COHERENT INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended December 28, 2002

or

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

For the transition period from to

Commission File Number: 0-5255

COHERENT, INC.

Delaware		94-1622541
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer 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

Securities registered pursuant to Section 12(b) of the Act:

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o

APPLICABLE ONLY TO ISSUERS INVOLVED
IN BANKRUPTCY PROCEEDING DURING
THE PRECEDING FIVE YEARS

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨ No ¨

APPLICABLE ONLY TO CORPORATE ISSUES:

The number of shares outstanding of registrant’s common stock, par value $.01 per share, at January 30, 2003 was 29,245,280 shares.

COHERENT, INC.

INDEX

Part I.	Financial Information

Item I.	Financial Statements

	Condensed Consolidated Statements of Operations Three months ended December 28, 2002 and December 29, 2001

	Condensed Consolidated Balance Sheets December 28, 2002 and September 28, 2002

	Condensed Consolidated Statements of Cash Flows Three months ended December 28, 2002 and December 29, 2001

	Notes to Condensed Consolidated Financial Statements

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures

Part II.	Other Information

Item I.	Legal Proceedings

Item 2.	Changes in Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

Item 4.	Submission of Matters to a Vote of Security Holders

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

Signatures

PART I. FINANCIAL INFORMATION

Item I. Financial Statements

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited; in thousands, except per share data)

	THREE MONTHS ENDED
	December 28, 2002			December 29, 2001

NET SALES	$	102,030		$	96,619
COST OF SALES	61,587			54,599
GROSS PROFIT	40,443			42,020
OPERATING EXPENSES:
Research and development	11,672			13,928
Selling, general and administrative	23,664			22,719
Restructuring and other charges	20,059
Intangibles amortization	835			908
TOTAL OPERATING EXPENSES	56,230			37,555
INCOME (LOSS) FROM OPERATIONS	(15,787		)	4,465
OTHER INCOME (EXPENSE):
Interest and dividend income	1,897			2,338
Interest expense	(1,084		)	(1,488		)
Foreign exchange loss	(311		)	(548		)
Write-down of Lumenis investment	(10,212		)
Other - net	(59		)	(520		)
TOTAL OTHER INCOME (EXPENSE), NET	(9,769		)	(218		)
INCOME (LOSS) FROM OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST	(25,556		)	4,247
PROVISION (BENEFIT) FOR INCOME TAXES	(5,350		)	1,372
INCOME (LOSS) FROM OPERATIONS BEFORE MINORITY INTEREST	(20,206		)	2,875
MINORITY INTEREST IN SUBSIDIARIES’ EARNINGS	(277		)	(145		)
NET INCOME (LOSS)	$	(20,483	)	$	2,730

NET INCOME (LOSS) PER SHARE:
Basic	$	(0.70	)	$	0.10
Diluted	$	(0.70	)	$	0.09

SHARES USED IN COMPUTATION:
Basic	29,134			28,511
Diluted	29,134			29,079

See Accompanying Notes to Condensed Consolidated Financial Statements

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; in thousands, except par value)

	December 28, 2002			September 28, 2002

*ASSETS*
CURRENT ASSETS:
Cash and cash equivalents	$	112,002		$	131,018
Short-term investments	127,930			133,940
Accounts receivable—net of allowances of $4,499 and $4,038, respectively	80,898			76,478
Inventories	94,199			89,218
Prepaid expenses and other assets	46,024			39,286
Deferred tax assets	65,372			55,883
TOTAL CURRENT ASSETS	526,425			525,823
PROPERTY AND EQUIPMENT	267,967			277,505
ACCUMULATED DEPRECIATION AND AMORTIZATION	(113,976		)	(105,504		)
Property and equipment—net	153,991			172,001
GOODWILL—net of accumulated amortization of $10,644	34,775			31,600
OTHER ASSETS	77,458			74,833
	$	792,649		$	804,257

