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EX-32.2 - EXHIBIT 32.2 - COHERENT INCcohr-ex322_2017q2.htm
EX-32.1 - EXHIBIT 32.1 - COHERENT INCcohr-ex321_2017q2.htm
EX-31.2 - EXHIBIT 31.2 - COHERENT INCcohr-ex312_2017q2.htm
EX-31.1 - EXHIBIT 31.1 - COHERENT INCcohr-ex311_2017q2.htm

 
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 April 1, 2017
or
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from          to          
Commission File Number: 001-33962 
COHERENT, INC.
Delaware
 
94-1622541
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
5100 Patrick Henry Drive, Santa Clara, California 95054
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (408) 764-4000 
___________________________________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer x
 
Accelerated filer ¨
 
 
 
Non-accelerated filer ¨
 
Smaller reporting company ¨
(do not check if a smaller reporting company)
 
 
Emerging growth company ¨

 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨


1


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x
 
The number of shares outstanding of registrant’s common stock, par value $.01 per share, on May 8, 2017 was 24,625,124.

2


COHERENT, INC.

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


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


3


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
 
Six Months Ended
 
April 1,
2017

April 2,
2016
 
April 1,
2017
 
April 2,
2016
Net sales
$
422,833


$
199,882

 
$
768,906

 
$
390,157

Cost of sales
243,318


111,283

 
447,877

 
217,660

Gross profit
179,515


88,599

 
321,029

 
172,497

Operating expenses:
 


 

 


 
 
Research and development
30,536


20,955

 
57,620

 
40,095

Selling, general and administrative
72,451


40,940

 
146,219

 
77,714

Gain from business combination



 
(5,416
)
 

Amortization of intangible assets
5,439


700

 
9,317

 
1,401

Total operating expenses
108,426


62,595

 
207,740

 
119,210

Income from operations
71,089


26,004

 
113,289

 
53,287

Other income (expense):
 




 


 
 
Interest income
135


263

 
278

 
503

Interest expense
(8,998
)

(30
)
 
(16,962
)
 
(45
)
Other—net
(1,392
)

(2,013
)
 
11,601

 
(2,460
)
Total other income (expense), net
(10,255
)

(1,780
)
 
(5,083
)
 
(2,002
)
Income from continuing operations before income taxes
60,834


24,224

 
108,206

 
51,285

Provision for income taxes
18,646


6,443

 
35,320

 
13,218

Net income from continuing operations
42,188


17,781

 
72,886

 
38,067

Loss from discontinued operations, net of income taxes

(343
)


 
(633
)
 

Net income
$
41,845


$
17,781

 
$
72,253

 
$
38,067

 

 
 
 

 
 
Basic net income per share:





 


 
 
Income per share from continuing operations
$
1.72


$
0.74

 
$
2.98

 
$
1.58

Loss per share from discontinued operations, net of income taxes
$
(0.01
)

$

 
$
(0.03
)
 
$

Net income per share
$
1.71


$
0.74

 
$
2.96

 
$
1.58







 


 
 
Diluted net income per share:
 


 

 


 
 
Income per share from continuing operations
$
1.70


$
0.73

 
$
2.95

 
$
1.57

Loss per share from discontinued operations, net of income taxes
$
(0.01
)

$

 
$
(0.03
)
 
$

Net income per share
$
1.69


$
0.73

 
$
2.93

 
$
1.57







 


 
 
Shares used in computation:
 


 

 


 
 
Basic
24,496


24,137

 
24,422

 
24,066

Diluted
24,757


24,362

 
24,700

 
24,299

 
See Accompanying Notes to Condensed Consolidated Financial Statements.


4



COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited; in thousands) 

 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
 
 
 
 
 
 
 
 
Net income
$
41,845

 
$
17,781

 
$
72,253

 
$
38,067

Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
  Translation adjustment, net of taxes (2)
1,417

 
13,568

 
(4,078
)
 
5,062

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


 
2

 

 
(28
)
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes (4)

 
2,325

 
(3,334
)
 
2,463

Defined benefit pension plans, net of taxes (5)

158

 

 
534

 

  Other comprehensive loss, net of tax
1,575

 
15,895

 
(6,878
)

7,497

Comprehensive income
$
43,420

 
$
33,676

 
$
65,375

 
$
45,564


(1)
Reclassification adjustments were not significant during the three and six months ended April 1, 2017 and April 2, 2016.

(2)
Tax expenses (benefits) of $0 and $(326) were provided on translation adjustments during the three and six months ended April 1, 2017, respectively.  Tax expenses of $465 and $119 were provided on translation adjustments during the three and six months ended April 2, 2016, respectively.

(3)
Tax expenses (benefits) of $1 and $(17) were provided on net gain (loss) on derivative instruments during the three and six months ended and April 2, 2016, respectively.

(4)
Tax expenses (benefits) of $0 and $(1,878) were provided on changes in unrealized gains (losses) on available-for-sale securities for the three and six months ended April 1, 2017, respectively. Tax expenses of $1,357 and $1,437 were provided on changes in unrealized gains (losses) on available-for-sale securities for the three and six months ended and April 2, 2016, respectively.

(5)
Tax expenses (benefits) of $0 and $21 were provided on changes in defined benefit pension plans for the three and six months ended April 1, 2017, respectively.





See Accompanying Notes to Condensed Consolidated Financial Statements.

5


COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except par value)
 
April 1,
2017
 
October 1,
2016
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
432,980

 
$
354,347

Restricted cash
1,284



Short-term investments
125

 
45,606

Accounts receivable—net of allowances of $6,860 and $2,420, respectively
252,542

 
165,715

Inventories
388,242

 
212,898

Prepaid expenses and other assets
73,802

 
37,073

Assets held-for-sale
65,963

 

Total current assets
1,214,938

 
815,639

Property and equipment, net
256,024

 
127,443

Goodwill
360,576

 
101,458

Intangible assets, net
206,506

 
13,874

Non-current restricted cash
11,786



Other assets
125,510

 
102,734

Total assets
$
2,175,340

 
$
1,161,148

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Short-term borrowings and current-portion of long-term obligations
$
5,161


$
20,000

Accounts payable
73,512

 
45,182

Income taxes payable
60,609

 
19,870

Other current liabilities
231,004

 
116,442

Total current liabilities
370,286

 
201,494

Long-term obligations
660,105

 

Other long-term liabilities
168,686

 
48,826

Commitments and contingencies (Note 11)


 


Stockholders’ equity:
 

 
 

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

 
 

Outstanding—24,578 shares and 24,324 shares, respectively
244

 
242

Additional paid-in capital
151,356

 
151,298

Accumulated other comprehensive loss
(12,178
)
 
(5,300
)
Retained earnings
836,841

 
764,588

Total stockholders’ equity
976,263

 
910,828

Total liabilities and stockholders’ equity
$
2,175,340

 
$
1,161,148


See Accompanying Notes to Condensed Consolidated Financial Statements.

