Edgar Filing: COHERENT INC

10-Q

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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, 2016



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

For the transition period from to

Commission File Number: 001-33962

COHERENT, INC.



Delaware		94-1622541
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

5100 Patrick Henry Drive, Santa Clara, California 95054

(Address of principal executive offices) (Zip Code)

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

___________________________________________________

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer x		Accelerated filer ¨

Non-accelerated filer ¨		Smaller reporting company ¨
(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares outstanding of registrant’s common stock, par value $.01 per share, on February 9, 2016 was 24,196,201.

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COHERENT, INC.

INDEX



		Page
Part I.	Financial Information

Item 1.	Financial Statements (unaudited)

	Condensed Consolidated Statements of Operations
	Three months ended January 2, 2016 and December 27, 2014	4

	Condensed Consolidated Statements of Comprehensive Income
	Three months ended January 2, 2016 and December 27, 2014	5

	Condensed Consolidated Balance Sheets
	January 2, 2016 and October 3, 2015	6

	Condensed Consolidated Statements of Cash Flows
	Three months ended January 2, 2016 and December 27, 2014	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36

Item 4.	Controls and Procedures	38

Part II.	Other Information

Item 1.	Legal Proceedings	39

Item 1A.	Risk Factors	39

Item 6.	Exhibits	54

Signatures		55

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in thousands, except per share data)



	Three Months Ended
	January 2, 2016			December 27, 2014
Net sales	$	190,275		$	200,615
Cost of sales	106,377			118,296
Gross profit	83,898			82,319
Operating expenses:
Research and development	19,140			19,173
Selling, general and administrative	36,774			38,141
Amortization of intangible assets	701			696
Total operating expenses	56,615			58,010
Income from operations	27,283			24,309
Other income (expense):
Interest income	240			96
Interest expense	(15		)	(11		)
Other—net	(447		)	(770		)
Total other expense, net	(222		)	(685		)
Income before income taxes	27,061			23,624
Provision for income taxes	6,775			6,194
Net income	$	20,286		$	17,430

Net income per share:
Basic	$	0.85		$	0.70
Diluted	$	0.84		$	0.69

Shares used in computation:
Basic	23,996			24,936
Diluted	24,236			25,197

See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; in thousands)



	Three Months Ended
	January 2, 2016			December 27, 2014

Net income	$	20,286		$	17,430
Other comprehensive income (loss): ⁽¹⁾
Translation adjustment, net of taxes ⁽²⁾	(8,506		)	(14,519		)
Net gain (loss) on derivative instruments, net of taxes ⁽³⁾	(30		)	375
Changes in unrealized gains (losses) on available-for-sale securities, net of taxes ⁽⁴⁾	138			(73		)
Other comprehensive loss, net of tax	(8,398		)	(14,217		)
Comprehensive income	$	11,888		$	3,213


(1)	Reclassification adjustments were not significant during the three months ended January 2, 2016 and December 27, 2014.


(2)	Tax benefit of $346 and $752 was provided on translation adjustments during the three months ended January 2, 2016 and December 27, 2014, respectively.


(3)	Tax expense (benefit) of $(18) and $217 was provided on net gain (loss) on derivative instruments during the three months ended January 2, 2016 and December 27, 2014, respectively.


(4)	Tax expense (benefit) of $80 and $(39) was provided on changes in unrealized gains (losses) on available-for-sale securities for the three months ended January 2, 2016 and December 27, 2014, respectively.

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, 2016			October 3, 2015
ASSETS
Current assets:
Cash and cash equivalents	$	142,343		$	130,607
Short-term investments	193,831			194,908
Accounts receivable—net of allowances of $2,733 and $3,015, respectively	144,595			142,260
Inventories	158,006			156,614
Prepaid expenses and other assets	32,733			28,294
Total current assets	671,508			652,683
Property and equipment, net	99,732			102,445
Goodwill	100,175			101,817
Intangible assets, net	20,070			22,776
Other assets	93,871			89,226
Total assets	$	985,356		$	968,947

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term borrowings	$	5,000		$	—
Accounts payable	28,858			33,379
Income taxes payable	10,557			4,279
Other current liabilities	79,219			84,932
Total current liabilities	123,634			122,590
Other long-term liabilities	51,483			49,939
Commitments and contingencies (Note 11)
Stockholders’ equity:
Common stock, Authorized—500,000 shares, par value $.01 per share:
Outstanding—24,190 shares and 23,970 shares, respectively	241			238
Additional paid-in capital	130,537			128,607
Accumulated other comprehensive loss	(17,911		)	(9,513		)
Retained earnings	697,372			677,086
Total stockholders’ equity	810,239			796,418
Total liabilities and stockholders’ equity	$	985,356		$	968,947

See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)



	Three Months Ended
	January 2, 2016			December 27, 2014
Cash flows from operating activities:
Net income	$	20,286		$	17,430
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	6,385			6,210
Amortization of intangible assets	2,092			2,180
Deferred income taxes	(3,492		)	6,988
Stock-based compensation	3,745			4,390
Other non-cash expense	165			360
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable	(3,646		)	2,760
Inventories	(3,713		)	4,715
Prepaid expenses and other assets	(3,551		)	(8,650		)
Other assets	(1,047		)	(658		)
Accounts payable	(4,252		)	(5,358		)
Income taxes payable/receivable	4,575			(7,277		)
Other current liabilities	(5,128		)	7,145
Other long-term liabilities	1,843			816
Net cash provided by operating activities	14,262			31,051

Cash flows from investing activities:
Purchases of property and equipment	(4,765		)	(5,138		)
Proceeds from dispositions of property and equipment	50			568
Purchases of available-for-sale securities	(50,151		)	(43,780		)
Proceeds from sales and maturities of available-for-sale securities	51,254			77,370
Net cash provided by (used in) investing activities	(3,612		)	29,020

Cash flows from financing activities:
Short-term borrowings	17,160			11,542
Repayments of short-term borrowings	(12,160		)	(11,542		)
Issuance of common stock under employee stock option and purchase plans	3,521			3,437
Repurchase of common stock	—			(17,298		)
Net settlement of restricted common stock	(5,317		)	(5,200		)
Net cash provided by (used in) financing activities	3,204			(19,061		)
Effect of exchange rate changes on cash and cash equivalents	(2,118		)	(2,807		)
Net increase in cash and cash equivalents	11,736			38,203
Cash and cash equivalents, beginning of period	130,607			91,217
Cash and cash equivalents, end of period	$	142,343		$	129,420

Noncash investing and financing activities:
Unpaid property and equipment purchases	$	1,499		$	807

See Accompanying Notes to Condensed Consolidated Financial Statements.