*LIABILITIES AND STOCKHOLDERS’ EQUITY*
CURRENT LIABILITIES:
Short-term borrowings	$	13,900		$	14,811
Current portion of long-term obligations	7,781			14,887
Accounts payable	13,919			13,757
Income taxes payable	541			1,274
Other current liabilities	58,017			53,478
TOTAL CURRENT LIABILITIES	94,158			98,207
LONG-TERM OBLIGATIONS	43,664			43,345
OTHER LONG-TERM LIABILITIES	60,741			55,860
MINORITY INTEREST IN SUBSIDIARIES	49,336			49,602
STOCKHOLDERS’ EQUITY:
Common stock, par value $.01:
Authorized—500,000 shares Outstanding—29,241 shares and 29,042 shares, respectively	291			289
Additional paid-in capital	287,343			284,182
Notes receivable from stock sales	(1,859		)	(2,045		)
Accumulated other comprehensive income	7,001			2,360
Retained earnings	251,974			272,457
TOTAL STOCKHOLDERS’ EQUITY	544,750			557,243
	$	792,649		$	804,257

See Accompanying Notes to Condensed Consolidated Financial Statements.

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)

	THREE MONTHS ENDED
	December 28, 2002			December 29, 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(20,483	)	$	2,730
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Purchases of short-term trading investments	(89,369		)	(19,424		)
Proceeds from sales of short-term trading investments	84,243			26,600
Write-down of Lumenis investment	10,212
Write-down of notes receivable from Picometrix	3,723
Restructuring and impairment charges	16,438
Depreciation and amortization	6,937			5,480
Intangibles amortization	835			908
Deferred income taxes	(11,255		)	(2,293		)
Other	523			634
Changes in operating assets and liabilities	(1,601		)	(3,498		)
Net Cash Provided By Operating Activities	203			11,137
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(5,848		)	(13,300		)
Proceeds from dispositions of property and equipment	826			733
Acquisition of business, net of cash acquired	(11,364		)
Other - net	978			1,340
Net Cash Used For Investing Activities	(15,408		)	(11,227		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt borrowings	288			8
Long-term debt payments	(8,583		)	(358		)
Short-term borrowings	676			3,963
Short-term repayments	(2,364		)	(1,467		)
Cash overdrafts increase (decrease)	786			(1,167		)
Sales of shares under employee stock plans	2,921			4,201
Collection of notes receivable from stock sales	186			66
Net Cash Provided By (Used for) Financing Activities	(6,090		)	5,246
Effect of Exchange Rate Changes on Cash and Cash Equivalents	2,279			(397		)
Net increase (decrease) in cash and cash equivalents	(19,016		)	4,759
Cash and cash equivalents, beginning of period	131,018			77,409
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	112,002		$	82,168

NONCASH INVESTING AND FINANCING ACTIVITIES:
Tax benefit from stock option exercises	$	200		$	225

See Accompanying Notes to Condensed Consolidated Financial Statements

COHERENT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), consistent with those reflected in our Annual Report to stockholders on Form 10-K for the year ended September 28, 2002. All adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

Certain prior period amounts have been reclassified to conform to the current period presentation. Such reclassification had no impact on net income (loss) or stockholders’ equity for any period presented.

2. DISCONTINUED OPERATIONS

On February 25, 2001, we entered into a definitive agreement to sell our Medical segment to Lumenis, Ltd. (formerly ESC Medical Systems Ltd.) and on April 30, 2001, we completed the sale of the Medical segment assets for cash of $100.0 million, notes receivable of $12.9 million and 5,432,099 shares of Lumenis common stock. We estimated the total value of this consideration as $236.0 million as of the closing of the sale. The agreement provided additional cash consideration up to $6.0 million if the actual net tangible assets sold are more than a predetermined amount and a note receivable reduction if the actual net tangible assets sold are less than a predetermined amount. In June 2002, we reached a purchase price settlement with Lumenis, resulting in a gain of $1.9 million (net of income taxes of $1.2 million), which was included in results of discontinued operations in fiscal 2002. In addition, the agreement provides a future earnout payment of up to $25.0 million based on the future sales of certain Medical laser and light-based products through December 31, 2004.

The face value of the note received is $12.9 million, bearing interest of 5% payable semi-annually over its 18 month term and was due on October 30, 2002. At April 30, 2001, we recorded the note at its fair value of $11.6 million and amortized the discount to interest income over the term of the note. In October 2002, we renegotiated the terms of our note receivable from Lumenis (see Note 10). The Lumenis common stock received is unregistered and its trading is subject to restrictions under Rule 144 of the Securities Act of 1933 and other contractual restrictions as defined in the definitive agreement. At April 30, 2001, we estimated the value of the Lumenis stock at $124.4 million. (See Note 5 concerning the subsequent write-down of this investment.)

