balance sheets.

 

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 $16.8 million of foreign lines of credit as of January 2, 2010.  At January 2, 2010, we had used $3.6 million of these available foreign lines of credit. These credit facilities were used in Europe during the first fiscal quarter of 2010 as guarantees.  In addition, our domestic line of credit, which was opened on March 31, 2008, includes a $40 million unsecured revolving credit account with Union Bank of California. The recently amended agreement will expire on March 31, 2012 and is subject to covenants related to financial ratios and tangible net worth with which we are currently in compliance.  No amounts have been drawn upon our domestic line of credit as of January 2, 2010.

 

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 our stock options granted to employees and shares purchased under the employee stock purchase plan for the three months ended January 2, 2010 and December 27, 2008 were estimated using the following weighted-average assumptions:

 

 

 

Employee Stock Option Plans

 

Employee Stock Purchase Plan

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

January 2,
2010

 

December 27,
2008

 

January 2,
2010

 

December 27,
2008

 

Expected life in years

 

4.5

 

4.0

 

0.5

 

0.5

 

Expected volatility

 

33.0

%

48.0

%

41.3

%

44.1

%

Risk-free interest rate

 

2.0

%

1.9

%

0.2

%

1.1

%

Expected dividends

 

 

 

 

 

Weighted average fair value per share

 

$

8.01

 

$

9.10

 

$

5.94

 

$

6.95

 

 

Stock 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 January 2, 2010 and December 27, 2008 (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2,

 

December 27,

 

 

 

2010

 

2008

 

Cost of sales

 

$

219

 

$

283

 

Research and development

 

273

 

195

 

Selling, general and administrative

 

1,670

 

1,212

 

Income tax benefit

 

(643

)

(537

)

 

 

$

1,519

 

$

1,153

 

 

During the three months ended January 2, 2010, $0.2 million was capitalized into inventory for all stock plans, $0.2 million was amortized to cost of sales and $0.3 million remained in inventory at January 2, 2010. During the three months ended December 27, 2008, $0.2 million was capitalized into inventory for all stock plans, $0.3 million was amortized to cost of sales and $0.3 million remained in inventory at December 27, 2008. Management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

 

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Table of Contents

 

At January 2, 2010, the total compensation cost related to unvested stock-based awards granted to employees under the Company’s stock option plans but not yet recognized was approximately $14.6 million, net of estimated forfeitures of $1.9 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.6 years and will be adjusted for subsequent changes in estimated forfeitures.

 

At January 2, 2010, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.4 million, which will be recognized over the offering period.

 

The cash flows resulting from excess tax benefits (tax benefits related to the excess of tax deduction resulting from an employee’s exercises of stock options over the stock-based compensation cost recognized for those options) are classified as financing cash flows. During the first three months of fiscal 2010 and fiscal 2009, we recorded an immaterial amount 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 Plans (in thousands, except per share amounts and remaining contractual term in years):

 

 

 

Number of
Shares

 

Weighted
Average
Exercise Price
Per Share

 

Weighted
Average
Remaining
Contractual
Term in Years

 

Aggregate
Intrinsic Value

 

Outstanding at October 4, 2009

 

2,494

 

$

29.44

 

 

 

 

 

Granted

 

443

 

26.16

 

 

 

 

 

Exercised

 

(31

)

24.94

 

 

 

 

 

Forfeitures

 

(22

)

24.46

 

 

 

 

 

Expirations

 

(5

)

33.01

 

 

 

 

 

Outstanding at January 2, 2010

 

2,879

 

$

29.02

 

3.7

 

$

7,025

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at January 2, 2010

 

2,812

 

$

29.11

 

3.6

 

$

6,708

 

 

 

 

 

 

 

 

 

 

 

Exercisable at January 2, 2010

 

2,069

 

$

30.77

 

2.6

 

$

2,813

 

 

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.  There were approximately 1.5 million outstanding options that were in-the-money at January 2, 2010. The aggregate intrinsic value of options exercised under the Company’s stock plans was less than $0.1 million for both the three months ended January 2, 2010 and the three months ended December 27, 2008, determined as of the date of option exercise.

 

The following table summarizes our restricted stock award and restricted stock unit activity for the first three months of fiscal 2010 (in thousands, except per share amounts):

 

 

 

Number of
Shares

 

Weighted
Average
Grant Date Fair
Value per Share

 

Nonvested stock at October 3, 2009

 

357

 

$

25.66

 

Granted

 

225

 

26.16

 

Vested

 

(52

)

23.30

 

Forfeited

 

(4

)

21.57

 

Nonvested stock at January 2, 2010

 

526

 

$

26.14

 

 

11.      COMMITMENTS AND CONTINGENCIES

 

We are subject to legal claims and litigation arising in the ordinary course of business, such as product liability, employment or intellectual property claims, including, but not limited to, the matters described below. 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.