6


COHERENT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited; in thousands)
 
Six Months Ended
 
April 1,
2017

April 2,
2016
Cash flows from operating activities:
 

 
 

Net income
$
72,253

 
$
38,067

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

Depreciation and amortization
19,958

 
12,883

Amortization of intangible assets
28,851

 
4,169

Gain on business combination
(5,416
)
 

Deferred income taxes
(5,620
)
 
(5,653
)
Amortization of debt issuance cost
1,707

 

Stock-based compensation
12,186

 
9,132

Non-cash restructuring charges
4,313

 

Other non-cash (income) expenses
567

 
(12
)
Changes in assets and liabilities, net of effect of acquisitions:
 

 
 

Accounts receivable
(2,798
)
 
(5,333
)
Inventories
4,962

 
(21,063
)
Prepaid expenses and other assets
(3,634
)
 
(4,857
)
Other long-term assets
(2,292
)
 
1,984

Accounts payable
8,672

 
7,516

Income taxes payable/receivable
12,854

 
5,979

Other current liabilities
47,046

 
3,821

Other long-term liabilities
2,051

 
(1,079
)
Cash flows from discontinued operations
(1,301
)
 

Net cash provided by operating activities
194,359

 
45,554

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(29,543
)
 
(16,256
)
Proceeds from dispositions of property and equipment
144

 
180

Purchases of available-for-sale securities

 
(84,629
)
Proceeds from sales and maturities of available-for-sale securities
25,108

 
79,470

Acquisition of businesses, net of cash acquired
(740,481
)
 

Cash flows from discontinued operations
(316
)
 

Net cash used in investing activities
(745,088
)
 
(21,235
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Short-term borrowings
6,930

 
34,792

Repayments of short-term borrowings
(28,700
)
 
(29,792
)
Proceeds from long-term borrowings
740,685

 

Repayments of long-term borrowings
(36,349
)
 

Cash paid to subsidiaries' minority shareholders
(816
)
 

Issuance of common stock under employee stock option and purchase plans
3,866

 
3,686

Net settlement of restricted common stock
(15,675
)
 
(5,344
)
Debt issuance costs
(25,892
)
 
(2,137
)
Net cash provided by financing activities
644,049

 
1,205

Effect of exchange rate changes on cash, cash equivalents and restricted cash
(1,617
)
 
1,045

Net increase in cash, cash equivalents and restricted cash
91,703


26,569

Cash, cash equivalents and restricted cash, beginning of period
354,347

 
130,607

Cash, cash equivalents and restricted cash, end of period
$
446,050

 
$
157,176

 
 
 
 
Noncash investing and financing activities:
 
 
 
  Unpaid property and equipment purchases
$
2,722

 
$
3,800

  Use of previously owned equity shares in acquisition
$
20,685

 
$


The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same amounts shown in the condensed consolidated statements of cash flows.
 
April 1,
2017
 
April 2,
2016
Cash and cash equivalents
$
432,980

 
$
157,176

Restricted cash, current
1,284

 

Restricted cash, non-current
11,786

 

Total Cash, Cash equivalents, and restricted cash shown in the condensed consolidated statement of cash flows
$
446,050

 
$
157,176

See Accompanying Notes to Condensed Consolidated Financial Statements.

7


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 condensed consolidated financial statements and notes thereto filed by Coherent, Inc. on Form 10-K for the fiscal year ended October 1, 2016. In the opinion of management, all adjustments necessary for a fair presentation of financial condition and results of operation as of and for the periods presented have been made and include only normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year or any other interim periods. Our fiscal year ends on the Saturday closest to September 30 and our second fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal year 2017 and 2016 both include 52 weeks.

The consolidated financial statements include the accounts of Coherent, Inc. and its direct and indirect subsidiaries (collectively, the "Company", "we", "our", "us" or "Coherent"). Intercompany balances and transactions have been eliminated.

On November 7, 2016, we acquired Rofin-Sinar Technologies, Inc. and its direct and indirect subsidiaries ("Rofin"). The significant accounting policies of Rofin have been aligned to conform to those of Coherent, and the consolidated financial statements include the results of Rofin as of the acquisition date.

The preparation of consolidated financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

As a result of the acquisition of Rofin in the first quarter of fiscal 2017, we reorganized our prior two reporting segments (Specialty Laser Systems and Commercial Lasers and Components) into two new reporting segments for the combined company based upon the organizational structure of the combined company and how the chief operating decision maker ("CODM") receives and utilizes information provided to allocate resources and make decisions: OEM Laser Sources (“OLS”) and Industrial Lasers & Systems (“ILS”). Accordingly, our segment information was restated retroactively in the first quarter of fiscal 2017. Rofin's operating results have primarily been included in our Industrial Lasers & Systems segment.


2.    RECENT ACCOUNTING STANDARDS

Adoption of New Accounting Pronouncement

In November 2016, the FASB issued amended guidance that require a statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard will become effective for our fiscal year beginning September 30, 2018. We elected to early adopt the standard in the first quarter of fiscal 2017 on a retrospective basis with no impact on our condensed consolidated financial statements and disclosures.

In April 2015, the FASB issued amended guidance that simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amended guidance. The new standard became effective for our fiscal year beginning October 2, 2016. We elected to early adopt the standard in the second quarter of fiscal 2016 and had recorded debt issuance costs of $5.2 million in other assets for the debt commitment we entered into in the second quarter of fiscal 2016 because

8


the debt was not outstanding as of October 1, 2016. The debt issuance costs related to the term loan facility were reclassified to debt in the first quarter of fiscal 2017 when we drew down the debt.

Recently Issued Accounting Pronouncements

In January 2017, the FASB issued amended guidance that simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the existing guidance, when computing the implied fair value of goodwill under Step 2, an entity is required to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the amendments in this update, an entity should simply perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. The new standard will become effective for our fiscal year beginning October 2, 2021. We are currently assessing the impact of this amended guidance and the timing of adoption.

In October 2016, the FASB issued amended guidance that improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under the new guidance, an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The new standard will become effective for our fiscal year beginning September 30, 2018. We are currently assessing the impact of this amended guidance and the timing of adoption.

In March 2016, the FASB issued amended guidance that simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under the new guidance, an entity recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. This change eliminates the notion of the APIC pool and significantly reduces the complexity and cost of accounting for excess tax benefits and tax deficiencies. The new standard will become effective for our fiscal year beginning October 1, 2017. We are currently assessing the impact of this amended guidance.

In May 2014, the FASB amended the Accounting Standards Codification and created a new Topic 606, "Revenue from Contracts with Customers". In May 2016, accounting guidance was issued to clarify the not yet effective revenue recognition guidance issued in May 2014. This additional guidance does not change the core principle of the revenue recognition guidance issued in May 2014, rather, it provides clarification of accounting for collections of sales taxes as well as recognition of revenue (i) associated with contract modifications, (ii) for noncash consideration, and (iii) based on the collectability of the consideration from the customer. The guidance also specifies when a contract should be considered “completed” for purposes of applying the transition guidance. The effective date and transition requirements for this guidance are the same as the effective date and transition requirements for the guidance previously issued in 2014, which is effective for our fiscal year beginning September 30, 2018. We are currently evaluating the new guidance and do not expect the guidance to have a material impact on our financial statements. We have not decided upon the method of adoption.

3.     BUSINESS COMBINATIONS
Fiscal 2017 Acquisitions
Rofin
On November 7, 2016, we completed our previously announced acquisition of Rofin pursuant to the Merger Agreement dated March 16, 2016. Rofin is one of the world's leading developers and manufacturers of high-performance industrial laser sources and laser-based solutions and components. Rofin has primarily been included in our Industrial Lasers & Systems segment.

As a condition of the acquisition, we are required to divest ourselves of Rofin’s low power CO2 laser business based in Hull, United Kingdom, and will report this business separately as a discontinued operation until it is divested (See Note 18).

Due to the timing of the acquisition, the total purchase consideration has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on a preliminary valuation analysis. These preliminary values may change in future reporting periods upon finalization of the valuation, which will occur no later than the third quarter of fiscal 2017.