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COHERENT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes thereto should be read in conjunction with the Coherent, Inc. (referred to herein as the “Company,” “we,” “our,” “us” or “Coherent”) condensed consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended October 3, 2015. In the opinion of management, all adjustments necessary for a fair presentation of financial condition and results of operation as of and for the periods presented have been made and include only normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year or any other interim periods. Our fiscal year ends on the Saturday closest to September 30 and our first fiscal quarters include 13 weeks of operations in each fiscal year presented. Fiscal year 2016 includes 52 weeks and fiscal year 2015 includes 53 weeks. Certain reclassifications have been made to the prior period amounts to conform to the current period’s presentation related to the $28.1 million reclassification of current deferred income tax assets to non-current deferred income tax assets.

2. RECENT ACCOUNTING STANDARDS

Adoption of New Accounting Pronouncement

In November 2015, the FASB issued amended guidance that clarifies that in a classified statement of financial position, an entity shall classify deferred tax liabilities and assets as noncurrent amounts. The new guidance supersedes ASC 740-10-45-5 which required the valuation allowance for a particular tax jurisdiction be allocated between current and noncurrent deferred tax assets for that tax jurisdiction on a pro rata basis. The new standard will become effective for our fiscal year beginning October 2, 2017. We elected to early adopt the standard retrospectively in the first quarter of fiscal 2016, which resulted in the reclassification of $28.1 million from current deferred income tax assets to non-current deferred income tax assets as of October 3, 2015.

Recently Issued Accounting Pronouncements

In January 2016, the FASB issued amended guidance that revises the recognition and measurement of financial instruments. The new guidance requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The new standard will become effective for our fiscal year beginning September 29, 2018. We are currently assessing the impact of this amended guidance and the timing of adoption.

In September 2015, the FASB issued amended guidance that simplifies the accounting for adjustments made to provisional amounts recognized in a business combination. Under previous guidance, the acquirer retrospectively adjusted the provisional amounts recognized at the acquisition date with a corresponding adjustment to goodwill, and would have to revise comparative information for prior periods presented in financial statements as needed. The update requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The new standard will become effective for our fiscal year beginning October 2, 2017. We are currently assessing the impact of this amended guidance and the timing of adoption.

In May 2014, the FASB amended the Accounting Standards Codification and created a new Topic 606, "Revenue from Contracts with Customers". The new guidance establishes a single comprehensive contract-based model for entities to use in accounting for revenue arising from contracts with customers. The new model significantly changes existing GAAP, requires substantial judgment in its application, and will generally require companies to make more disclosures about

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revenue. The core principle of the amendment is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new standard provides for two alternative implementation methods. The first is to apply the new standard retrospectively to each prior reporting period presented. This method does allow the use of certain practical expedients. The second method is to apply the new standard retrospectively in the year of initial adoption and record a cumulative effect adjustment for the impact of adjusting contracts open at the date of adoption. Under this transition method, we would apply this guidance retrospectively only to contracts that are not completed contracts at the date of initial application. We would then recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. This method also requires us to disclose comparative information for the year of adoption. In July 2015, the FASB approved a one-year deferral of the effective date. The new standard will become effective for our fiscal year beginning September 30, 2018. We are currently evaluating the new guidance and have not determined the impact this standard may have on our financial statements nor have we decided upon the method of adoption.

3. BUSINESS COMBINATIONS

Fiscal 2015 Acquisitions

Raydiance, Inc.

On July 24, 2015, we acquired certain assets of Raydiance, Inc. ("Raydiance") for approximately $5.0 million, excluding transaction costs. Raydiance manufactured complete tools and lasers for ultrafast processing systems and subsystems in the precision micromachining processing market. The Raydiance assets have been included in our Specialty Lasers and Systems segment.

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



Tangible assets	$	1,048
Goodwill	1,552
Intangible assets:
Existing technology	800
Customer lists	1,600
Total	$	5,000

The purchase price allocated to goodwill was finalized in the first quarter of fiscal 2016 with an increase of $0.4 million and has been updated from the preliminary allocation in the fourth quarter of fiscal 2015.

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

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

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

We expensed $0.1 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations for our fiscal year 2015.

Tinsley Optics

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

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



Tangible assets:
Inventories	$	2,263
Accounts receivable	2,240
Prepaid expenses and other assets	1,132
Property and equipment	2,451
Liabilities assumed	(1,702		)
Deferred tax liabilities	(768		)
Gain on business combination	(1,316		)
Total	$	4,300

The purchase price was lower than the fair value of net assets purchased, resulting in a gain of $1.3 million recorded as a separate line item in our consolidated statements of operations for our fiscal year 2015. The Company reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that all acquired assets and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate.

The gain from the bargain purchase is not subject to income taxation.

We expensed $0.4 million of acquisition-related costs as selling, general and administrative expenses in our consolidated statements of operations for our fiscal year 2015.

4. FAIR VALUES

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

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

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	Aggregate Fair Value			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Aggregate Fair Value			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs
	January 2, 2016									October 3, 2015
				(Level 1)			(Level 2)						(Level 1)		(Level 2)
Assets:
Cash equivalents:
Money market fund deposits	$	21,763		$	21,763		$	—		$	8,297		$	8,297	$	—
Commercial paper ⁽²⁾	9,694			—			9,694			—			—		—
Short-term investments:
U.S. Treasury and agency obligations ⁽²⁾	$	147,487		$	—		$	147,487		$	150,748		$	—	$	150,748
Corporate notes and obligations ⁽²⁾	19,803			—			19,803			17,942			—		17,942
Commercial paper ⁽²⁾	9,497			—			9,497			9,740			—		9,740
Equity securities ⁽¹⁾	17,044			17,044			—			16,478			16,478		—
Prepaid and other assets:
Foreign currency contracts ⁽³⁾	1,780			—			1,780			258			—		258
Mutual funds — Deferred comp and supplemental plan ⁽⁴⁾	14,815			14,815			—			13,891			13,891		—
Total	$	241,883		$	53,622		$	188,261		$	217,354		$	38,666	$	178,688

Liabilities:
Other current liabilities:
Foreign currency contracts ⁽³⁾	$	(384	)	$	—		$	(384	)	$	(239	)	$	—	$	(239	)
Short term borrowings	(5,000		)	(5,000		)	—			—			—		—
Total	$	236,499		$	48,622		$	187,877		$	217,115		$	38,666	$	178,449

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(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 January 2, 2016, prepaid expenses and other assets include $1,780 non-designated forward contracts and $0 foreign currency contracts designated for cash flow hedges, respectively; other current liabilities include $380 non-designated forward contracts and $4 foreign currency contracts designated for cash flow hedges, respectively. At October 3, 2015, prepaid expenses and other assets include $217 non-designated forward contracts and $41 foreign currency contracts designated for cash flow hedges, respectively; other current liabilities include $239 non-designated forward contracts and $0 foreign currency contracts designated for cash flow hedges, respectively. See Note 6, "Derivative Instruments and Hedging Activities".