 

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Derivative Lawsuit—Between February 15, 2007 and March 2, 2007, three purported shareholder derivative lawsuits were filed in the United States District Court for the Northern District of California against certain of the Company’s current and former officers and directors. The Company is named as a nominal defendant. The complaints generally alleged that the defendants breached their fiduciary duties and violated the securities laws in connection with the granting of stock options, the accounting treatment for such grants, the issuance of allegedly misleading public statements and stock sales by certain of the individual defendants. On May 30, 2007, these lawsuits were consolidated under the caption In re Coherent, Inc. Shareholder Derivative Litigation, Lead Case No. C-07-0955-JF (N.D. Cal.). On June 25, 2007, plaintiffs filed an amended consolidated complaint. The consolidated complaint asserted causes of action for alleged violations of federal securities laws, violations of California securities laws, breaches of fiduciary duty and/or aiding and abetting breaches of fiduciary duty, abuse of control, gross mismanagement, constructive fraud, corporate waste, unjust enrichment, insider selling and misappropriation of information. The consolidated complaint sought, among other relief, disgorgement and damages in an unspecified amount, an accounting, rescission of allegedly improper stock option grants, punitive damages and attorneys’ fees and costs.

 

The Company’s Board of Directors appointed a Special Litigation Committee (“SLC”) comprised of independent director Sandeep Vij to investigate and evaluate the claims asserted in the derivative litigation and to determine what action(s) should be taken with respect to the derivative litigation. On September 8, 2009, Coherent, Inc., by and through the SLC, plaintiffs, and certain of Coherent’s former and current officers and directors filed with the court a Stipulation of Settlement reflecting the terms of a settlement that would resolve all claims alleged in the consolidated complaint.

 

On September 14, 2009, the United States District Court for the Northern District of California issued an order granting preliminary approval of the settlement of the three purported shareholder derivative lawsuits. On November 20, 2009, the court held a hearing for final approval of the settlement, and on November 24, 2009, the court entered an Order and Final Judgment, which approved the settlement and dismissed the action with prejudice. Following the payment of the plaintiff attorneys’ fees and expenses, we received a net cash benefit of $2.2 million from the settlement on December 11, 2009, which has been recorded in selling general and administrative expenses in the Condensed Consolidated Statement of Operations for the three months ended January 2, 2010.

 

Income Tax Audits—The Internal Revenue Service (“IRS”) is conducting an audit of our 2003 and 2004 U.S. federal tax returns. The IRS has issued a number of Notices of Proposed Adjustments (“NOPAs”) to these returns. Among other items, the IRS has challenged our research and development credits and our extraterritorial income (“ETI”) exclusion. We have agreed to the various adjustments proposed by the IRS and we believe that we have adequately provided for these exposures and any other items identified by the IRS as a result of the audit of these tax years. As part of its audit of our 2003 and 2004 years, the IRS has requested information related to our stock option investigation and we complied with this request and we will address any issues that are raised in a timely manner. The IRS has also indicated that it may consider an audit of our 2005 and 2006 tax returns.

 

The IRS is also auditing the research and development credits generated in the years 1999 through 2001 and carried forward to future tax years. We received a NOPA from the IRS in October 2008 to decrease the amount of research and development credits generated in years 2000 and 2001.  We responded to this NOPA and we are disputing the adjustment with the IRS through the appeals process available to us.  While we believe that we have adequately provided for any adjustments that may be proposed by the IRS related to these credits, there exists the possibility of a material adverse impact on our results of operations in the event that this issue is resolved unfavorably to us.

 

The German tax authorities are conducting an audit of our subsidiary in Göttingen for the tax years 1999 through 2005. We believe that we have adequately provided for any adjustments that may be proposed by the German tax authorities.

 

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12.       ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The components of comprehensive income (loss), net of income taxes, are as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2,

 

December 27,

 

 

 

2010

 

2008

 

 

 

 

 

 

 

Net income (loss)

 

$

4,179

 

$

(14,679

)

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Translation adjustment

 

(3,225

)

(10,161

)

Net gain on derivative instruments, net of taxes

 

2

 

2

 

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

 

(8

)

7

 

Other comprehensive income (loss), net of tax

 

(3,231

)

(10,152

)

Comprehensive income (loss)

 

$

948

 

$

(24,831

)

 

The following summarizes activity in accumulated other comprehensive income (loss) related to derivatives, net of income taxes, held by us (in thousands):

 

Balance, September 27, 2008

 

$

(93

)