9



The total preliminary purchase consideration allocated to net assets acquired was approximately $936.3 million and consisted of the following (in thousands):
Cash consideration to Rofin's shareholders
$
904,491

Cash settlement paid for Rofin employee stock options
15,290

Total cash payments to Rofin shareholders and option holders
919,781

Add: fair value of previously owned Rofin shares
20,685

Less: post-merger stock compensation expense
(4,152
)
Total purchase price to allocate
$
936,314


The acquisition was an all-cash transaction at a price of $32.50 per share of Rofin common stock. We funded the payment of the aggregate consideration with a combination of our available cash on hand and the proceeds from the Euro Term Loan described in Note 9. The total payment of $15.3 million due to the cancellation of options held by employees of Rofin was allocated between total estimated merger consideration of $11.1 million and post-merger stock-based compensation expense of $4.2 million based on the portion of the total service period of the underlying options that have not been completed by the merger date.

We recognized a gain of $5.4 million in the first quarter of fiscal 2017 on the increase in fair value from the date of purchase for the shares we already owned.

Under the acquisition method of accounting, the total estimated acquisition consideration is allocated to the acquired tangible and intangible assets and assumed liabilities of Rofin based on their fair values as of the acquisition date. Any excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed is allocated to goodwill. We expect that all such goodwill will not be deductible for tax purposes.

Our preliminary allocation of the purchase price is as follows (in thousands):
Cash, cash equivalents and short-term investments
$
163,425

Accounts receivable
90,877

Inventory
191,159

Prepaid expenses and other assets
20,473

Assets held-for-sale, current
63,666

Property and equipment
126,507

Other assets
28,556

Intangible assets:

  Existing technology
169,029

  In-process research and development
6,000

  Backlog
5,600

  Customer relationships
39,209

  Trademarks
5,699

  Patents
300

Goodwill
265,609

Current portion of long-term obligations
(3,633
)
Current liabilities held for sale
(7,186
)
Accounts payable
(21,603
)
Other current liabilities
(70,193
)
Long-term debt
(11,641
)
Other long-term liabilities
(125,539
)
Total
$
936,314

The fair value write-up of acquired finished goods and work-in-process inventory was $26.8 million, which will be

10


amortized over the expected period during which the acquired inventory is sold, or 6 months. Accordingly, for the three and six months ended April 1, 2017, we recorded $13.0 million and $21.9 million, respectively, of incremental cost of sales associated with the fair value write-up of inventory acquired in the merger with Rofin.

The fair value write-up of acquired property, plant and equipment of $36.8 million will be amortized over the useful lives of the assets. Property, plant and equipment is valued at its value-in-use, unless there was a known plan to dispose of the asset.

The acquired existing technology, backlog, trademarks and patents are being amortized on a straight-line basis, which approximates the economic use of the asset, over their estimated useful lives of 3 to 5 years, 6 months, 3 years, and 5 years, respectively. Customer relationships are being amortized on an accelerated basis utilizing free cash flows over periods ranging from 5 to 10 years. The useful lives of in-process research and development will be defined in the future upon further evaluation of the status of these applications. The fair value of the acquired intangibles was determined using the income approach. In performing these valuations, the key underlying probability-adjusted assumptions of the discounted cash flows were projected revenues, gross margin expectations and operating cost estimates. The valuations were based on the information that was available as of the acquisition date and the expectations and assumptions that have been deemed reasonable by our management. There are inherent uncertainties and management judgment required in these determinations. This acquisition resulted in a purchase price that exceeded the estimated fair value of tangible and intangible assets, which was allocated to goodwill.

We believe the amount of goodwill relative to identifiable intangible assets relates to several factors including: (1) potential buyer-specific synergies related to market opportunities for a combined product offering; and (2) potential to leverage our sales force to attract new customers and revenue and cross sell to existing customers.

In-process research and development (“IPR&D”) consists of two projects that have not yet reached technological feasibility. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. The value assigned to IPR&D was determined by considering the value of the products under development to the overall development plan, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. During the development period, these assets will not be amortized as charges to earnings; instead these assets will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPR&D projects, the assets would then be considered finite-lived intangible assets and amortization of the assets will commence. The projects have not been completed as of April 1, 2017.

We expensed $2.9 million and $17.2 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations in the three and six months ended April 1, 2017, respectively.

The results of this acquisition were included in our consolidated operations beginning on November 7, 2016. The amount of continuing Rofin net sales and net loss from continuing operations included in our condensed consolidated statements of operations for the three months ended April 1, 2017 was approximately $110.7 million and $17.9 million, respectively. The amount of continuing Rofin net sales and net loss from continuing operations included in our condensed consolidated statements of operations for the six months ended April 1, 2017 was approximately $185.1 million and $29.9 million, respectively.

Unaudited Pro Forma Information

The following unaudited pro forma financial information presents our combined results of operations as if the acquisition of Rofin and the related issuance of our Euro Term Loan had occurred on October 4, 2015. The unaudited pro forma financial information is not necessarily indicative of what our condensed consolidated results of operations actually would have been had the acquisition been completed on October 4, 2015. In addition, the unaudited pro forma financial information does not attempt to project the future results of operations of the combined company. The actual results may differ significantly from the pro forma results presented here due to many factors.

11


 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Total net sales
$
432,998

 
$
308,898

 
$
822,814

 
$
609,337

Net income (loss)
$
55,519

 
$
(6,511
)
 
$
94,702

 
$
(38,558
)
Net income (loss) per share:
 
 


 
 
 
 
Basic
$
2.27

 
$
(0.27
)
 
$
3.88

 
$
(1.60
)
Diluted
$
2.24

 
$
(0.27
)
 
$
3.83

 
$
(1.59
)
The unaudited pro forma financial information above includes the net income of Rofin’s low power CO2 laser business based in Hull, United Kingdom, which is recorded as a discontinued operation in the three and six months ended April 1, 2017.

The unaudited pro forma financial information above reflects the following material adjustments:

Incremental amortization and depreciation expense related to the estimated fair value of identifiable intangible assets and property, plant and equipment from the purchase price allocation.
The exclusion of amortization of inventory step-up to its estimated fair value from the three and six months ended April 1, 2017 and the addition of the amortization to the three and six months ended April 2, 2016.
The exclusion of revenue adjustments as a result of the reduction in customer deposits and deferred revenue related to its estimated fair value from the three and six months ended April 1, 2017 and the addition of these adjustments to the three and six months ended April 2, 2016.
Incremental interest expense and amortization of debt issuance costs related to our Euro Term Loan and Revolving Credit Agreement.
The exclusion of acquisition costs incurred by both Coherent and Rofin from the three and six months ended April 1, 2017 and the addition of these costs to the three and six months ended April 2, 2016.
The exclusion of a stock-based compensation charge related to the acceleration of Rofin options from the six months ended April 1, 2017 and the addition of this charge to the six months ended April 2, 2016.
The exclusion of a gain on business combination for our previously owned shares of Rofin from the six months ended April 1, 2017 and the addition of this gain to the six months ended April 2, 2016.
The exclusion of a foreign exchange gain on forward contracts related to our debt commitment and debt issuance from the six months ended April 1, 2017 and the addition of this gain to the six months ended April 2, 2016.
The estimated tax impact of the above adjustments.


4.     FAIR VALUES
 
We have not changed our valuation techniques in measuring the fair value of any financial assets and liabilities during the period. We recognize transfers between levels within the fair value hierarchy, if any, at the end of each quarter. There were no transfers between levels during the periods presented. As of April 1, 2017 and October 1, 2016, we did not have any assets or liabilities valued based on Level 3 valuations.