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(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. 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, 2016
	Cost Basis		Unrealized Gains		Unrealized Losses			Fair Value
Cash and cash equivalents	$	142,343	$	—	$	—		$	142,343

Short-term investments:
Available-for-sale securities:
Commercial paper	$	9,497	$	—	$	—		$	9,497
U.S. Treasury and agency obligations	146,996		706		(215		)	147,487
Corporate notes and obligations	19,744		104		(45		)	19,803
Equity securities	15,269		1,775		—			17,044
Total short-term investments	$	191,506	$	2,585	$	(260	)	$	193,831



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

Short-term investments:
Available-for-sale securities:
Commercial paper	$	9,740	$	—	$	—		$	9,740
U.S. Treasury and agency obligations	149,708		1,040		—			150,748
Corporate notes and obligations	17,892		52		(2		)	17,942
Equity Securities	15,269		1,209		—			16,478
Total short-term investments	$	192,609	$	2,301	$	(2	)	$	194,908

None of the unrealized losses as of January 2, 2016 or October 3, 2015 were considered to be other-than-temporary impairments.

The amortized cost and estimated fair value of available-for-sale investments in debt securities as of January 2, 2016 and October 3, 2015 classified as short-term investments on our condensed consolidated balance sheet were as follows (in thousands):

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	January 2, 2016				October 3, 2015
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Investments in available-for-sale debt securities due in less than one year	$	140,303	$	140,835	$	148,088	$	149,100
Investments in available-for-sale debt securities due in one to five years ⁽¹⁾	$	35,934	$	35,952	$	29,252	$	29,330

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

During the three months ended January 2, 2016, we received proceeds totaling $15.1 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million. During the three months ended December 27, 2014, we received proceeds totaling $29.6 million from the sale of available-for-sale securities and realized gross gains of less than $0.1 million.

6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

We maintain operations in various countries outside of the United States and have foreign subsidiaries that manufacture and sell our products in various global markets. The majority of our sales are transacted in U.S. dollars. However, we do generate revenues in other currencies, primarily the Euro, Japanese Yen, South Korean Won and Chinese Renminbi (RMB). As a result, our earnings, cash flows and cash balances are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through financial market instruments. We utilize derivative instruments, primarily forward contracts with maturities of two months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in foreign currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying instruments. We do not use derivative financial instruments for speculative or trading purposes. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency or interest rates at each respective date.

Non-Designated Derivatives

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

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	U.S. Notional Contract Value						U.S. Fair Value
	January 2, 2016			October 3, 2015			January 2, 2016			October 3, 2015
Euro currency hedge contracts
Purchase	$	56,001		$	52,699		$	1,500		$	33
Sell	(2,710		)	—			19			—

Japanese Yen currency hedge contracts
Purchase	$	—		$	558		$	—		$	8
Sell	$	(21,743	)	$	(15,804	)	$	(340	)	$	(84	)

South Korean Won currency hedge contracts
Purchase	$	—		$	253		$	—		$	—
Sell	$	(14,034	)	$	(17,747	)	$	131		$	30

Chinese RMB currency hedge contracts
Sell	$	(9,957	)	$	(10,900	)	$	37		$	(106	)

Other foreign currency hedge contracts
Purchase	$	5,220		$	3,283		$	(30	)	$	(49	)
Sell	$	(5,597	)	$	(5,835	)	$	83		$	146

Designated Derivatives

Cash flow hedges related to anticipated transactions are designated and documented at the inception of the hedge when we enter into contracts for specific future transactions. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of OCI in stockholder's equity and is reclassified into earnings when the underlying transaction affects earnings. The majority of the after-tax net income or loss related to derivative instruments included in OCI at January 2, 2016 is expected to be reclassified into earnings within 12 months. Changes in the fair value of currency forward contracts due to changes in time value are excluded from the assessment of effectiveness and recognized in other income (expense) as incurred. We classify the cash flows from the foreign exchange forward contracts that are accounted for as cash flow hedges in the same section 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.

For derivative instruments that are not designated as hedging instruments, gains and losses are recognized in other income (expense).

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



	U.S. Notional Contract Value						U.S. Fair Value
	January 2, 2016			October 3, 2015			January 2, 2016			October 3, 2015
Japanese Yen currency hedge contracts
Sell	$	(901	)	$	(2,093	)	$	(4	)	$	41

We have entered into certain derivative forward contracts to sell Japanese Yen and buy Euro to hedge revenue exposures related to our photonics-based solutions in Asia. In order to facilitate the hedge, we transact with counterparties in the U.S. directly and then allocate the hedge contracts to our affiliates through a back-to-back relationship with our German subsidiary. The German subsidiary designates these hedge contracts as cash flow hedges under ASC 815.

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).

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The locations and amounts of designated and non-designated derivative instruments’ gains and losses in the condensed consolidated financial statements for the indicated periods were as follows (in thousands):



	Location in financial statements	Three Months Ended
	Location in financial statements	January 2, 2016			December 27, 2014
Derivatives designated as hedging instruments
Gains(losses) in OCI on derivatives (effective portion), after tax	OCI	$	(30	)	$	375
Gains(losses) reclassified from OCI into income (effective portion)	Cost of sales	$	—		$	(614	)
Gains(losses) reclassified from OCI into income (effective portion)	Revenue	$	—		$	300
Gains(losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)	Other income(expense)	$	(29	)	$	35
Derivatives not designated as hedging instruments
Losses recognized in income	Other income(expense)	$	(2,331	)	$	(712	)

During the first quarter of fiscal 2016 we recognized a loss of $31 in other income (expense) as ineffectiveness related to a portion of an anticipated hedged transaction that failed to occur within the original hedge period plus two months. The remainder of the hedged transaction is still expected to occur and the effective portion is recorded in OCI as shown in the above table.

The amounts that will be reclassified from OCI to earnings will generally be offset by the recognition of the hedged transactions (e.g., anticipated cost of sales) in earnings, thereby achieving the realization of prices contemplated by the underlying risk management strategies and will vary from the expected amounts presented above as a result of changes in foreign exchange rates.

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

Offsetting of Financial Assets/Liabilities under Master Netting Agreements with Derivative Counterparties as of January 2, 2016 and October 3, 2015 (in thousands):

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							Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Gross Amounts of Recognized Derivative Assets		Gross Amounts Offset in the Condensed Consolidated Balance Sheets		Net Amounts of Derivative Assets Presented in the Condensed Consolidated Balance Sheets		Financial Instruments (1)			Cash Collateral Received		Net Amounts
As of January 2, 2016:
Foreign exchange contracts	$	1,780	$	—	$	1,780	$	(384	)	$	—	$	1,396
As of October 3, 2015:
Foreign exchange contracts	$	258	$	—	$	258	$	(116	)	$	—	$	142

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



									Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
	Gross Amounts of Recognized Derivative Liabilities			Gross Amounts Offset in the Condensed Consolidated Balance Sheets		Net Amounts of Derivative Liabilities Presented in the Condensed Consolidated Balance Sheets			Financial Instruments (1)		Cash Collateral Paid		Net Amounts
As of January 2, 2016:
Foreign exchange contracts	$	(384	)	$	—	$	(384	)	$	384	$	—	$	—
As of October 3, 2015:
Foreign exchange contracts	$	(239	)	$	—	$	(239	)	$	116	$	—	$	(123	)

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

7. GOODWILL AND INTANGIBLE ASSETS

During the three months ended January 2, 2016, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment. We will conduct our annual goodwill testing during the fourth fiscal quarter.