Changes in fair value of derivatives

 

 

Net losses reclassified from OCI

 

2

 

Balance, December 27, 2008

 

$

(91

)

 

 

 

 

Balance, October 3, 2009

 

$

(85

)

Changes in fair value of derivatives

 

 

Net losses reclassified from OCI

 

2

 

Balance, January 2, 2010

 

$

(83

)

 

Accumulated other comprehensive income (net of tax) at January 2, 2010 is comprised of accumulated translation adjustments of $77.1 million and a net loss on derivative instruments of $0.1 million. Accumulated other comprehensive income (net of tax) at October 3, 2009 is comprised of accumulated translation adjustments of $80.3 million and a net loss on derivative instruments of $0.1 million.

 

13.  EARNINGS PER SHARE

 

Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.

 

The following table presents information necessary to calculate basic and diluted earnings (loss) per share (in thousands, except per share data):

 

 

 

Three Months Ended

 

 

 

January 2,

 

December 27,

 

 

 

2010

 

2008

 

Weighted average shares outstanding —basic (1)

 

24,469

 

24,145

 

Dilutive effect of employee stock awards

 

209

 

 

Weighted average shares outstanding—diluted

 

24,678

 

24,145

 

 

 

 

 

 

 

Net income (loss)

 

$

4,179

 

$

(14,679

)

 

 

 

 

 

 

Net income (loss) per basic share

 

$

0.17

 

$

(0.61

)

Net income (loss) per diluted share

 

$

0.17

 

$

(0.61

)

 


(1)   Net of restricted stock

 

A total of 2,267,286 potentially dilutive securities have been excluded from the dilutive share calculation for the first quarter fiscal 2010 as their effect was anti-dilutive. As the Company incurred a net loss for the first quarter of fiscal 2009, all potentially dilutive securities from stock options, employee stock purchase plan and restricted stock awards have been excluded from the diluted net loss per share computation as their effects were deemed anti-dilutive.

 

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14.  OTHER INCOME (EXPENSE)

 

Other income (expense) is as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2, 2010

 

December 27,
2008

 

Interest and dividend income

 

$

148

 

$

1,444

 

Interest expense

 

(47

)

(77

)

Foreign exchange gain (loss)

 

(357

)

502

 

Gain (loss) on investments, net

 

1,067

 

(6,798

)

Other—net

 

(19

)

699

 

Other income (expense), net

 

$

792

 

$

(4,230

)

 

15.  INCOME TAXES

 

Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discreet to the period. Our estimated effective tax rate for the three months ended January 2, 2010 was 35.5%.  Our effective tax rate for the three months ended January 2, 2010 was higher than the statutory rate of 35% due primarily to permanent differences related to deemed dividend inclusions under the Subpart F tax rules, partially offset by the benefit of foreign tax credits, income subject to foreign tax rates that are lower than U.S. tax rates, an unrealized gain on life insurance policy investments related to our deferred compensation plan and federal research and development credits. The difference between the statutory rate of 35% and our effective tax rate of (8.9%) on income (loss) before income taxes for the first quarter of fiscal 2009 was due primarily to permanent differences related to the non-deductibility of the goodwill impairment charge, deemed dividend inclusions under the Subpart F tax rules, an unrealized loss on life insurance policy investments related to our deferred compensation plan and an increase in valuation allowance against certain foreign net operating loss carryforwards.  These amounts are partially offset by permanent differences related to the benefit of research and development credits, including additional credits reinstated from fiscal 2008 resulting from the enactment of the “Emergency Economic Stabilization Act of 2008,” and the benefit of foreign tax credits.

 

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 January 2, 2010, the total amount of gross unrecognized tax benefits was $57.7 million, of which $31.9 million, if recognized, would affect our effective tax rate. Our total gross unrecognized tax benefits 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 January 2, 2010, the total amount of gross interest and penalties accrued was $8.1 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 1999 are closed. The years 2003 and 2004 are currently under examination by the IRS. The IRS is also auditing the research and development credits generated in the years 1999 through 2001 and carried forward to future years.  We responded to a NOPA issued by the IRS in October 2008 to decrease the amount of research and development credits generated in 2000 and 2001 and we are disputing the proposed adjustment with the IRS through the appeals process available to us.  The IRS has also indicated that it may consider an audit of our 2005 and 2006 tax returns. In our major state jurisdiction and our major foreign jurisdiction, the years subsequent to 1998 remain open and could be subject to examination by the taxing authorities.