Financial assets and liabilities measured at fair value as of April 1, 2017 and October 1, 2016 are summarized below (in thousands):


12


 
 
Aggregate Fair Value
 
Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
Aggregate Fair Value
 
Quoted Prices
in
Active Markets
for Identical
Assets
 
Significant
Other
Observable
Inputs
 
 
April 1, 2017
 
October 1, 2016
 
 
 
 
(Level 1)
 
(Level 2)
 
 
 
(Level 1)
 
(Level 2)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
Money market fund deposits
 
$
63,258

 
$
63,258

 
$

 
$
237,142

 
$
237,142

 
$

Short-term investments:
 
 
 
 
 
 
 


 


 


U.S. Treasury and agency obligations (2)
 
125

 

 
125

 
125

 

 
125

Commercial paper (2)
 

 

 

 
24,999

 

 
24,999

Equity securities (1)
 

 

 

 
20,482

 
20,482

 

Prepaid and other assets:
 
 
 
 
 
 
 


 


 


Foreign currency contracts (3)
 
790

 

 
790

 
889

 

 
889

Mutual funds — Deferred comp and supplemental plan (4)
 
14,953

 
14,953

 

 
14,399

 
14,399

 

Total
 
$
79,126

 
$
78,211

 
$
915

 
$
298,036

 
$
272,023

 
$
26,013

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency contracts (3)
 
(787
)
 

 
(787
)
 
(3,100
)
 

 
(3,100
)
Total
 
$
78,339

 
$
78,211

 
$
128

 
$
294,936

 
$
272,023

 
$
22,913



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

(2)
Valuations are based upon quoted market prices in active markets involving similar assets. The market inputs used to value these instruments generally consist of market yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Pricing sources include industry standard data providers, security master files from large financial institutions, and other third party sources which are input into a distribution-curve-based algorithm to determine a daily market value. This creates a “consensus price” or a weighted average price for each security.

(3)
The principal market in which we execute our foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. At April 1, 2017, prepaid expenses and other assets include $790 non-designated forward contracts; other current liabilities include $787 non-designated forward contracts. At October 1, 2016, prepaid expenses and other assets include $889 non-designated forward contracts; other current liabilities include $3,100 non-designated forward contracts. See Note 6, "Derivative Instruments and Hedging Activities".

(4)
The fair value of mutual funds is determined based on quoted market prices. Securities traded on a national exchange are stated at the last reported sales price on the day of valuation; other securities traded in over-the-counter markets and listed securities for which no sale was reported on that date are stated as the last quoted bid price.  

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

13


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):
 
 
April 1, 2017
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
432,980

 
$

 
$

 
$
432,980

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

U.S. Treasury and agency obligations
$
125

 
$

 
$

 
$
125

Total short-term investments
$
125

 
$

 
$

 
$
125

 
 
October 1, 2016
 
Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash and cash equivalents
$
354,347

 
$

 
$

 
$
354,347

 
 
 
 

 
 

 
 
Short-term investments:
 

 
 

 
 

 
 

Available-for-sale securities:
 

 
 

 
 

 
 

Commercial paper
$
24,999

 
$

 
$

 
$
24,999

       U.S. Treasury and agency obligations
125

 

 

 
125

Equity Securities
15,269

 
5,213

 

 
20,482

Total short-term investments
$
40,393

 
$
5,213

 
$

 
$
45,606


None of the unrealized losses as of April 1, 2017 or October 1, 2016 were considered to be other-than-temporary impairments.

The amortized cost and estimated fair value of available-for-sale investments in debt securities as of April 1, 2017 and October 1, 2016 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands): 
 
April 1, 2017
 
October 1, 2016
 
Amortized Cost
 
Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year
$
125

 
$
125

 
$
25,124

 
$
25,124

 
During the three and six months ended April 1, 2017, we received proceeds totaling $0.0 million and $0.1 million, respectively from the sale of available-for-sale securities and realized no gross gains or losses. During the three and six months ended April 2, 2016, we received proceeds totaling $13.5 million and $28.6 million, respectively, from the sale of available-for-sale securities and realized gross gains of less than $0.1 million and $0.1 million, respectively.
 
6.    DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, Japanese Yen, South Korean Won and Chinese Renminbi (RMB). As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of four months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading

14


purposes. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency rates at each respective date.
 
Non-Designated Derivatives

The outstanding notional contract and fair value asset (liability) amounts of non-designated hedge contracts, with maximum maturity of four months, are as follows (in thousands):
 
 
U.S. Notional Contract Value
 
U.S. Fair Value
 
April 1, 2017
 
October 1, 2016
 
April 1, 2017
 
October 1, 2016
Euro currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
102,403

 
$
91,108

 
$
778

 
$
162

Sell
$

 
$
(750,454
)
 
$

 
$
(2,234
)
 
 
 
 
 
 
 
 
Japanese Yen currency hedge contracts
 
 
 
 
 
 
 
Purchase
$

 
$

 
$

 
$

Sell
$
(15,600
)
 
$
(36,450
)
 
$
(72
)
 
$
(343
)
 
 
 
 
 
 
 
 
South Korean Won currency hedge contracts
 
 
 
 
 
 
 
Purchase
$
15,744

 
$
31,248

 
$
(380
)
 
$
413

  Sell
$
(36,018
)
 
$
(37,929
)
 
$
(310
)
 
$
(152
)
 
 
 
 
 
 
 
 
Chinese RMB currency hedge contracts
 
 
 
 
 
 
 
Purchase
$
518

 
$

 
$
3

 
$

Sell
$
(9,211
)
 
$
(25,237
)
 
$
(12
)
 
$
(91
)
 
 
 
 
 
 
 
 
Other foreign currency hedge contracts
 

 
 

 
 

 
 

Purchase
$
5,008

 
$
6,033

 
$
9

 
$
(4
)
Sell
$
(2,068
)
 
$
(1,775
)
 
$
(13
)
 
$
38


The fair value of our derivative instruments is included in prepaid expenses and other assets and in other current liabilities in our Condensed Consolidated Balance Sheets (See Note 4).

During the three and six months ended April 1, 2017, we recognized a loss of $0.1 million and a gain of $9.4 million, respectively, in other income (expense) for derivative instruments not designated as hedging instruments. During the three and six months ended April 2, 2016, we recognized a loss of $0.2 million and a loss of $2.5 million, respectively, in other income (expense) for derivative instruments not designated as hedging instruments.

Designated Derivatives

Cash flow hedges related to anticipated transactions are designated and documented at the inception of the hedge when we enter into contracts for specific future transactions. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of OCI in stockholder's equity and is reclassified into earnings when the underlying transaction affects earnings. We had no cash flow hedges outstanding at April 1, 2017 or October 1, 2016. Changes in the fair value of currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and recognized in other income (expense) as incurred. We classify the cash flows from the foreign exchange forward contracts that are accounted for as cash flow hedges in the same section as the underlying item, primarily within cash flows from operating activities since we do not designate our cash flow hedges as investing or financing activities.

15



During the three and six months ended April 2, 2016, we recorded losses in OCI and in other income (expense) related to the accounting for derivatives designated as cash flow hedges. These losses were not material. During the three and six months ended April 1, 2017, we did not have any activities related to designated cash flow hedges.