The disposal of the Medical segment represents the disposal of a business segment under Accounting Principles Board Opinion No. 30 “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” Accordingly, results of the operations of the Medical segment have been classified as discontinued and prior periods have been reclassified on this basis.

3. ACQUISITIONS

On December 6, 2002, we acquired Molectron Detector, Inc. (Molectron) of Portland, Oregon for approximately $11.5 million in cash. Molectron designs and manufactures laser test and measurement equipment used across all photonics-based applications and markets. The acquisition was accounted for as a purchase and, accordingly, we recorded $3.2 million as goodwill and $6.1 million as other intangibles for the excess of the purchase price over the fair value of net tangible assets acquired. The other intangibles, principally existing technology, customer base and trade name, are amortized over the estimated useful lives of 1 to 10 years. Pro forma results of operations have not been presented because the effects of this acquisition were not material to our consolidated results of operations.

4. REVENUE RECOGNITION

We recognize revenue in accordance with SAB 101, “Revenue Recognition”. Accordingly, revenue is recognized when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or determinable and collection is probable. Delivery is generally considered to have occurred upon shipment. Our products typically include a one-year warranty and the estimated cost of product warranty claims is accrued at the time the sale is recognized, based on historical experience.

We generally recognize product revenue at the time of delivery and, for certain products for which we perform product installation services, the cost of installation is generally accrued at the time product revenue is recognized.

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

The vast majority of our sales are made to original equipment manufacturers (OEMs), distributors and resellers and end-users in the non-scientific market. Sales made to these customers do not require installation of the products by us and are not subject to other post-delivery obligations, except in occasional instances where, for example, we have agreed to perform installation or provide training. In those instances, we either defer revenue related to installation services until installation is completed or, if the installation services are inconsequential or perfunctory, we accrue installation costs at the time that product revenue is recognized. We defer revenue on training services until training services are provided.

Sales to end-users in the scientific market typically require installation and, thus, involve post-delivery obligations, however our post-delivery installation obligations are not essential to the functionality of our products. For a limited number of products or arrangements where management considers installation to be significant in comparison to the value of the product sold, we defer revenue related to installation services until completion of these services.

For most products, training is not provided and thus no post-delivery training obligation exists. However, when training is provided to our customers, it is typically priced separately and is recognized as revenue when the training service is provided.

5. SHORT-TERM INVESTMENTS

All highly liquid investments with a remaining maturity of three months or less at the time of purchase are considered to be cash equivalents and are classified as trading securities. Marketable short-term investments in debt securities are generally classified and accounted for as trading securities and are valued based on quoted market prices. Marketable short-term investments in equity securities are generally classified and accounted for as available-for-sale and are valued based on quoted market prices. Management determines the appropriate classification of debt and equity securities at the time of purchase. Investments in debt and equity securities classified as trading are reported at fair value, with unrealized gains and losses included in earnings. Instruments classified as available-for-sale are reported at fair value with unrealized gains and losses, net of related tax, recorded as a separate component of comprehensive income in stockholders’ equity until realized. Interest and amortization of premiums and discounts for debt securities are included in interest income. Gains and losses on securities sold are determined based on the specific identification method and are included in other income (expense).

Cash, cash equivalents and short-term investments consist of the following (in thousands):

	December 28, 2002
	Cost Basis		Unrealized Gains		Unrealized Losses			Fair Value

Cash and equivalents	$	112,002						$	112,002

Short-term investments:
Trading securities:
Commercial paper	3,087		3					3,090
Certificates of deposit	3,000		64					3,064
US government and agency obligations	44,859		566		(3		)	45,422
Corporate notes and obligations	65,678		784		(49		)	66,413
Total trading securities	116,624		1,417		(52		)	117,989

Available-for-sale securities:
Corporate equity securities	9,941							9,941
Total available-for-sale securities	9,941							9,941

Short-term investments	126,565		1,417		(52		)	127,930

Cash and short-term investments	$	238,567	$	1,417	$	(52	)	$	239,932

	September 28, 2002
	Cost Basis		Unrealized Gains		Unrealized Losses			Fair Value

Cash and equivalents	$	131,018						$	131,018

Short-term investments:
Trading securities:
Commercial paper	10,940		3					10,943
Certificates of deposit	3,000		46					3,046
US government and agency obligations	38,107		526		(15		)	38,618
Corporate notes and obligations	59,656		665		(65		)	60,256
Total trading securities	111,703		1,240		(80		)	112,863

Available-for-sale securities:
Corporate equity securities	20,153		924					21,077
Total available-for-sale securities	20,153		924					21,077

Short-term investments	131,856		2,164		(80		)	133,940

Cash and short-term investments	$	262,874	$	2,164	$	(80	)	$	264,958

Debt securities are classified as trading securities. Realized gains from debt securities were $28,000 and $84,000 for the three months ended December 28, 2002 and December 29, 2001, respectively.