 

Management believes that it has adequately provided for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. Should any issues addressed in our tax audits be resolved in a manner not consistent with management’s expectations, we could be required to adjust our provision for income tax in the period such resolution occurs. Although timing of the resolution and/or closure of audits is highly uncertain, we do not believe it is reasonably possible that our unrecognized tax benefits would materially change. Within the next 12 months, we anticipate a lapse in the statute of limitations which could result in a release of interest expense accrued under ASC 740, “Income Taxes.” This amount is not considered significant.

 

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The “Worker, Homeownership and Business Assistance Act of 2009” was enacted on November 6, 2009.  Under the Act, businesses with net operating losses for 2008 and 2009 may carry back those losses for up to five years.  The Company intends to carry back losses incurred in fiscal 2009 in accordance with this new legislation and this tax law change has minimal financial statement impact.

 

Deferred Income Taxes

 

As of January 2, 2010, our condensed consolidated balance sheet included net deferred tax assets, before valuation allowance, of approximately $82.2 million, which consists of tax credit carryovers, deferred gain on subsidiary stock issuance, accruals and reserves, competent authority offset to transfer pricing tax reserve, employee stock-based compensation expenses, depreciation and amortization, 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 $6.8 million reported as of January 2, 2010.  We intend to maintain the valuation allowance until sufficient positive evidence exists to support reversal of the valuation allowance.

 

16.  SEGMENT INFORMATION

 

We are organized into two reportable operating segments: Commercial Lasers and Components (“CLC”) and Specialty Lasers and Systems (“SLS”). This segmentation reflects the go-to-market strategies for various products and markets.  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 OEM components and instrumentation and materials processing. SLS develops and manufactures configurable, advanced-performance products largely serving the microelectronics and scientific research 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.

 

We have identified CLC and SLS as operating segments for which discrete financial information is available. Both units have engineering, marketing, product business management and product line management. 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. Assets by segment are not a measure used to assess the performance of the company by the CODM; therefore we do not report assets by segment internally or in our disclosures. Income (loss) from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain research and development, management, finance, legal and human resources) and are included in the results below under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.

 

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The following table provides net sales and income (loss) from operations for our operating segments (in thousands):

 

 

 

Three Months Ended

 

 

 

January 2,

 

December 27,

 

 

 

2010

 

2008

 

Net sales:

 

 

 

 

 

Commercial Lasers and Components

 

$

37,081

 

$

37,380

 

Specialty Laser Systems

 

85,709

 

86,983

 

Corporate and other

 

25

 

25

 

Total net sales

 

$

122,815

 

$

124,388

 

 

 

 

 

 

 

Income (loss) from operations:

 

 

 

 

 

Commercial Lasers and Components

 

$

(5,460

)

$

(23,768

)

Specialty Laser Systems

 

17,786

 

13,734

 

Corporate and other

 

(6,644

)

788

 

Total income (loss) from operations

 

$

5,682

 

$

(9,246

)

 

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

 

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:

 

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·                  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 expand into new markets, such as laser based processing development tools for solar manufacturing and high power materials processing solutions.

 

·                  Optimize our leadership position in existing markets—There are a number of markets where we have historically been at the forefront of technological development and product deployment and from which we have derived a substantial portion of our revenues. We plan to optimize our financial returns from these markets.

 

·                  Maintain and develop additional strong collaborative customer and industry relationships—We believe that the Coherent brand name and reputation for product quality, technical performance and customer satisfaction will help us to further develop our loyal customer base. We plan to maintain our current customer relationships and develop new ones with customers who are industry leaders and work together with these customers to design and develop innovative product systems and solutions as they develop new technologies.

 

·                  Develop and acquire new technologies and market share—We will continue to enhance our market position through our existing technologies and develop new technologies through our internal research and development efforts, as well as through the acquisition of additional complementary technologies, intellectual property, manufacturing processes and product offerings.

 

·                  Streamline our manufacturing structure and improve our cost structure—We will focus on optimizing the mix of products that we manufacture internally and externally. We will utilize vertical integration where our internal manufacturing process is considered proprietary and seek to leverage external sources when the capabilities and cost structure are well developed and on a path towards commoditization.

 

·                  Focus on long-term improvement of adjusted EBITDA expressed as a percentage of net sales—We define adjusted EBITDA as earnings before interest, taxes, depreciation, amortization, stock compensation expenses and certain other non-operating income and expense items. Key initiatives to reach our goals for EBITDA improvements include our program of consolidating manufacturing locations, rationalizing our supply chain and selective outsourcing of manufacturing operations.

 

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 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 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.

 

Revenue Recognition

 

We recognize revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists, the product has been delivered or the service has been rendered, the price is fixed or determinable and collection is probable. Revenue from product sales is recorded when all of the foregoing conditions are met and risk of loss and title passes to the customer. Our products typically include a warranty and the estimated cost of product warranty claims (based on historical experience) is recorded at the time the sale is recognized. Sales to customers are generally not subject to any price protection or return rights.