Master Netting Arrangements

To mitigate credit risk in derivative transactions, we enter into master netting arrangements that allow each counterparty in the arrangements to net settle amounts of multiple and separate derivative transactions under certain conditions. We present the fair value of derivative assets and liabilities within our condensed consolidated balance sheet on a gross basis even when derivative transactions are subject to master netting arrangements and may otherwise qualify for net presentation. The impact of netting derivative assets and liabilities is not material to our financial position for any of the periods presented. Our derivative contracts do not contain any credit risk related contingent features and do not require collateral or other security to be furnished by us or the counterparties.


7.    GOODWILL AND INTANGIBLE ASSETS 

During the six months ended April 1, 2017, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment. We will conduct our annual goodwill testing during the fourth fiscal quarter.
 
The changes in the carrying amount of goodwill by segment for the period from October 1, 2016 to April 1, 2017 are as follows (in thousands):
 
OEM Laser Sources
 
Industrial Lasers & Systems
 
Total
Balance as of October 1, 2016
$
97,015

 
$
4,443

 
$
101,458

Additions (see Note 3)
1,421

 
264,188

 
265,609

Translation adjustments and other
(3,156
)
 
(3,335
)
 
(6,491
)
Balance as of April 1, 2017
$
95,280

 
$
265,296

 
$
360,576

 
Components of our amortizable intangible assets are as follows (in thousands):
 
 
April 1, 2017
 
October 1, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Existing technology
$
193,707

 
$
(38,000
)
 
$
155,707

 
$
70,664

 
$
(61,133
)
 
$
9,531

Patents
308

 
(22
)
 
286

 

 

 

Customer relationships
47,743

 
(8,902
)
 
38,841

 
15,968

 
(11,658
)
 
4,310

Trade Name
5,682

 
(826
)
 
4,856

 
384

 
(351
)
 
33

Order backlog
5,493

 
(4,564
)
 
929

 

 

 

In-process research & development
5,887

 

 
5,887

 

 

 

Total
$
258,820

 
$
(52,314
)
 
$
206,506

 
$
87,016

 
$
(73,142
)
 
$
13,874


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

Amortization expense for intangible assets for the six months ended April 1, 2017 and April 2, 2016 was $28.9 million and $4.2 million, respectively. The change in the accumulated amortization also includes $1.0 million and $0.1 million of foreign exchange impact for the six months ended April 1, 2017 and April 2, 2016, respectively.

At April 1, 2017, estimated amortization expense for the remainder of fiscal 2017, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):

16


 
Estimated
Amortization
Expense
2017 (remainder)
$
29,362

2018
52,957

2019
49,867

2020
43,158

2021
12,943

2022
3,196

Thereafter
15,023

Total (including IPR&D)
$
206,506


8.     BALANCE SHEET DETAILS
 
Inventories consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Purchased parts and assemblies
$
116,085

 
$
56,824

Work-in-process
134,241

 
88,391

Finished goods
137,916

 
67,683

Total inventories
$
388,242

 
$
212,898

 
Prepaid expenses and other assets consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Prepaid and refundable income taxes
$
34,633

 
$
12,415

Other taxes receivable
12,808

 
10,538

Prepaid expenses and other assets
26,361

 
14,120

Total prepaid expenses and other assets
$
73,802

 
$
37,073

 
Other assets consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Assets related to deferred compensation arrangements
$
28,552

 
$
26,356

Deferred tax assets
82,725

 
67,157

Other assets
14,233

 
9,221

Total other assets
$
125,510

 
$
102,734


Other current liabilities consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Accrued payroll and benefits
$
61,354

 
$
47,506

Deferred revenue
77,791

 
33,034

Warranty reserve
30,786

 
15,949

Accrued expenses and other
32,068

 
18,356

Current liabilities held for sale
7,454

 

Customer deposits
21,551

 
1,597

Total other current liabilities
$
231,004

 
$
116,442

 

17


Components of the reserve for warranty costs during the first six months of fiscal 2017 and 2016 were as follows (in thousands):
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
Beginning balance
$
15,949

 
$
15,308

Additions related to current period sales
16,135

 
10,412

Warranty costs incurred in the current period
(15,105
)
 
(10,693
)
Accruals resulting from acquisitions
14,314

 

Adjustments to accruals related to foreign exchange and other
(507
)
 
(55
)
Ending balance
$
30,786

 
$
14,972

 
Other long-term liabilities consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Long-term taxes payable
$
27,433

 
$
2,951

Deferred compensation
30,579

 
28,313

Deferred tax liabilities
59,360

 
1,468

Deferred revenue
3,990

 
4,069

Asset retirement obligations liability
4,884

 
2,796

Defined benefit plan liabilities
40,023

 
8,123

Other long-term liabilities
2,417

 
1,106

Total other long-term liabilities
$
168,686

 
$
48,826

 
9.     BORROWINGS
 
On November 4, 2016, we repaid the outstanding balance, plus accrued interest, on our former domestic line of credit and terminated the $50.0 million credit facility with Union Bank of California. We assumed two term loans having an aggregated principal amount of $15.3 million as of November 7, 2016 and several lines of credit totaling approximately $18.1 million with the completion of the Rofin acquisition.

On November 7, 2016, we entered into the Credit Agreement by and among us, Coherent Holding GmbH, as borrower (the “Borrower”), and certain of our direct and indirect subsidiaries from time to time party thereto, as guarantors, the lenders from time to time party thereto, Barclays Bank PLC, as administrative agent and an L/C Issuer, Bank of America, N.A., as an L/C Issuer, and MUFG Union Bank, N.A., as an L/C Issuer. The Credit Agreement provides for a 670.0 million Euro senior secured term loan facility (the "Euro Term Loan") and a $100.0 million senior secured revolving credit facility ("Revolving Credit Facility") with a $30.0 million letter of credit sublimit and a $10.0 million swing line sublimit. The Borrower may increase the aggregate revolving commitments or borrow incremental term loans in an aggregate principal amount not to exceed the sum of $150.0 million and an amount that would not cause the senior secured net leverage ratio to be greater than 2.75 to 1.00, subject to certain conditions, including obtaining additional commitments from the lenders then party to the Credit Agreement or new lenders. On November 7, 2016, the Borrower borrowed the full 670.0 million Euros under the Euro Term Loan and its proceeds were used to finance the acquisition of Rofin and pay related fees and expenses. On November 7, 2016, we also used 10.0 million Euro of the capacity under the Revolving Credit Facility for the issuance of a letter of credit.

The terms of the Credit Agreement require Borrower to prepay the term loans in certain circumstances, including from excess cash flow beyond a threshold amount, from the receipt of proceeds from certain dispositions or from the incurrence of certain indebtedness, and from extraordinary receipts resulting in net cash proceeds in excess of $10.0 million in any fiscal year. The Borrower has the right to prepay loans under the Credit Agreement in whole or in part at any time without premium or penalty, subject to customary breakage costs. Revolving loans may be borrowed, repaid and reborrowed until the fifth anniversary of the Closing Date, at which time all outstanding revolving loans must be repaid. The Euro Term Loan matures on the seventh anniversary of the Closing Date, at which time all outstanding principal and accrued and unpaid interest on the Euro Term Loan must be repaid.


18


On March 31, 2017, we made a voluntary principal payment of 30.0 million Euros on the Euro Term Loan. As of April 1, 2017, the outstanding principal amount of the Euro Term Loan was 636.7 million Euros. As of April 1, 2017, the outstanding principal amount of the Revolving Credit Facility was 10.0 million Euro.