The changes in the carrying amount of goodwill by segment for the period from October 3, 2015 to January 2, 2016 are as follows (in thousands):



	Specialty Lasers and Systems			Commercial Lasers and Components		Total
Balance as of October 3, 2015	$	95,454		$	6,363	$	101,817
Translation adjustments and other	(1,642		)	—		(1,642		)
Balance as of January 2, 2016	$	93,812		$	6,363	$	100,175

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



	January 2, 2016							October 3, 2015
	Gross Carrying Amount		Accumulated Amortization			Net		Gross Carrying Amount		Accumulated Amortization			Net
Existing technology	$	70,402	$	(56,517	)	$	13,885	$	71,365	$	(55,452	)	$	15,913
Customer lists	15,803		(10,027		)	5,776		16,099		(9,661		)	6,438
Trade name	390		(344		)	46		399		(349		)	50
In-process research & development	363		—			363		375		—			375
Total	$	86,958	$	(66,888	)	$	20,070	$	88,238	$	(65,462	)	$	22,776

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

Amortization expense for intangible assets for the three months ended January 2, 2016 and December 27, 2014 was $2.1 million and $2.2 million, respectively, which includes $1.6 million and $1.7 million, respectively, for amortization of existing technology. The change in the accumulated amortization also includes $0.7 million and $0.9 million of foreign exchange impact for the three months ended January 2, 2016 and December 27, 2014, respectively.

At January 2, 2016, estimated amortization expense for the remainder of fiscal 2016, the next five succeeding fiscal years and all fiscal years thereafter are as follows (in thousands):



	Estimated Amortization Expense
2016 (remainder)	$	5,892
2017	6,902
2018	4,247
2019	2,190
2020	684
2021	52
Thereafter	103
Total	$	20,070

8. BALANCE SHEET DETAILS

Inventories consist of the following (in thousands):



	January 2, 2016		October 3, 2015
Purchased parts and assemblies	$	49,308	$	50,182
Work-in-process	60,225		56,225
Finished goods	48,473		50,207
Total inventories	$	158,006	$	156,614

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



	January 2, 2016		October 3, 2015
Prepaid and refundable income taxes	$	9,570	$	8,846
Other taxes receivable	6,844		6,574
Prepaid expenses and other assets	16,319		12,874
Total prepaid expenses and other assets	$	32,733	$	28,294

Other assets consist of the following (in thousands):

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	January 2, 2016		October 3, 2015
Assets related to deferred compensation arrangements	$	26,202	$	25,131
Deferred tax assets	64,118		60,254
Other assets	3,551		3,841
Total other assets	$	93,871	$	89,226

On June 8, 2010, we invested $2.0 million in SiOnyx, a privately-held company. The investment was included in other assets and was being carried on a cost basis. During the third quarter of fiscal 2015 we determined that our investment became other-than temporarily impaired. As a result, during the third quarter of fiscal 2015, we recorded a non-cash charge of $2.0 million in our results of operations to impair this investment.

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



	January 2, 2016		October 3, 2015
Accrued payroll and benefits	$	27,689	$	35,504
Deferred revenue	16,805		16,474
Warranty reserve	14,645		15,308
Accrued expenses and other	11,792		10,965
Other taxes payable	5,687		4,888
Customer deposits	2,601		1,793
Total other current liabilities	$	79,219	$	84,932

Components of the reserve for warranty costs during the first three months of fiscal 2016 and 2015 were as follows (in thousands):



	Three Months Ended
	January 2, 2016			December 27, 2014
Beginning balance	$	15,308		$	16,961
Additions related to current period sales	4,954			5,608
Warranty costs incurred in the current period	(5,390		)	(5,135		)
Adjustments to accruals related to foreign exchange and other	(227		)	(830		)
Ending balance	$	14,645		$	16,604

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



	January 2, 2016		October 3, 2015
Long-term taxes payable	$	7,691	$	7,651
Deferred compensation	27,753		26,691
Deferred tax liabilities	2,754		2,717
Deferred revenue	3,495		3,149
Asset retirement obligations liability	2,625		2,654
Other long-term liabilities	7,165		7,077
Total other long-term liabilities	$	51,483	$	49,939

9. SHORT-TERM BORROWINGS

We have several lines of credit which allow us to borrow in the applicable local currency. We have a total of $12.9 million of unsecured foreign lines of credit as of January 2, 2016. At January 2, 2016, we had used $2.9 million of these available foreign lines of credit as guarantees. These credit facilities were used in Europe and Japan during the first three months of fiscal 2016. In addition, our domestic line of credit consists of a $50.0 million unsecured revolving credit account. The

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agreement will expire on May 31, 2017. The line of credit is subject to covenants related to financial ratios and tangible net worth with which we are currently in compliance. We have an outstanding balance of $5.0 million and have used $1.1 million for letters of credit against our domestic line of credit as of January 2, 2016.

10. STOCK-BASED COMPENSATION

Fair Value of Stock Compensation

We recognize compensation expense for all share based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis over the respective requisite service period of the awards.

Determining Fair Value

The fair values of shares purchased under the Employee Stock Purchase Plan (“ESPP”) for the three months ended January 2, 2016 and December 27, 2014, respectively, were estimated using the following weighted-average assumptions:



	Employee Stock Purchase Plan
	Three Months Ended
	January 2, 2016			December 27, 2014
Expected life in years	0.5			0.5
Expected volatility	28.7		%	24.8		%
Risk-free interest rate	0.19		%	0.10		%
Expected dividend yield	—		%	—		%
Weighted average fair value per share	$	13.27		$	13.97

There were no stock options granted during the three months ended January 2, 2016 and December 27, 2014.

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:



	Three Months Ended
	January 2, 2016		December 27, 2014
Risk-free interest rate	1.20	%	0.96	%
Volatility	27.0	%	28.7	%
Weighted average fair value	$74.48		$70.57

We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period, with no adjustment in future periods based upon the actual shareholder return over the performance period.

Stock 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, 2016 and December 27, 2014 (in thousands):

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	Three Months Ended
	January 2, 2016			December 27, 2014
Cost of sales	$	605		$	597
Research and development	426			330
Selling, general and administrative	2,714			3,463
Income tax benefit	(351		)	(430		)
	$	3,394		$	3,960

During the three months ended January 2, 2016, $0.6 million was capitalized into inventory for all stock plans, $0.6 million was amortized to cost of sales and $0.7 million remained in inventory at January 2, 2016. During the three months ended December 27, 2014, $0.7 million was capitalized into inventory for all stock plans, $0.6 million was amortized to cost of sales and $0.8 million remained in inventory at December 27, 2014.