 

The vast majority of our sales are made to original equipment manufacturers (OEMs), distributors, resellers and end-users in the non-scientific market. Sales made to these customers do not require installation of the products by us and are not subject to other post-delivery obligations, except in occasional instances where we have agreed to perform installation or provide training. In those instances, we defer revenue related to installation services or training until these services have been rendered. We allocate revenue from multiple element arrangements to the various elements based upon relative fair values.

 

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Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. Failure to obtain anticipated orders due to delays or cancellations of orders could have a material adverse effect on our revenue. In addition, pressures from customers to reduce our prices or to modify our existing sales terms may have a material adverse effect on our revenue in future periods.

 

Our sales to distributors, resellers and end-user customers typically do not have customer acceptance provisions and only certain of our sales to OEM customers have customer acceptance provisions. Customer acceptance is generally limited to performance under our published product specifications. For the few product sales that have customer acceptance provisions because of higher than published specifications, (1) the products are tested and accepted by the customer at our site or by the customer’s acceptance of the results of our testing program prior to shipment to the customer, or (2) the revenue is deferred until customer acceptance occurs.

 

Sales to end-users in the scientific market typically require installation and, thus, involve post-delivery obligations; however our post-delivery installation obligations are not essential to the functionality of our products. We defer revenue related to installation services until completion of these services.

 

For most products, training is not provided; therefore, no post-delivery training obligation exists. However, when training is provided to our customers, it is typically priced separately and recognized as revenue after these services have been provided.

 

Long-Lived Assets and Goodwill

 

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.

 

We have determined that our reporting units are the same as our operating segments as each constitutes a business for which discrete financial information is available and for which segment management regularly reviews the operating results.  We make this determination in a manner consistent with how the operating segments are managed.  Based on this analysis, we have identified two reporting units which are our reportable segments: CLC and SLS.

 

Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired (see Note 7 in the Notes to Condensed Consolidated Financial Statements). We perform our annual impairment tests at the beginning of the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.

 

During the first quarter of fiscal 2009, our stock price declined substantially which, combined with expectations of declines in forecasted operating results due to the slowdown in the global economy, led the Company to conclude that a triggering event for review for potential goodwill impairment had occurred. Accordingly, as of December 27, 2008, we performed an interim goodwill impairment evaluation. Goodwill is tested for impairment by comparing the respective fair value with the respective carrying value of the reporting unit. If such comparison indicates a potential impairment, then the impairment is determined as the difference between the recorded value of goodwill and its fair value. The performance of this test is a two-step process.

 

Step 1 of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform Step 2 of the goodwill impairment test to determine the amount of impairment loss. Step 2 of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill against the carrying value of that goodwill.

 

We rely on the following three valuation approaches to determine the fair value of both of our reporting units.  (1) The Income approach utilizes the discounted cash flow model to provide an estimation of fair value based on the cash flows that a business expects to generate. These cash flows are based on forecasts developed internally by management which are then discounted at an after tax rate of return required by equity and debt market participants of a business enterprise.  This rate of return or cost of capital is weighted based on the capitalization of comparable companies.  (2) The Market approach determines fair value by comparing the reporting units to comparable companies in similar lines of business that are publicly traded.  Total Enterprise Value (TEV) multiples such as TEV to revenues and TEV to earnings (if applicable) before interest and taxes of the publicly traded companies are calculated.  These multiples are then applied to the reporting unit’s operating results to obtain an estimate of fair value.  (3) The Transaction approach estimates the fair value of the reporting unit based on market prices in actual transactions.  A comparison is done between the reporting units and other similar businesses. Total Enterprise Value multiples for revenue and earnings as noted in the Market approach above are calculated from the comparable companies and then applied to the reporting unit’s operating results to obtain an estimate of fair value.   Each of these three approaches captures aspects of value in each reporting unit.  The Income approach captures our expected future performance, the Market approach captures how investors view the reporting units through other competitors; and, the Transaction approach captures value through transactions for sales of similar types of companies. We believe these valuation approaches are proven valuation techniques and methodologies for our industry and are widely accepted by investors.

 

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We weighted each of these approaches equally as none are perceived by us to deliver any greater indication of value than the other. The sensitivity analysis performed by management determined that by changing the weighting placed on the three approaches, the result of the Step 1 test for both reporting units was not affected.