Loans under the Credit Agreement bear interest, at the Borrower’s option, at a rate equal to either (i)(x) in the case of calculations with respect to U.S. Dollars or certain other alternative currencies, the London interbank offered rate (the “LIBOR”) or (y) in the case of calculations with respect to the Euro, the euro interbank offered rate ("EURIBOR" and, together with LIBOR, the "Eurocurrency Rate") or (ii) a base rate (the “Base Rate”) equal to the highest of (x) the federal funds rate, plus 0.50%, (y) the prime rate then in effect and (z) the Eurocurrency Rate for loans denominated in U.S. dollars applicable to a one-month interest period, plus 1.0%, in each case, plus an applicable margin. The applicable margin for Euro Term Loan borrowed as Eurocurrency Rate loans, is 3.50% initially, and following the first anniversary of the Closing Date ranges from 3.50% to 3.00% depending on the consolidated total gross leverage ratio at the time of determination. For Euro Term Loan borrowed as Base Rate Loans, the applicable margin initially is 2.50%, and following the first anniversary of the Closing Date ranges from 2.50% to 2.00% depending upon the consolidated total gross leverage ratio at the time of determination. The applicable margin for revolving loans borrowed as Eurocurrency Rate Loans, ranges from 4.25% to 3.75%, and for revolving loans borrowed as Base Rate Loans, ranges from 3.25% to 2.75%, in each case, based on the consolidated total gross leverage ratio at the time of determination. Interest on Base Rate Loans is payable quarterly in arrears. Interest on Eurocurrency Rate Loans is payable at the end of the applicable interest period (or at three month intervals if the interest period exceeds three months). Interest periods for Eurocurrency Rate loans may be, at the Borrower’s option, one, two, three or six months.

Refer Note 19 "Subsequent Events" for discussion of Amendment No. 1 and Waiver to the Credit Agreement entered into on May 8, 2017.

The Credit Agreement requires the Borrower to make scheduled quarterly payments on the Euro Term Loan of 0.25% of the original principal amount of the Euro Term Loan, with any remaining principal payable at maturity. A commitment fee accrues on any unused portion of the revolving loan commitments under the Credit Agreement at a rate of 0.375% or 0.5% depending on the consolidated total gross leverage ratio at any time of determination. The Borrower is also obligated to pay other customary fees for a credit facility of this size and type.

On the Closing Date, we and certain of our direct and indirect subsidiaries, as guarantors, provided an unconditional guaranty of all obligations of the Borrower and the other loan parties arising under the Credit Agreement, the other loan documents and under swap contracts and treasury management agreements with the lenders or their affiliates (with certain limited exceptions). The Borrower and the guarantors have also granted security interests in substantially all of their assets to secure such obligations.

The Credit Agreement contains customary affirmative covenants, including covenants regarding the payment of taxes and other obligations, maintenance of insurance, reporting requirements and compliance with applicable laws and regulations, and negative covenants, including covenants limiting the ability of us and our subsidiaries to, among other things, incur debt, grant liens, make investments, make certain restricted payments, transact with affiliates, and sell assets. The Credit Agreement also requires us and our subsidiaries to maintain a senior secured net leverage ratio as of the last day of each fiscal quarter of less of than or equal to 3.50 to 1.00. The Credit Agreement contains customary events of default that include, among other things, payment defaults, cross defaults with certain other indebtedness, violation of covenants, inaccuracy of representations and warranties in any material respect, change in control of us and the Borrower, judgment defaults, and bankruptcy and insolvency events. If an event of default exists, the lenders may require the immediate payment of all Obligations, as defined in the Credit Agreement, and may exercise certain other rights and remedies provided for under the Credit Agreement, the other loan documents and applicable law. The acceleration of such obligations is automatic upon the occurrence of a bankruptcy and insolvency event of default. We were in compliance with all covenants at April 1, 2017.

We incurred $28.5 million of debt issuance costs related to the Euro Term Loan, which are included in short-term borrowings and current portion of long-term obligations and long-term obligations in the condensed consolidated balance sheets and will be amortized to interest expense over the seven year life of the Euro Term Loan using the effective interest method. We incurred $2.3 million of debt issuance costs in connection with the Revolving Credit Facility which were capitalized and included in prepaid expenses and other assets and other assets in the condensed consolidated balance sheets and will be amortized to interest expense using the straight-line method over the contractual term of five years of the Revolving Credit Facility.

For the three and six months ended April 1, 2017, we recognized interest expense of $7.6 million and $12.2 million,

19


respectively, in relation to the Euro Term Loan and $1.1 million and $1.7 million, respectively, amortization of debt issuance costs.

Additional sources of cash available to us were international currency lines of credit and bank credit facilities totaling $30.9 million as of April 1, 2017, of which $24.8 million was unused and available. These unsecured international credit facilities were used in Europe and Japan during the first six months of fiscal 2017. As of April 1, 2017, we had utilized $6.1 million of the international credit facilities as guarantees in Europe.

Short-term borrowings and current portion of long-term obligations consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Current portion of Euro Term Loan (1)
$
3,457

 
$

1.3% Term loan due 2024
1,335

 

1.0% State of Connecticut term loan due 2023
369

 

Line of credit borrowings

 
20,000

Total short-term borrowings and current portion of long-term obligations
$
5,161

 
$
20,000

(1) Net of debt issuance costs of $3.7 million.

Long-term obligations consist of the following (in thousands):
 
April 1,
2017
 
October 1,
2016
Euro Term Loan due 2024 (1)
$
649,461

 
$

1.3% Term loan due 2024
8,678

 

1.0% State of Connecticut term loan due 2023
1,966

 

Total long-term obligations
$
660,105

 
$

(1) Net of debt issuance costs of $23.4 million.

Contractual maturities of our debt obligations as of April 1, 2017 are as follows (in thousands):
 
Amount
2017 (remainder)
$
4,460

2018
8,862

2019
8,866

2020
8,870

2021
8,874

2022
8,877

Thereafter
643,545

Total
$
692,354


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.
 

20


Determining Fair Value
 
The fair values of shares purchased under the Employee Stock Purchase Plan (“ESPP”) for the three and six months ended April 1, 2017 and April 2, 2016, respectively, were estimated using the following weighted-average assumptions:
 
 
Employee Stock Purchase Plan
 
 
Three Months Ended
 
Six Months Ended
 
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Expected life in years
 
0.5

 
0.5

 
0.5

 
0.5

Expected volatility
 
25.2
%
 
26
%
 
28.5
%
 
27.4
%
Risk-free interest rate
 
0.50
%
 
0.30
%
 
0.48
%
 
0.20
%
Expected dividend yield
 
%
 
%
 
%
 
%
Weighted average fair value per share
 
$
22.64

 
$
12.50

 
$
23.01

 
$
12.89


There were no stock options granted during the three and six months ended April 1, 2017 and April 2, 2016.

We grant performance restricted stock units to officers and certain employees. The performance restricted stock unit agreements provide for the award of performance restricted stock units with each unit representing the right to receive one share of our common stock to be issued after the applicable award vesting period. The final number of units awarded, if any, for these performance grants will be determined as of the vesting dates, based upon our total shareholder return over the performance period compared to the Russell 2000 Index and could range from no units to a maximum of twice the initial award units. The weighted average fair value for these performance units was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:
 
 
Six Months Ended
 
 
April 1, 2017
 
April 2, 2016
Risk-free interest rate
 
1.3
%
 
1.2
%
Volatility
 
31.0
%
 
27.0
%
Weighted average fair value
 
$163.17
 
$74.48

We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period of approximately 3 years, with no adjustment in future periods based upon the actual shareholder return over the performance period.
 