The investments in corporate equity securities at December 28, 2002 and September 28, 2002 represent the fair value of our investment (5,432,099 shares) in Lumenis common stock and are classified as available-for-sale. The Lumenis common stock is unregistered and its trading is subject to restrictions under Securities and Exchange Commission Rule 144 and other restrictions as defined in the definitive agreement. The unrealized gain (loss) on the investment was included in accumulated comprehensive income (loss).

In determining if and when a decline in the value of our Lumenis stock is other-than-temporary, as required by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, management evaluates the length of time that the market value has been below cost, the severity of the decline relative to cost, current and expected future market conditions, the financial condition of Lumenis and other relevant criteria. When such a decline in value is deemed to be other-than-temporary, we recognize an impairment loss in the current period operating results to the extent of the decline. As of June 29, 2002 the market value of our investment in Lumenis had declined from our initial valuation of $124.4 million to $20.2 million. This decline was deemed to be other-than-temporary and an impairment loss of $104.2 million ($79.2 million after income tax benefit of $25.0 million) was recognized in the quarter ended June 29, 2002. The $25.0 million in tax benefit related to the impairment loss in the quarter ended June 29, 2002 is net of a $16.6 million valuation allowance recorded against this capital loss deferred tax asset. As of December 28, 2002 the market value of our investment in Lumenis had declined to $9.9 million. This decline was deemed to be other-than-temporary and an additional impairment loss of $10.2 million was recognized in the quarter ended December 28, 2002. We recorded no net tax benefit related to the $10.2 million impairment loss as we recorded a $10.2 million valuation allowance against this capital loss deferred tax asset. Unrealized gains and losses from the new cost basis will be recorded in accumulated other comprehensive income (loss). If the market value of the Lumenis stock continues to decline in the remainder of fiscal 2003 or beyond, we may recognize additional losses on this investment.

6. DERIVATIVES

Effective October 1, 2000, we adopted Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS No. 133) as amended. The statement requires that all derivatives, whether designated in hedging relationships or not, be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of the changes in the fair value of the derivative are recorded in other comprehensive income (OCI) and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in other income (expense).

Our objective of holding derivatives is to minimize the risks of foreign currency fluctuation by using the most effective methods to eliminate or reduce the impact of these exposures. Principal currencies hedged include the Euro, Yen and British Pound. Forwards used to hedge a portion of forecasted international revenue for up to 15 months in the future are designated as cash flow hedging instruments.

For foreign currency forward contracts under SFAS No. 133, hedge effectiveness is measured by comparing the cumulative change in the hedged contract with the cumulative change in the hedged item, both of which are based on forward rates. For foreign currency option contracts under SFAS No. 133, hedge effectiveness is asserted when the critical elements representing the total changes in the option’s cash flows continue to match the related elements of the hedged forecasted transaction. Should discrepancies arise, effectiveness is measured by comparing the change in option value and the change in value of a hypothetical derivative mirroring the critical elements of the forecasted transaction.

The net derivative loss of $148,000 included in OCI as of December 28, 2002 will be amortized into earnings through December 2020 for a hedge related to a building purchase option which was exercised in December 2000.

We entered into a loan to hedge our firm commitment to one Euro customer through June 2004. For this fair value hedge, effectiveness is measured by comparing the principal balance of the loan against the firm commitment balance. As of December 28, 2002, the loan balance of $564,000 exceeded the firm commitment by $117,000. The effect on earnings is recorded to other income (expense) and was not significant for the quarter ended December 28, 2002.

Forwards not designated as hedging instruments under SFAS No. 133 are also used to hedge the impact of the variability in exchange rates on accounts receivable and collections denominated in certain foreign currencies. Changes in the fair value of these derivatives are recognized in other income (expense).