At January 2, 2016, the total compensation cost related to unvested stock-based awards granted to employees under the Company’s stock plans but not yet recognized was approximately $30.5 million, net of estimated forfeitures of $2.9 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 January 2, 2016, total compensation cost related to options to purchase common shares under the ESPP but not yet vested was approximately $0.6 million, which will be recognized over the six month offering period.

Stock Awards Activity

The following table summarizes the activity of our time-based and performance restricted stock units for the first three months of fiscal 2016 (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 3, 2015	394		$	65.17	199		$	67.09
Granted	231		61.06		57		74.48
Vested ⁽¹⁾	(168	)	60.59		(57	)	48.48
Forfeited	(1	)	65.04		(38	)	48.48
Nonvested stock at January 2, 2016	456		$	64.78	161		$	74.09

__________________________________________

(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 filed a notice

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to appeal this decision to the German Supreme Court. 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. We are currently under audit in South Korea for customs duties and value added tax for the period March 2009 to March 2014. Although we do not expect that the audit will ultimately have a material adverse effect on our condensed consolidated financial position, results of operations or cash flows, an adverse result in this matter could negatively affect our results in the period in which it occurs. As of January 2, 2016, management has accrued an estimated liability of $1.6 million related to this matter, of which $1.5 million had been paid to date in the second quarter of fiscal 2016.

12. STOCK REPURCHASE

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

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

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

13. EARNINGS PER SHARE

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

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

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	Three Months Ended
	January 2, 2016		December 27, 2014
Weighted average shares outstanding —basic	23,996		24,936
Dilutive effect of employee stock awards	240		261
Weighted average shares outstanding—diluted	24,236		25,197

Net income	$	20,286	$	17,430

Net income per basic share	$	0.85	$	0.70
Net income per diluted share	$	0.84	$	0.69

A total of 32,213 and 159,618 potentially dilutive securities have been excluded from the diluted share calculation for the three months ended January 2, 2016 and December 27, 2014, respectively as their effect was anti-dilutive.

14. OTHER INCOME (EXPENSE)

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



	Three Months Ended
	January 2, 2016			December 27, 2014
Foreign exchange loss	$	(1,322	)	$	(1,161	)
Gain on deferred compensation investments, net	875			384
Other	—			7
Other - net	$	(447	)	$	(770	)

15. INCOME TAXES

Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for items which are considered discrete to the period. Our effective tax rate for the three months ended January 2, 2016 was 25.0%. Our effective tax rate for the three months ended January 2, 2016 was 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 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).

The effective tax rate on income before income taxes for the first quarter of fiscal 2015 of 26.2% was lower than the statutory rate of 35.0% primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including South Korea and Singapore tax exemptions, 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 2014. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

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

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We are subject to taxation and file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2011 are closed. In our major foreign jurisdictions and our major state jurisdictions, the years prior to 2006 and 2011, respectively, are closed to examination. Earlier years in our various jurisdictions may remain open for adjustment to the extent that we have tax attribute carryforwards from those years. In December 2011 and January 2012, three of our German subsidiaries received notices of tax audits for the fiscal years 2006 through 2010. In fiscal year 2013, we received a preliminary assessment for two of the German subsidiaries and the amount is immaterial. In September 2015, the German tax authorities issued preliminary tax findings for Coherent GmbH for the years 2006 to 2010 and Coherent management met with the German tax authorities in December 2015 to discuss the preliminary assessments. In July 2015, Coherent Kaiserslautern GmbH (formerly Lumera Laser GmbH) received a tax audit notice for the years 2010 to 2013. The audit began in August 2015. We acquired the shares of Lumera Laser GmbH in December 2012 and we should not have responsibility for any assessments related to the pre-acquisition period.

Management believes that it has adequately provided reserves for any adjustments that may result from tax examinations. We regularly engage in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign and state tax matters may be concluded in the next 12 months.

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

16. SEGMENT INFORMATION

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



	Three Months Ended
	January 2, 2016				December 27, 2014
Net sales:
Specialty Laser Systems	$	135,951			$	145,091
Commercial Lasers and Components	54,324				55,524
Total net sales	$	190,275			$	200,615

Income from operations:
Specialty Laser Systems	$	35,795			$	34,554
Commercial Lasers and Components	1,815			1,825	703
Corporate and other	(10,327		)		(10,948		)
Total income from operations	27,283				24,309
Total other expense, net	(222		)		(685		)
Income before income taxes	27,061				23,624
Provision for income taxes	6,775				6,194
Net Income	$	20,286			$	17,430

Major Customers

We had one major customer during the three months ended January 2, 2016 who accounted for 17.6% of consolidated revenue. We had another major customer who accounted for 10.6% and 18.6% of consolidated revenue for the three months ended January 2, 2016 and December 27, 2014, respectively. The customers purchased primarily from our SLS segment.

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We had one major customer who accounted for 22.8% of accounts receivable at January 2, 2016. We had another major customer who accounted for 16.3% and 21.4% of accounts receivable at January 2, 2016 and October 3, 2015, respectively. The customers purchased primarily from our SLS segment.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMPANY OVERVIEW

BUSINESS BACKGROUND

We are one of the world’s leading providers of lasers and laser-based technology in a broad range of scientific, commercial and industrial applications. We design, manufacture, service and market lasers and related accessories for a diverse group of customers. Since inception in 1966, we have grown through internal expansion and through strategic acquisitions of complementary businesses, technologies, intellectual property, manufacturing processes and product offerings.

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

Income from operations is the measure of profit and loss that our chief operating decision maker (“CODM”) uses to assess performance and make decisions. Income from operations represents the sales less the cost of sales and direct operating expenses incurred within the operating segments as well as allocated expenses such as shared sales and manufacturing costs. We do not allocate to our operating segments certain operating expenses, which we manage separately at the corporate level. These unallocated costs include stock-based compensation and corporate functions (certain advanced research and development, management, finance, legal and human resources) and are included in Corporate and other. Management does not consider unallocated Corporate and other costs in its measurement of segment performance.

MARKET APPLICATIONS

Our products address a broad range of applications that we group into the following markets: Microelectronics, Scientific Research and Government Programs, OEM Components and Instrumentation and Materials Processing.

OUR STRATEGY

We strive to develop innovative and proprietary products and solutions that meet the needs of our customers and that are based on our core expertise in lasers and optical technologies. In pursuit of our strategy, we intend to:

•

Leverage our technology portfolio and application engineering to lead the proliferation of photonics into broader markets—We will continue to identify opportunities in which our technology portfolio and application engineering can be used to offer innovative solutions and gain access to new markets. We plan to utilize our expertise to increase our market share in the mid to high power material processing applications.