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 and six months ended April 1, 2017 and April 2, 2016 (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Cost of sales
$
778

 
$
594

 
$
1,738

 
$
1,199

Research and development
597

 
610

 
1,650

 
1,036

Selling, general and administrative
5,308

 
4,183

 
12,950

 
6,897

Income tax benefit
(1,815
)
 
(1,511
)
 
(3,304
)
 
(1,862
)
 
$
4,868

 
$
3,876

 
$
13,034

 
$
7,270


As a result of our acquisition of Rofin on November 7, 2016, we made a payment of $15.3 million due to the cancellation of options held by employees of Rofin. The payment was allocated between total estimated merger consideration of $11.1 million and post-merger stock-based compensation expense of $4.2 million, recorded in the six months ended April 1, 2017, based on the portion of the total service period of the underlying options that have not been completed by the merger date.


21


During the three and six months ended April 1, 2017, $0.9 million and $1.7 million, respectively, was capitalized into inventory for all stock plans, $0.8 million and $1.5 million, respectively, was amortized to cost of sales and $1.0 million remained in inventory at April 1, 2017. During the three and six months ended April 2, 2016, $0.7 million and $1.3 million, respectively, was capitalized into inventory for all stock plans, $0.6 million and $1.2 million, respectively, was amortized to cost of sales and $0.8 million remained in inventory at April 2, 2016
 
At April 1, 2017, the total compensation cost related to unvested stock-based awards granted to employees under our stock plans but not yet recognized was approximately $43.0 million, net of estimated forfeitures of $1.3 million. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.7 years and will be adjusted for subsequent changes in estimated forfeitures.

At April 1, 2017, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.2 million, which will be recognized over the six month offering period.

Stock Awards Activity

The following table summarizes the activity of our time-based and performance restricted stock units for the first six months of fiscal 2017 (in thousands, except per share amounts):
 
Time Based Restricted Stock Units
 
Performance Restricted Stock Units
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Nonvested stock at October 1, 2016
459

 
$
66.47

 
169

 
$
74.10

Granted
184

 
130.49

 
115

 
163.17

Vested (1)
(228
)
 
66.01

 
(104
)
 
77.10

Forfeited
(11
)
 
72.34

 
(4
)
 
70.57

Nonvested stock at April 1, 2017
404

 
$
118.00

 
176

 
$
105.34


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


11.      COMMITMENTS AND CONTINGENCIES

We are subject to legal claims and litigation arising in the ordinary course of business, such as product liability, employment or intellectual property claims, including, but not limited to, the matters described below. On May 14, 2013, IMRA America (“Imra”) filed a complaint for patent infringement against two of our subsidiaries in the Regional Court of Düsseldorf, Germany, captioned In re IMRA America Inc. versus Coherent Kaiserslautern GmbH et. al. 4b O 38/13. The complaint alleges that the use of certain of the Company’s lasers infringes upon EP Patent No. 754,103, entitled “Method For Controlling Configuration of Laser Induced Breakdown and Ablation,” issued November 5, 1997. The patent, now expired in all jurisdictions, is owned by the University of Michigan and licensed to Imra. The complaint seeks unspecified compensatory damages, the cost of court proceedings and seeks to permanently enjoin the Company from infringing the patent in the future. Following the filing of the infringement suit, our subsidiaries filed a separate nullity action with the Federal Patent Court in Munich, Germany requesting that the court hold that the Patent was invalid based on prior art. On October 1, 2015, the Federal Patent Court ruled that the German portion of the Patent was invalid. Imra has appealed this decision to the Federal Court of Justice, the highest civil jurisdiction court in Germany. The infringement action is currently stayed pending the outcome of such appeal. Management has made an accrual with respect to this matter and has determined, based on its current knowledge, that the amount or range of reasonably possible losses in excess of the amounts already accrued is not reasonably estimable. Although we do not expect that such legal claims and litigation will ultimately have a material adverse effect on our consolidated financial position, results of operations or cash flows, an adverse result in one or more matters could negatively affect our results in the period in which they occur.

The United States and many foreign governments impose tariffs and duties on the import and export of certain products we sell. From time to time our duty calculations and payments are audited by government agencies. During the second quarter

22


of fiscal 2016, we concluded an audit in South Korea for customs duties and value added tax for the period March 2009 to March 2014. We paid $1.6 million related to this matter in the second quarter of fiscal 2016 and have no remaining accrual at October 1, 2016.

On November 7, 2016, we entered into a Credit Agreement with Barclays, BAML and MUFG. See Note 9 "Borrowings" for further discussion of the issuance of the financing.


12.  EARNINGS PER SHARE
 
Basic earnings per share is computed based on the weighted average number of shares outstanding during the period, excluding unvested restricted stock. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive employee stock awards, including stock options, restricted stock awards and stock purchase plan contracts, using the treasury stock method.
 
The following table presents information necessary to calculate basic and diluted earnings per share (in thousands, except per share data): 
 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Weighted average shares outstanding —basic
24,496

 
24,137

 
24,422

 
24,066

Dilutive effect of employee stock awards
261

 
225

 
278

 
233

Weighted average shares outstanding—diluted
24,757

 
24,362

 
24,700

 
24,299

 
 
 
 
 
 
 
 
Net income from continuing operations
$
42,188

 
$
17,781

 
72,886

 
$
38,067

Loss from discontinued operations, net of income taxes
(343
)
 

 
(633
)
 

Net income
$
41,845

 
$
17,781

 
$
72,253

 
$
38,067

 
A total of 0 and 7,078 potentially dilutive securities have been excluded from the diluted share calculation for the three months ended April 1, 2017 and April 2, 2016, respectively, as their effect was anti-dilutive.

A total of 2,042 and 9,451 potentially dilutive securities have been excluded from the diluted share calculation for the six months ended April 1, 2017 and April 2, 2016, respectively, as their effect was anti-dilutive.

 
13.  OTHER INCOME (EXPENSE)
 
Other income (expense) is as follows (in thousands): 
 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Foreign exchange gain (loss)
$
(2,732
)
 
$
(198
)
 
$
10,367

 
$
(1,520
)
Gain (loss) on deferred compensation investments, net
1,747

 
(1,877
)
 
1,695

 
(1,002
)
Other
(407
)
 
62

 
(461
)
 
62

Other - net
$
(1,392
)
 
$
(2,013
)
 
$
11,601

 
$
(2,460
)

14.  INCOME TAXES
 
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discrete to the period. Our effective tax rates for the three and six months ended April 1, 2017 were 30.7% and 32.6%, respectively. Our effective tax rates for three and six months ended April 1, 2017 were lower than the statutory rate of 35% primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including the Singapore tax exemption, the benefit

23


of foreign tax credits and the benefit of federal research and development tax credits. These amounts are partially offset by Rofin transaction costs not deductible for tax purposes, tax costs of Rofin restructuring, ASC 740-10 (formerly FIN48) tax liabilities for transfer pricing, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

The effective tax rate on income before income taxes for the second quarter of fiscal 2016 of 26.6% and the effective tax rate on income before income taxes for the first six months of fiscal 2016 of 25.8% were lower than the statutory rate of 35.0% primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including the Singapore tax exemption, the benefit of foreign tax credits and the benefit of federal research and development tax credits including renewal of the federal research and development tax credits for fiscal 2015. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

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

We had U.S. federal deferred tax assets related to research and development credits, foreign tax credits and other tax attributes that can be used to offset federal taxable income in future periods. These credit carryforwards will expire if they are not used within certain time periods. As of April 1, 2017, management determined that there is sufficient positive evidence to conclude that it is more likely than not sufficient taxable income will exist in the future allowing us to recognize these deferred tax assets. It is possible that some or all these attributes could ultimately expire unused. If facts and circumstances change in the future, management may determine at that time a valuation allowance is necessary. A valuation allowance would materially increase our tax expense in the period applied and would adversely affect our results of operations and statement of financial condition. Changes in our underlying facts or circumstances, such as the impact of the Rofin acquisition, will be continually assessed and we will re-evaluate its position accordingly.