7. RECENT ACCOUNTING STANDARDS

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. However, it retains the requirement in APB No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. We adopted SFAS No. 144 on September 29, 2002. The adoption did not have a material effect on our operating results or financial condition.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. We will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 28, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of our commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

In November 2002, the EITF reached a consensus on Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into after June 15, 2003. We are currently determining what effect, if any, the provisions of EITF Issue No. 00-21 will have on our operating results or financial condition.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. We adopted the disclosure requirements of FIN 45 in the first quarter of fiscal 2003 (see Note 10 concerning the reserve for warranty costs). The recognition and measurement provisions will be applied to guarantees issued or modified after December 31, 2002. We do not expect the adoption of the recognition and measurement provisions to have a material effect on our operating results or financial condition.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We will adopt the disclosure provisions of SFAS No. 148 in the second quarter of fiscal 2003. We have not yet determined the effect that the transition provisions of SFAS No. 148 would have on our operating results or financial position, if any.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), which addresses consolidation by business enterprises of entities that are not controllable through voting interests or in which the equity investors do not bear the residual economic risks. These entities have been commonly referred to as “special purpose entities”. The underlying principle behind the new Interpretation is that if a business enterprise has a controlling financial interest in an entity, defined in the guidance as a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. The Interpretation explains how to identify variable interest entities and how an enterprise should assess its interest in an entity to decide whether to consolidate that entity. The Company will apply the provisions of FIN 46 prospectively for all variable interest entities created after January 31, 2003. For variable interest entities created before January 31, 2003, we will be required to consolidate all entities in which it was deemed to be the primary beneficiary beginning in the fourth quarter of fiscal

2003. If it is reasonably possible an enterprise will consolidate or disclose information about a variable interest entity when FIN 46 becomes effective, the enterprise shall disclose information about those entities in all financial statements issued after January 31, 2003.

It is reasonably possible that we may be required to consolidate or disclose information about our interest in the Santa Clara facility. During the second quarter of fiscal 2002, we renewed a lease for 216,000 square feet of office, research and development and manufacturing space in Santa Clara, California, a portion of which we are subleasing to our former Medical segment, which is a part of Lumenis. The lease expires in February 2007. Upon expiration of the lease, we have an option to purchase the property for $24.6 million, renew the lease for an additional five years or arrange for the sale of the property to a third party where we would retain an obligation to the owner for the difference between the sale price, if less than $24.6 million, and $21.3 million, subject to certain provisions of the lease. If we do not purchase the property or arrange for its sale as discussed above, we would be obligated for an additional lease payment of $21.3 million. As a result of our interest in the specific assets and liabilities of the Santa Clara facility, if it is determined that the lessor of the facility is a variable interest entity, it is possible that we may be required to consolidate the specific assets and liabilities related to the facility. We are currently in the process of analyzing the lessor in accordance with FIN 46 to determine if they are a variable interest entity.

Effective October 1, 2001 we adopted SFAS No. 142, “Goodwill and Other Intangible Assets” which establishes new standards for goodwill acquired in a business combination and other intangible assets, eliminates amortization of existing goodwill balances, and requires annual evaluation of goodwill for impairment. SFAS 142 was effective for fiscal years beginning after December 15, 2001, with early adoption allowed for companies with fiscal years beginning after March 15, 2001. Upon adoption of SFAS 142, we stopped the amortization of goodwill with a net carrying value of $32.1 million at September 29, 2001 and annual amortization of $4.1 million, including amortization resulting from the acquisitions of Crystal Associates, Inc. in November 2000 and DeMaria Electro-Optics Systems, Inc. and MicroLas Laser System GmbH in April 2001, that resulted from business combinations initiated prior to the adoption of SFAS 141, “Business Combinations”.

Under SFAS No. 142, material amounts of goodwill attributable to each of our reporting units were tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined using a discounted cash flow methodology. These impairment tests are required to be performed at adoption and at least annually thereafter. On an ongoing basis (absent any impairment indicators), we perform our impairment tests during the fourth quarter (based on our third quarter financial statements), in conjunction with our annual budgeting process.