 

The valuation analysis requires significant judgments and estimates to be made by management in particular related to the forecast.  The assumed growth rates and gross margins as well as period expenses were determined based on internally developed forecasts considering our future plans.  The assumptions used were management’s best estimates based on projected results and market conditions as of the date of testing. In order to test the sensitivity of these fair values, management further reviewed other scenarios relative to these assumptions to see if the resulting impact on fair values would have resulted in a different Step 1 conclusion for the CLC and SLS reporting units.

 

Based on these forecast scenarios, the fair value of both reporting units was re-calculated. In addition, this sensitivity analysis applied more conservative assumptions with regard to control premiums as well as multipliers used in the Market approach and the Transaction approach.  In each of the sensitivity analyses performed, the CLC reporting unit failed and the SLS reporting unit passed. None of the outcomes of the sensitivity analyses performed would have impacted our Step 1 conclusions or the non-cash impairment charge for goodwill of $19.3 million recorded in the first quarter of fiscal 2009.

 

Sensitivity was also applied to the discount rate used in the Income approach for both the CLC and SLS reporting units.  At December 27, 2008, the discount rate for the CLC reporting unit could have been reduced by more than 40% and still resulted in a failure.  For the SLS reporting unit, the discount rate could have been increased by more than 40% and still resulted in no impairment.

 

During the second quarter of fiscal 2009, our expectations of declines in forecasted operating results due to the slowdown in the global economy and the further declines in our stock price led us to conclude that a triggering event for review for potential goodwill impairment had occurred.  Accordingly, as of April 4, 2009, we performed an interim goodwill impairment evaluation.  This interim impairment evaluation utilized the same valuation techniques used in our impairment valuation in the first quarter of fiscal 2009.  A similar sensitivity analysis was also done at April 4, 2009 where we determined that the discount rate used in the Income approach for the SLS reporting unit could have been increased by approximately 20% and still resulted in no impairment. Based on the results of our Step 1 analysis, we determined that no additional goodwill impairment was indicated.

 

During the three months ended January 2, 2010, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment.

 

At January 2, 2010, we had $68.9 million of goodwill and $100.1 million of property and equipment and $23.1 million of purchased intangible assets on our condensed consolidated balance sheet.

 

It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In addition, if the price of our common stock were to significantly decrease combined with any other adverse change in market conditions, thus indicating that the underlying fair value of our reporting units or other long-lived assets may have decreased, we may be required to assess the recoverability of such assets in the period such circumstances are identified. In that event, additional impairment charges or shortened useful lives of certain long-lived assets may be required.

 

Inventory Valuation

 

We record our inventory at the lower of cost (computed on a first-in, first-out basis) or market. We write-down our inventory to its estimated market value based on assumptions about future demand and market conditions. Inventory write-downs are generally recorded within guidelines set by management when the inventory for a device exceeds 12 months of its demand and when individual parts have been in inventory for greater than 12 months. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required which could materially affect our future results of operations. Due to rapidly changing forecasts and orders, additional write-downs for excess or obsolete inventory, while not currently expected, could be required in the future. In the event that alternative future uses of fully written down inventories are identified, we may experience better than normal profit margins when such inventory is sold. Differences between actual results and previous estimates of excess and obsolete inventory could materially affect our future results of operations. We write-down our demonstration inventory by amortizing the cost of demonstration inventory over a twenty month period starting from the fourth month after such inventory is placed in service.

 

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Warranty Reserves

 

We provide warranties on certain of our product sales and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances 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.

 

Stock-Based Compensation

 

We account for stock based compensation using the fair value of the awards granted. We estimate the fair value of stock options granted using the Black Scholes Merton model. We use historical data to estimate pre-vesting option forfeitures and record stock based compensation expense only for those awards that are expected to vest. We amortize the fair value of stock options on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. We value restricted stock units using the intrinsic value method. We amortize the value of restricted stock units on a straight-line basis over the restriction period. See Note 10 “Stock Based Compensation” for a description of our stock based employee compensation plans and the assumptions we use to calculate the fair value of stock based employee compensation.

 

Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets.

 

We record a valuation allowance to reduce our deferred tax assets to an amount that more likely than not will be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the allowance for the deferred tax assets would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance for the deferred tax assets would be charged to income in the period such determination was made.

 

We evaluate our need for reserves for our uncertain tax positions using a two-step approach. The first step, recognition, occurs when we conclude (based solely on the technical aspects of the matter) that a tax position is more likely than not to be sustained upon examination by a taxing authority. The second step, measurement, is only considered after step one has been satisfied and measures any tax benefit at the largest amount that is deemed more likely than not to be realized upon ultimate settlement of the uncertainty. These determinations involve significant judgment by management. Tax positions that fail to qualify for initial recognition are recognized in the first subsequent interim period that they meet the more likely than not standard or when they are resolved through negotiation or litigation with factual interpretation, judgment and certainty. Tax laws and regulations themselves are complex and are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court filings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially to reverse previously recorded tax liabilities.