We are subject to taxation and file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2011 are closed. We agreed to extend the statutes of limitations for its fiscal 2011 and 2012 U.S. federal tax returns to June 30, 2018 due to an ongoing Advanced Pricing Agreement (“APA”) between the U.S. and South Korea. The rollback period of this APA may be resolved by the tax authorities in South Korea and the U.S. through a Mutual Agreement Procedure (“MAP”). In March 2016, the Internal Revenue Service (IRS) issued an audit notice and Information Documentation Requests (IDRs) for fiscal 2013. The audit is currently in progress and the statute of limitation was extended to June 30, 2018. In our major foreign jurisdictions and our major state jurisdictions, the years prior to 2011 and 2012, respectively, are closed to examination. Earlier years in our various jurisdictions may remain open for adjustment to the extent that we have tax attribute carryforwards from those years. In July 2015 and March 2016, Coherent Kaiserslautern GmbH (formerly Lumera Laser GmbH) received tax audit notices for the fiscal years 2010 to 2014. The audit began in August 2015. We acquired the shares of Lumera Laser GmbH in December 2012 and, pursuant to the terms of the acquisition agreement, we should not have responsibility for any assessments related to the pre-acquisition period. In June, 2016, Coherent Holding GmbH and Coherent Deutschland GmbH each received a tax audit notice for the fiscal years 2011 to 2014. The audit began August 2016. Coherent GmbH, Coherent LaserSystems GmbH & Co. KG and Coherent Germany GmbH received audit notices for the period that they were in existence during the fiscal years 2011 through 2014. The audit work began in January 2017.

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

The following table summarizes the activity related to the Company's gross unrecognized tax benefits for the six months ended April 1, 2017 (amounts in thousands):


24


 
Six Months Ended
 
April 1, 2017
Balance as of the beginning of the year
$
20,442

Increase related to acquisitions
22,693

Tax positions related to current year:

  Additions
815

  Reductions

Tax positions related to prior year:

  Additions
3,018

  Reductions

Settlements

Lapses in statutes of limitations

Foreign currency revaluation adjustment
(594
)
Balance as of end of period
$
46,374


As of April 1, 2017, the total amount of gross interest and penalties accrued was approximately $1.8 million, mostly due to the Rofin acquisition, and it is classified as long-term taxes payable in the consolidated balance sheet.

15.  DEFINED BENEFIT PLANS
 
As a result of the Rofin acquisition, we have assumed all assets and liabilities of Rofin’s defined benefit plans for the Rofin-Sinar Laser, GmbH ("RSL") and Rofin-Sinar Inc. ("RS Inc.") employees. The U.S. plan began in fiscal year 1995 and is funded. Any new employees hired after January 1, 2007, are not eligible for the RS Inc. pension plan. As is the customary practice with German companies, the German pension plan is unfunded. Any new employees hired after the acquisition of Rofin-Baasel Lasertechnik in 2000 are not eligible for the RSL pension plan. The measurement date of these pension plans is September 30.

Effective January 1, 2012, the RS Inc. defined benefit plan was amended to exclude highly compensated employees, as defined by the Internal Revenue Service, from receiving future years of service under the RS Inc. defined benefit plan. A non-qualified defined benefit plan was created to replace the benefits lost by the employees that were otherwise excluded from the qualified defined benefit plan.

In addition, we have defined benefit plans in Coherent Korea, Coherent Japan, and Coherent Italy, covering all full-time employees with at least one year of service, and a defined benefit plan in Coherent Germany covering two individuals. As is the customary practice with European and Asian companies, the plans are unfunded. We have elected to recognize all actuarial gains and losses on these plans immediately, as incurred. The measurement date of these defined benefit plans is September 30.

For financial reporting purposes, the calculation of net periodic pension costs is based upon a number of actuarial assumptions including a discount rate for plan obligations, an assumed rate of return on pension assets and an assumed rate of compensation increase for employees covered by the plan. All of these assumptions were based upon management's judgment, considering all known trends and uncertainties. Actual results that differ from these assumptions would impact future expense recognition and the cash funding requirements of our defined benefit plans.

Components of net periodic cost were as follows for the three and six months ended April 1, 2017 and April 2, 2016:


25


 
Three Months Ended
 
Six Months Ended
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
Service cost
$
458

 
$
148

 
$
843

 
$
291

Interest cost
262

 
21

 
450

 
35

Expected return on plan assets
(184
)
 

 
(306
)
 

Amortization of prior service cost
19

 

 
31

 

Amortization of prior net (gain) loss
139

 

 
231

 

Recognized net actuarial loss
228

 
166

 
458

 
288

Net periodic pension cost
$
922

 
$
335

 
$
1,707

 
$
614



16.  SEGMENT INFORMATION

As a result of the acquisition of Rofin in the first quarter of fiscal 2017, we reorganized our prior two reporting segments (Specialty Laser Systems and Commercial Lasers and Components) into two new reporting segments for the combined company based upon the organizational structure of the combined company and how the chief operating decision maker ("CODM") receives and utilizes information provided to allocate resources and make decisions: OEM Laser Sources (“OLS”) and Industrial Lasers & Systems (“ILS”). Accordingly, our segment information was restated retroactively in the first quarter of fiscal 2017. This segmentation reflects the go-to-market strategies and synergies for our broad portfolio of laser technologies and products. While both segments deliver cost-effective, highly reliable photonics solutions, the OLS business segment is focused on high performance laser sources and complex optical sub-systems, typically used in microelectronics manufacturing, medical diagnostics and therapeutic medical applications, as well as in scientific research. Our ILS business segment delivers high performance laser sources, sub-systems and tools primarily used for industrial laser materials processing, serving important end markets like automotive, machine tool, consumer goods and medical device manufacturing. Rofin has primarily been included in our Industrial Lasers & Systems segment.
 
We have identified OLS and ILS as operating segments for which discrete financial information is available. Both units have dedicated engineering, manufacturing, product business management and product line management functions. A small portion of our outside revenue is attributable to projects and recently developed products for which a segment has not yet been determined. The associated direct and indirect costs are presented in the category of Corporate and other, along with other corporate costs as described below.

Our Chief Executive Officer has been identified as the CODM as he assesses the performance of the segments and decides how to allocate resources to the segments. Income from operations is the measure of profit and loss that our CODM uses to assess performance and make decisions. As assets are not a measure used to assess the performance of the company by the CODM, asset information is not tracked or compiled by segment and is not available to be reported in our disclosures. Income from operations represents the net sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain research and development, management, finance, legal and human resources) and are included in the results below under Corporate and other in the reconciliation of operating results. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.

The following table provides net sales and income from continuing operations for our operating segments and a reconciliation of our total income from continuing operations to income from continuing operations before income taxes (in thousands):

26


 
 
Three Months Ended
 
Six Months Ended
 
 
April 1,
2017
 
April 2,
2016
 
April 1,
2017
 
April 2,
2016
 
Net sales:
 
 
 
 
 
 
 
 
OEM Laser Sources
$
277,144

 
$
167,042