As part of our adoption of SFAS No. 142, we completed the initial impairment tests during the second quarter of fiscal 2002 and the annual impairment tests during the fourth quarter of fiscal 2002 and these tests resulted in no impairment. The carrying amount of goodwill attributable to each reportable segment is as follows (in thousands):

	December 28, 2002		September 28, 2002
Lambda Physik	$	20,618	$	20,618
Electro-Optics	14,157		10,982
	$	34,775	$	31,600

In connection with adopting SFAS No. 142, we also reassessed the useful lives and the classification of our identifiable intangible assets and determined that they continued to be appropriate, except for workforce-in-place with a net carrying value of $790,000, which was reclassified into goodwill. The components of our amortizable intangible assets are as follows (in thousands):

	December 28, 2002				September 28, 2002
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization

Acquired existing technology	$	25,084	$	3,656	$	19,404	$	3,198
Patents	7,304		1,911		6,961		1,668
Licenses	4,261		3,303		4,261		3,195
Drawings	1,003		340		956		272
Order backlog	991		991		945		945
Customer lists	980		375		630		324
Trade name	80		7
	$	39,703	$	10,583	$	33,157	$	9,602

Amortization expense for intangible assets during the first quarter of fiscal 2003 was $0.8 million. Estimated amortization expense for the remainder of fiscal 2003 and the five succeeding fiscal years are as follows (in thousands):

	Estimated Amortization Expense

2003 (remainder)	$	2,833
2004	3,631
2005	3,291
2006	2,863
2007	2,563
2008	2,560

8. COMPREHENSIVE LOSS

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

	THREE MONTHS ENDED
	December 28, 2002			December 29, 2001
Net income	$	(20,483	)	$	2,730
Translation adjustment	5,181			(3,931		)
Net gain on derivative instruments	90			48
Changes in unrealized loss on available-for-sale securities	(630		)	(5,368		)
Total comprehensive loss	$	(15,842	)	$	(6,521	)

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

Balance, September 29, 2001	$	47
Changes in fair value of derivatives	(270		)
Net gains reclassified from OCI	318
Balance, December 29, 2001	$	95

Balance, September 28, 2002	$	(238	)
Changes in fair value of derivatives	3
Net gains reclassified from OCI	87
Balance, December 28, 2002	$	(148	)

Accumulated other comprehensive income (net of tax) at December 28, 2002 is comprised of accumulated translation adjustments of $7.2 million, net loss on derivative instruments of $(148,000) and unrealized loss on available-for-sale securities of $(53,000), respectively. Accumulated other comprehensive income (net of tax) at

September 28, 2002 is comprised of accumulated translation adjustments of $2.0 million, net loss on derivative instruments of $(238,000) and unrealized gain on available-for-sale securities of $577,000, respectively.

9. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is computed based on the weighted average number of shares outstanding during the period. Diluted earnings (loss) per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive stock options and stock purchase contracts, using the treasury stock method, and shares issuable under the Productivity Incentive Plan.

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

	THREE MONTHS ENDED
	December 28, 2002			December 29, 2001
Weighted average shares outstanding - Basic	29,134			28,511

Common stock equivalents	—			546
Employee stock purchase plan equivalents	—			22

Weighted average shares and equivalents – Diluted	29,134			29,079
Net income (loss) for basic and diluted earnings per share computation	$	(20,483	)	$	2,730
Net income (loss) per share –basic	$	(0.70	)	$	0.10
Net income (loss) per share –diluted	$	(0.70	)	$	0.09

A total of 3,829,000 and 2,311,000 anti-dilutive weighted shares have been excluded from the dilutive share equivalents calculation for the three months ended December 28, 2002 and December 29, 2001, respectively.

10. BALANCE SHEET DETAILS:

Inventories are as follows (in thousands):

	December 28, 2002		September 28, 2002
Purchased parts and assemblies	$	35,034	$	31,516
Work-in- process	36,136		32,845
Finished goods	23,029		24,857
Net inventories	$	94,199	$	89,218

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

	December 28, 2002		September 28, 2002
Prepaid expenses and other	$	15,282	$	16,757
Note receivable from Lumenis	10,754		12,828
Prepaid income taxes	10,162		9,235
Assets held for sale	9,826		466
Prepaid expenses and other assets	$	46,024	$	39,286

In October 2002, we renegotiated the terms of our note receivable from Lumenis that we received as part of the consideration for the sale of our Medical segment to Lumenis. The face value of the note is $12.9 million with 5% per annum interest and the note was originally due on October 30, 2002. Under the renegotiated terms, Lumenis made payments of $2.2 million in the quarter ended December 28, 2002, $1.1 million on December 31, 2002 and $1.4 million on January 31, 2003 and is required to pay the remainder in six equal monthly installments beginning on

February 28, 2003. Payment of the final three monthly installments will be accelerated in the event that Lumenis receives certain additional financing, as defined in the note agreement. In consideration for the renegotiated terms, interest on unpaid principal accrues at 9% per annum (compared to 5% under the original terms) and is payable monthly.