 

The “Worker, Homeownership and Business Assistance Act of 2009” was enacted on November 6, 2009.  Under the Act, businesses with net operating losses for 2008 and 2009 may carry back those losses for up to five years.  The Company intends to carry back losses incurred in fiscal 2009 in accordance with this new legislation and this tax law change has minimal financial statement impact.

 

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KEY PERFORMANCE INDICATORS

 

The following is a summary of some of the quantitative performance indicators (as defined below) that may be used to assess our results of operations and financial condition:

 

 

 

Three Months Ended

 

 

 

 

 

 

 

January 2,
2010

 

December 27,
2008

 

Change

 

% Change

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Bookings

 

$

158,395

 

$

103,319

 

$

55.076

 

53.3

%

Net sales—Commercial Lasers and Components

 

$

37,081

 

$

37,380

 

$

(299

)

(0.8

)%

Net sales—Specialty Lasers and Systems

 

$

85,709

 

$

86,983

 

$

(1,274

)

(1.5

)%

Gross profit as a percentage of net sales—Commercial Lasers and Components

 

28.6

%

30.0

%

(1.4

)%

(4.7

)%

Gross profit as a percentage of net sales—Specialty Lasers and Systems

 

47.4

%

45.0

%

2.4

%

5.3

%

Research and development as a percentage of net sales

 

12.5

%

11.9

%

0.6

%

5.0

%

Income (loss) before income taxes

 

$

6,474

 

$

(13,476

)

$

19,950

 

148.0

%

Net cash provided by (used in) operating activities

 

$

17,600

 

$

(9,398

)

$

26,998

 

287.3

%

Days sales outstanding in receivables

 

55.8

 

68.9

 

(13.1

)

(19.0

)%

Annualized inventory turns

 

2.9

 

2.5

 

0.4

 

16.0

%

Capital spending as a percentage of net sales

 

2.7

%

7.2

%

(4.5

)%

(62.5

)%

 

Definitions and analysis of these performance indicators are as follows:

 

Bookings

 

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.

 

Fiscal 2009 began with a significant decrease in bookings in all markets compared to fiscal 2008, particularly in the microelectronics and OEM components and instrumentation markets that were most impacted by the decline in consumer confidence and spending. In the second quarter of fiscal 2009, the business environment remained challenging, with continued declines in bookings due to drops in consumer confidence in the microelectronics and OEM components and instrumentation markets as many companies, including us, were closely managing inventory levels and expenses. Although bookings in the scientific and materials processing markets decreased in the first quarter of fiscal 2009 from the levels of the fourth quarter of fiscal 2008, they began to show some signs of stability in the second quarter of fiscal 2009. The third quarter of fiscal 2009 continued to be impacted by macroeconomic conditions, with the largest impact felt in the microelectronics market. All four of our markets showed signs of recovery, with increases in bookings during the fourth quarter of fiscal 2009, led by significant increases in the microelectronics and scientific markets.

 

All four of our markets continued to show signs of recovery in the first quarter of fiscal 2010, led by a significant increase in the microelectronics market. First fiscal quarter bookings increased 53.3% from the same quarter one year ago, with increases in all four markets.

 

Microelectronics

 

Microelectronics bookings, which set a new Company record, increased 109% compared to the same quarter one year ago and increased 65% from the fourth quarter of fiscal 2009.

 

The trend for the semiconductor market remains positive with utilization rates continuing to rise and capital spending projected to increase more than 50% compared to fiscal 2009.  In the first quarter of fiscal 2010, this resulted in greater service bookings and new capacity buys with a 20% sequential increase in semiconductor orders.  We also continue to capture key design wins which should enable us to maintain our market leadership position.

 

Orders for advanced packaging applications doubled from a year ago with increased activity in all three submarkets.  While not yet at fiscal 2008 levels, we are encouraged by the current trends in the market. The via drilling market is benefitting from two technology trends: (1) global demand for smart phones is driving overall capacity expansion and  (2) recent enhancements to our CO2 platform are helping our lead customer gain market share. Laser direct imaging applications in the printed circuit board industry that rely on our high power ultraviolet lasers are also strengthening. Finally, we secured production orders for silicon singulation for logic devices and sapphire scribing for high brightness LEDs in the first quarter of fiscal 2010.

 

Orders from the flat panel display market remain above fiscal 2009 levels as utilization rates and corresponding service orders increase. Orders were down compared to the fourth quarter of fiscal 2009 when we booked multiple annealing systems for use in organic light-emitting diode (OLED) manufacturing.