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

•

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


•	Develop and acquire new technologies and market share—We will continue to enhance our market position through our existing technologies and develop new technologies through our internal research and development

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efforts, as well as through the acquisition of additional complementary technologies, intellectual property, manufacturing processes and product offerings.

•

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

•

Focus on long-term improvement of adjusted EBITDA, in dollars and as a percentage of net sales—We define adjusted EBITDA as operating income adjusted for depreciation, amortization, stock compensation expenses, major restructuring costs and certain other non-operating income and expense items. Key initiatives to reach our goals for EBITDA improvements include utilization of our Asian manufacturing locations, rationalizing our supply chain and continued leveraging of our infrastructure.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, accounting for long-lived assets (including goodwill and intangible assets), inventory valuation, warranty reserves, stock-based compensation and accounting for income taxes. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for our fiscal year ended October 3, 2015.

KEY PERFORMANCE INDICATORS

Below is a summary of some of the quantitative performance indicators (as defined below) that are evaluated by management to assess our financial performance. Some of the indicators are non-GAAP measures and should not be considered as an alternative to any other measure for determining operating performance or liquidity that is calculated in accordance with generally accepted accounting principles.

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	Three Months Ended
	January 2, 2016			December 27, 2014			Change			% Change
	(Dollars in thousands)

Bookings	$	273,004		$	162,524		$	110,480		68.0	%
Book-to-bill ratio	1.43			0.81			0.62			76.5	%
Net sales—Specialty Lasers and Systems	$	135,951		$	145,091		$	(9,140	)	(6.3	)%
Net sales—Commercial Lasers and Components	$	54,324		$	55,524		$	(1,200	)	(2.2	)%
Gross profit as a percentage of net sales— Specialty Lasers and Systems	47.6		%	44.0		%	3.6		%	8.2	%
Gross profit as a percentage of net sales—Commercial Lasers and Components	36.4		%	34.7		%	1.7		%	4.9	%
Research and development as a percentage of net sales	10.1		%	9.6		%	0.5		%	5.2	%
Income before income taxes	$	27,061		$	23,624		$	3,437		14.5	%
Net cash provided by operating activities	$	14,262		$	31,051		$	(16,789	)	(54.1	)%
Days sales outstanding in receivables	68.4			58.5			9.9			16.9	%
Annualized first quarter inventory turns	2.7			2.9			(0.2		)	(6.9	)%
Capital spending as a percentage of net sales	2.5		%	2.6		%	(0.1		)%	(3.8	)%
Net income as a percentage of net sales	10.7		%	8.7		%	2.0		%	23.0	%
Adjusted EBITDA as a percentage of net sales	21.3		%	18.7		%	2.6		%	13.9	%

Definitions and analysis of these performance indicators are as follows:

Bookings and Book-to-Bill Ratio

Bookings represent orders received during the current period for products and services to be provided pursuant to service contracts. While we generally have not experienced a significant rate of cancellation, bookings are generally cancelable by our customers without substantial penalty and, therefore, we cannot assure all bookings will be converted to net sales.

The book-to-bill ratio is calculated as quarterly bookings divided by quarterly net sales. This is an indication of the strength of our business but can sometimes be impacted by a single large order or a single large shipment. A ratio of greater than 1.0 indicates that demand for our products is greater than what we supply in the quarter whereas a ratio of less than 1.0 indicates that demand for our products is less than what we supply in the quarter.

Bookings were a new quarterly record and increased 68.0% in the first quarter of fiscal 2016 compared to the same quarter one year ago, led by a significant increase in the microelectronics market. Compared to the fourth quarter of fiscal 2015, bookings increased 32.9% with a significant increase in the microelectronics market partially offset by decreases in the materials processing and OEM components and instrumentation markets. The book-to-bill ratio was 1.43 in the first quarter of fiscal 2016.

Backlog represents orders which we expect to be shipped within 12 months and the current portion of service contracts. For a discussion of backlog, see “BACKLOG”.

Microelectronics

Microelectronics bookings were a new quarterly record and increased 162% compared to the same quarter one year ago and 94% from bookings in the fourth quarter of fiscal 2015. The microelectronics book-to-bill ratio for the first quarter of fiscal 2016 was 1.96.

Record flat panel display orders in the first quarter of fiscal 2016 increased 497% from orders in the first quarter of fiscal 2015 and 152% from orders in the fourth quarter of fiscal 2015, primarily due to the timing of order placement by customers, with orders received from multiple customers for large format Linebeam systems to be used in organic light-emitting diode (OLED) production. In the second quarter of fiscal 2016, we have received additional Linebeam system orders and we believe that there

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are additional orders pending for the balance of the second quarter and for the remainder of fiscal 2016. In order to meet our delivery commitments, we are expanding our footprint in Göttingen, Germany, adding optics fabrication capacity at our site in Richmond, California and increasing purchases of certain long-lead time supplies. We expect that deliveries for these large orders already received will begin in the third quarter of fiscal 2016 and run through calendar 2017. Despite the recent increase in orders for flat panel display systems, we expect continued fluctuations in order volumes on a quarterly basis going forward.

Orders in the advanced packaging (API) market decreased 38% from orders in the first quarter of fiscal 2015 and decreased 25% from orders in the fourth quarter of fiscal 2015. API equipment manufacturers have adopted a more cautionary posture for legacy products based on recent trends in the semiconductor market. We believe that flex packaging and system in package ("SiP") are two applications that are promising in the API market. Flex packaging, which relies upon UV lasers, is used in mobile and wearable devices and several systems manufacturers have seen strength in this area. SiP has been building momentum in mobile devices and future smartphones are likely to incorporate more SiP design elements, which we believe will lead to an increase in ultrafast lasers for packaging.

Orders from semiconductor capital equipment OEMs decreased 6% from the first quarter of fiscal 2015 but increased 10% from the fourth quarter of fiscal 2015. The correlation between semiconductor inventories and fab utilization rates was evident in the first quarter of fiscal 2016, with inventories rising and utilization dipping. We experienced a predictable response in our service business skewed towards legacy nodes, but new system orders improved for a second consecutive quarter and we believe these orders are linked to specific capacity expansions rather than signaling the start of a broader cycle.

Materials Processing

Materials processing orders decreased 15% compared to the same quarter one year ago and decreased 39% from the fourth quarter of fiscal 2015. The materials processing book-to-bill ratio for the first quarter of fiscal 2016 was 0.88. Bookings were adversely affected by the timing of certain orders, a slowdown in China and seasonality. We have been working on a number of projects for marking new materials and expected orders in the first or second quarter of fiscal 2016, but these orders have been delayed as final details of the process window and tool configuration are being finalized. China was stable in fiscal 2015, but the market softened in the first quarter of fiscal 2016 and inventories have been trimmed accordingly. Customers are citing volatility of the Chinese stock market and the ensuing impact on consumer confidence as the main reason for the softening market, with some additional contribution from the devaluation of the Chinese currency that have made imports more expensive. This has more of an effect upon the low end of the laser market where local alternatives are available and is less of an issue at higher performance levels. Overall, our outlook for China in fiscal 2016 is neutral with specific projects offsetting market uncertainty. We are scheduled to begin deliveries of our second-generation fiber laser platform in the second quarter of fiscal 2016, an important step towards validating our platform and building a position in the market.