 

For several quarters we have been active in the crystalline silicon solar market, partnering with industry leaders in several new applications such as those that enhance optical-to-electrical conversion efficiency.  During the first quarter of fiscal 2010, we received orders in excess of $23 million for both process development and high volume production level tools, with the majority of such orders from our lead customer. These orders are scheduled to be delivered within fiscal 2010.

 

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Materials Processing

 

Materials processing orders increased 32% compared to the same quarter one year ago and increased 21% from the fourth quarter of fiscal 2009.

 

Materials processing remains a tale of two markets.  Low power applications in marking and engraving that largely serve consumer products continue to trend higher, especially in China.  All relevant products — CO2, diode and solid-state lasers — are benefitting from the trend.  Although this is positive news, we expect customers to closely manage inventory versus demand, leading to fluctuating levels of bookings.

 

The high power market still lacks a catalyst and we do not foresee a change before the middle of calendar 2010 at the earliest.  The customer qualification process of the E-1000 kilowatt CO2 laser is proceeding on schedule and the feedback has been very positive.  We have begun to accept production orders and revenue shipments will commence in the third quarter of fiscal 2010.  We are also seeing encouraging results from our kilowatt fiber laser program, thanks in part to optimized material provided by our recently acquired fiber facility.  We expect to ship prototypes in fiscal 2010 as originally planned.

 

OEM Components and Instrumentation

 

OEM Components and Instrumentation orders increased 30% compared to the same quarter one year ago and increased 2% from the fourth quarter of fiscal 2009.

 

We have been working with leading ophthalmic system manufacturers to qualify our Genesis™ 577 OPS laser for use in non-refractive procedures including photocoagulation and photodisruption.  We continue to capture design wins and are booking initial production orders as well.

 

The instrumentation market increased significantly on both a sequential and annual basis as customers see demand trending towards fiscal 2008 levels.  Demand was strong for our Sapphire™ OPS laser, recognized as the industry standard for visible light sources, as well as our Genesis™ 355 OPS laser, which is becoming the standard for UV light sources.  Some of the recent order strength has been attributed to calendar year-end spending in Asia-Pacific, specifically from Japan.  We are not certain whether projected National Institute of Health (“NIH”) stimulus funds have been factored into orders received over the past two quarters.

 

For the past several quarters, we have seen a resurgence in the light show market through our Taipan™ OPS lasers.  These lasers have sparked renewed interest from the digital cinema industry, who value color gamut, power, reliability, ease of use and cost.  While a technical solution is readily achievable, we believe the financing model for cinema operators will be the ultimate decision factor.

 

Scientific and Government Programs

 

Scientific and government programs orders increased 26% compared to the same quarter one year ago, but decreased 11% from the fourth quarter of fiscal 2009’s record surge in orders.

 

The first quarter fiscal 2010 bookings were the second highest all time and included record highs for Europe and Japan with in-line seasonal performance for North America. We established a second consecutive bookings record for our Chameleon™ product line, with about half of the orders for our latest version of the Chameleon™ Vision.  Stimulus money has played a role in the increased volume, but we also believe we are gaining market share.  Orders for non-biological imaging products accounted for the bookings decline from the fourth quarter of fiscal 2009 as the total number of opportunities was lower in the first quarter of fiscal 2010 compared to the fourth quarter of fiscal 2009.

 

We are tracking the flow of stimulus funds.  We believe the National Science Foundation has committed approximately half of its ARRA (American Recovery and Reinvestment Act of 2009) funds and the other half represents a future opportunity.  By contrast, very little stimulus money has been released by the NIH.  When and if such stimulus money is released, it could represent potential upside for fiscal 2010.

 

On the product front, we have introduced several enhancements to our scientific portfolio. We released two new versions of our Legend Elite amplifier, one of which targets the emerging field of attosecond (10-(18) seconds) physics.  In the first quarter of fiscal 2010, we also introduced the Verdi G7 that is based upon our highly successful Optically Pumped Semiconductor Laser platform.

 

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Net Sales

 

Net sales include sales of lasers, related accessories and service contracts. Net sales for the first fiscal quarter decreased 0.8% in our CLC segment and decreased 1.5% in our SLS segment from the same quarter one year ago. For a more complete 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 decreased from 30.0% to 28.6% in our CLC segment and increased from 45.0% to 47.4% in our SLS segment from the same quarter one year ago.  For a more complete 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 12.5% from 11.9% in our first fiscal quarter from the same quarter one year ago.  For a more complete 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 shown on our Condensed Consolidated Statements of Cash Flows primarily represents the excess or shortfall of cash collected from billings to our customers and other receipts over cash paid to our vendors for expenses and inventory purcha