OEM Components and Instrumentation

OEM Components and Instrumentation orders decreased 5% compared to the same quarter one year ago and 27% from the fourth quarter of fiscal 2015. The book-to-bill ratio for the first quarter of fiscal 2016 was 0.76.

Instrumentation orders decreased 20% compared to the same quarter one year ago and 47% compared to the fourth quarter of fiscal 2015 due to timing of orders coming off the high orders in the fourth quarter of fiscal 2015. The large decrease from the fourth quarter of fiscal 2015 is primarily a result of order timing in the instrumentation business with a smaller macro effect in the medical OEM market. Bioinstrumentation customers remain positive on their opportunities in personalized medicine, especially for age-related, chronic diseases and the fight against global epidemics, which is driving growth in dedicated, tabletop instruments. We are seeing our customers increasing their investment in two areas: expanding their bioassay or reagent portfolio and introducing dedicated tools to support testing. For dedicated tools to support testing, we are developing multi-wavelength, plug-and-play light engines based upon our OBIS™ and BioRay™ platforms.

Orders for medical OEM products decreased 10% compared to the same quarter one year ago and 9% compared to the fourth quarter of fiscal 2015. The medical OEM market experienced some slowdowns from inventory management tied to concerns about China. Much of the market focus is on cataract treatment and dental procedures. Testing of our Monaco™ laser for cataracts is proceeding well and our position for next generation tools is strengthening. Within the dental market, reviews for the CO₂-based procedure have been positive and we believe our products are positioned to be successfully adopted by customers in this market.

Scientific and Government Programs

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Scientific and government programs orders decreased 3% compared to the same quarter one year ago and increased 1% from the fourth quarter of fiscal 2015. The book-to-bill for the first quarter of fiscal 2016 was 1.07.

Demand for amplified ultrafast systems including the Astrella™, Libra™ and Legend™ series remained strong across all regions, with key contributions from the biological imaging market. We saw market share growth in Japan due to the Chameleon™ Discovery being qualified with a major microscope vendor. In addition we see a shift from the traditional microscope companies to smaller players that specialize in neuroscience solutions. On a geographic basis, China was particularly strong as institutions spent the remaining funds in the last quarter of the country’s prior five-year plan.

Net Sales

Net sales include sales of lasers, laser tools, related accessories and service. Net sales for the first fiscal quarter decreased 6.3% in our SLS segment and decreased 2.2% in our CLC segment from the same quarter one year ago. For a description of the reasons for changes in net sales refer to the “Results of Operations” section of this quarterly report.

Gross Profit as a Percentage of Net Sales

Gross profit as a percentage of net sales (“gross profit percentage”) is calculated as gross profit for the period divided by net sales for the period. Gross profit percentage in the first quarter increased from 44.0% to 47.6% in our SLS segment and increased from 34.7% to 36.4% in our CLC segment from the same quarter one year ago. For a description of the reasons for changes in gross profit refer to the “Results of Operations” section of this quarterly report.

Research and Development as a Percentage of Net Sales

Research and development as a percentage of net sales (“R&D percentage”) is calculated as research and development expense for the period divided by net sales for the period. Management considers R&D percentage to be an important indicator in managing our business as investing in new technologies is a key to future growth. R&D percentage increased to 10.1% from 9.6% in our first fiscal quarter compared to the same period one year ago. For a description of the reasons for changes in R&D spending refer to the “Results of Operations” section of this quarterly report.

Net Cash Provided by Operating Activities

Net cash provided by operating activities as reflected on our Condensed Consolidated Statements of Cash Flows primarily represents the excess of cash collected from billings to our customers and other receipts over cash paid to our vendors for expenses and inventory purchases to run our business. We believe that cash flows from operations is an important performance indicator because cash generation over the long term is essential to maintaining a healthy business and providing funds to help fuel growth. For a description of the reasons for changes in Net Cash Provided by Operating Activities refer to the “Liquidity and Capital Resources” section of this quarterly report.

Days Sales Outstanding in Receivables

We calculate days sales outstanding (“DSO”) in receivables as net receivables at the end of the period divided by net sales during the period and then multiplied by the number of days in the period, using 90 days for quarters. DSO in receivables indicates how well we are managing our collection of receivables, with lower DSO in receivables resulting in higher working capital availability. The more money we have tied up in receivables, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our DSO in receivables for the first quarter of fiscal 2016 increased from 58.5 days to 68.4 days compared to the same quarter one year ago primarily due to the timing of flat panel display system sales towards the end of the quarter in Japan, slower collections in the U.S. and Asia, and the unfavorable impact of foreign exchange rates.

Annualized Third Quarter Inventory Turns

We calculate annualized first quarter inventory turns as the cost of sales during the first quarter annualized and divided by net inventories at the end of the first quarter. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. The more money we have tied up in inventory, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our annualized inventory turns for the first quarter of fiscal 2016 decreased from 2.9 to 2.7 turns compared to the same quarter one year ago primarily due to the planned build-up of inventory levels in certain business units to support increased demand.

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Capital Spending as a Percentage of Net Sales

Capital spending as a percentage of net sales (“capital spending percentage”) is calculated as capital expenditures for the period divided by net sales for the period. Capital spending percentage indicates the extent to which we are expanding or improving our operations, including investments in technology and equipment. Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage decreased to 2.5% from 2.6% for the first quarter compared to the same period one year ago primarily due to lower purchases of production-related assets partially offset by lower revenues in the first quarter of fiscal 2016. We expect higher capital spending in the remainder of fiscal 2016 to expand our footprint in Göttingen, Germany and add optics fabrication capacity at our site in Richmond, California.

Adjusted EBITDA as a Percentage of Net Sales

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

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

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



	Three Months Ended
	January 2, 2016		December 27, 2014
Net income as a percentage of net sales	10.7	%	8.7	%
Income tax expense	3.5	%	3.1	%
Interest and other income (expense), net	0.6	%	0.6	%
Depreciation and amortization	4.5	%	4.1	%
Stock-based compensation	2.0	%	2.2	%
Adjusted EBITDA as a percentage of net sales	21.3	%	18.7	%

RESULTS OF OPERATIONS

CONSOLIDATED SUMMARY

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

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	Three Months Ended
	January 2, 2016		December 27, 2014
Net sales	100.0	%	100.0	%
Cost of sales	55.9	%	59.0	%
Gross profit	44.1	%	41.0	%
Operating expenses:
Research and development	10.1	%	9.6	%
Selling, general and administrative	19.3	%	19.0	%
Amortization of intangible assets	0.4	%	0.3	%
Total operating expenses	29.8	%	28.9	%
Income from operations	14.3	%	12.1	%
Other expense	(0.1	)%	(0.3	)%
Income before income taxes	14.2	%	11.8	%
Provision for income taxes	3.5	%	3.1	%
Net income	10.7	%	8.7	%

Net income for the first quarter of fiscal 2016 was $20.3 million ($0.84 per diluted share) including $3.4 million of after-tax stock-related compensation expense, $1.4 million amortization of intangible assets and a benefit of $1.2 million related to the renewal of the federal research and development tax credits for fiscal 2015. Net income for the first quarter of fiscal 2015 was $17.4 million ($0.69 per diluted share) including $4.0 million of after-tax stock-related compensation expense, $1.6 million amortization of intangible assets and a benefit of $1.1 million related to the renewal of the federal research and development tax credits for fiscal 2014.

BACKLOG

Backlog represents orders which we expect to be shipped within 12 months and the current portion of service contracts. Orders used to compute backlog are generally cancelable and subject to rescheduling by our customers without substantial penalties. Historically, we have not experienced a significant rate of cancellation or rescheduling, though we cannot guarantee that the rate of cancellations or rescheduling will not increase in the future. We have a backlog of orders shippable within 12 months of $370.0 million at January 2, 2016, including a significant concentration in the flat panel display market (46%) for customers which are primarily in Asia.

NET SALES

Market Application

The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands):



	Three Months Ended
	January 2, 2016				December 27, 2014
	Amount		Percentage of total net sales		Amount		Percentage of total net sales
Consolidated:
Microelectronics	$	96,506	50.7	%	$	99,311	49.5	%
OEM components and instrumentation	39,333		20.7	%	41,289		20.6	%
Materials processing	23,034		12.1	%	28,758		14.3	%
Scientific and government programs	31,402		16.5	%	31,257		15.6	%
Total	$	190,275	100.0	%	$	200,615	100.0	%

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Net sales for the first quarter of fiscal 2016 decreased by $10.3 million, or 5%, compared to the first quarter of fiscal 2015, including decreases due to the unfavorable impact of foreign exchange rates. Sales decreased in the materials processing, microelectronics and OEM components and instrumentation markets.

Sales in the materials processing market decreased $5.7 million, or 20%, primarily due to lower shipments for cutting and other materials processing applications. The decrease in the microelectronics market of $2.8 million, or 3%, was primarily due to lower shipments for advanced packaging and micro materials processing applications partially offset by higher shipments for semiconductor applications. The decrease in the OEM components and instrumentation market of $2.0 million, or 5%, was due primarily to lower shipments for medical and machine vision applications partially offset by higher shipments for military and bio-instrumentation applications. Sales in the scientific and government programs market increased less than 1%.

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

Segments

We are organized into two reportable operating segments: SLS and CLC. SLS develops and manufactures configurable, advanced-performance products largely serving the microelectronics, scientific research and government programs and OEM components and instrumentation markets. CLC focuses on higher volume products that are offered in set configurations. CLC’s primary markets include materials processing, OEM components and instrumentation and microelectronics.

The following tables set forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands):



	Three Months Ended
	January 2, 2016				December 27, 2014
	Amount		Percentage of total net sales		Amount		Percentage of total net sales
Consolidated:
Specialty Lasers and Systems (SLS)	$	135,951	71.4	%	$	145,091	72.3	%
Commercial Lasers and Components (CLC)	54,324		28.6	%	55,524		27.7	%
Total	$	190,275	100.0	%	$	200,615	100.0	%

Net sales for the first quarter of fiscal 2016 decreased by $10.3 million, or 5%, compared to the first quarter of fiscal 2015, with decreases of $9.1 million, or 6%, in our SLS segment and decreases of $1.2 million, or 2%, in our CLC segment. The decreases in both SLS and CLC segment sales included decreases due to the unfavorable impact of foreign exchange rates.

The decrease in our SLS segment sales was primarily due to lower advanced packaging, medical and materials processing application sales. The decrease in our CLC segment sales was primarily due to lower materials processing and machine vision application sales partially offset by higher sales to the bio-instrumentation market.

GROSS PROFIT

Consolidated

Our gross profit rate increased to 44.1% in the first quarter of fiscal 2016 from 41.0% in the first quarter of fiscal 2015.

The increase in the gross profit rate was primarily due to favorable product margins (2.8%) as a result of favorable mix for both service and systems in the microelectronics market, particularly in flat panel display applications, and the favorable impact from foreign currency fluctuations partially offset by the unfavorable impact of the acquisitions of Tinsley and Raydiance in the fourth quarter of fiscal 2015. Also contributing to the increase in gross profit rate were lower warranty costs (0.2%) due to fewer warranty events.

Our gross profit rate has been and will continue to be affected by a variety of factors including market and product mix, pricing on volume orders, shipment volumes, our ability to manufacture advanced and more complex products, manufacturing

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efficiencies, excess and obsolete inventory write-downs, warranty costs, amortization of intangibles, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, commodity prices and foreign currency fluctuations, particularly the recent weakening of the Euro and a lesser extent, the Japanese Yen and South Korean Won.

Specialty Lasers and Systems

The gross profit rate in our SLS segment increased to 47.6% in the first quarter of fiscal 2016 from 44.0% in the first quarter of fiscal 2015.

The 3.6% first quarter increase in the gross profit rate was primarily due to favorable product margins (3.2%) resulting from favorable product mix and pricing in the microelectronics market related to improved mix and pricing with a favorable service revenue mix and improved mix and pricing in system shipments to the flat panel display market. In addition, the favorable impact from foreign currency fluctuations as well as favorable mix in the scientific and government programs market partially offset by the unfavorable impact of the acquisitions of Tinsley and Raydiance in the fourth quarter of fiscal 2015 impacted the gross profit rate. Also contributing to the increase in gross profit rate were lower warranty costs (0.4%) due to fewer warranty events.

Commercial Lasers and Components

The gross profit rate in our CLC segment increased to 36.4% in the first quarter of fiscal 2016 from 34.7% in the first quarter of fiscal 2015.

The 1.7% first quarter increase in the gross profit rate was primarily due to favorable product margins (2.1%) and lower other costs (0.1%) as a percentage of sales due to lower freight costs and lower inventory provisions in certain business units partially offset by higher warranty costs (0.5%) due to more warranty events. The 2.1% product margin improvement results from favorable product mix in the OEM components and instrumentation and materials processing markets.

OPERATING EXPENSES:



	Three Months Ended
	January 2, 2016				December 27, 2014
	Amount		Percentage of total net sales		Amount		Percentage of total net sales
	(Dollars in thousands)
Research and development	$	19,140	10.1	%	$	19,173