In August 2002, we entered into a loan agreement with Picometrix, Inc. (Picometrix) of Michigan. Picometrix develops and manufactures ultra high-speed photoreceivers and instrumentation for the telecommunication, data communication and test and measurement markets, focusing on epitaxial growth, photodetector design and microfabrication, high-speed microwave packaging, hybrid circuit assembly and high-speed testing. Under the loan agreement, we provided Picometrix with $6.0 million of debt financing in exchange for (1) a nine-month option to purchase 100% of the equity of Picometrix for $6.0 million plus a two-year earn-out of up to $25.0 million and (2) the repayment of the $6.0 million of loan principal at maturity and interest at the greater of prime (4.25% at September 28, 2002) minus 0.5% or 3.0% payable monthly over its term. The maturity date varies depending on whether we exercise the option to acquire Picometrix. We originally recorded the purchase option at its fair value of $1.4 million and the note at its fair value of $4.6 million, and were amortizing the discount to interest income over the estimated 18-month term of the note. On November 22, 2002, we terminated our option to purchase Picometrix and, as a result, the note is payable to us in full on May 26, 2003. As a result of this decision, we evaluated the collectibility of the Picometrix note receivable, including the ability of Picometrix to make the required interest and principal payments. We determined that the estimated net realizable value of the note at December 28, 2002 was $1.0 million, and accordingly recorded an impairment loss of $3.7 million ($2.3 million after-tax) during the quarter ended December 28, 2002. In addition, during the quarter ended December 28, 2002, we recorded a charge of $1.4 million to write-off the option to purchase Picometrix (see Note 11).

Assets held for sale at December 28, 2002 include $9.1 million of buildings, building improvements and land for our Lincoln, California, facility, $0.5 million of impaired telecommunications equipment and $0.2 million of impaired equipment at the Lincoln facility, all of which are recorded at net realizable value (see Note 11). Assets held for sale at September 28, 2002 include $0.5 million of impaired telecommunications equipment recorded at net realizable value.

Other assets consist of the following (in thousands):

	December 28, 2002		September 28, 2002
Intangible assets	$	29,120	$	23,555
Deferred tax assets	26,636		23,665
Deferred compensation	17,107		15,516
Other assets	3,582		11,065
Assets held for investment	1,013		1,032
Other assets	$	77,458	$	74,833

Accumulated amortization of intangible assets is $10.6 million and $9.6 million at December 28, 2002 and September 28, 2002, respectively. Assets held for investment at December 28, 2002 and at September 28, 2002 include our former manufacturing facility in Sturbridge, Massachusetts which we are leasing to Convergent Prima, Inc.

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

	December 28, 2002		September 28, 2002
Accrued expenses and other	$	24,696	$	18,368
Accrued payroll and benefits	17,858		19,217
Reserve for warranty	9,317		8,495
Customer deposits	3,240		3,074
Deferred income	2,906		4,324
Other current liabilities	$	58,017	$	53,478

We provide warranties on certain of our product sales (generally one year) and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

Components of the reserve for warranty costs during the quarter ended December 28, 2002 were as follows (in thousands):

Balance at September 28, 2002	$	8,495
Additions related to current period sales	3,106
Warranty costs incurred in the current period	(2,194		)
Adjustments to accruals related to prior period sales	(90		)
Balance at December 28, 2002	$	9,317

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

	December 28, 2002		September 28, 2002
Deferred tax liabilities	$	39,522	$	36,433
Deferred compensation	17,107		15,516
Deferred income and other	3,482		3,271
Environmental remediation costs	630		640
Other long-term liabilities	$	60,741	$	55,860

11. RESTRUCTURING AND OTHER CHARGES

During the quarter ended December 28, 2002, we recorded restructuring, impairment and other charges of $20.1 million ($13.2 million after-tax) that were classified in our statement of operations as follows (in thousands):

	Amount
Termination of activities of the Coherent Telecom-Actives Group	$	13,378
Impairment of Lincoln land and building	3,060
Impairment of Picometrix note (Note 10)	3,723
Other	(102		)
	$	20,059

On November 6, 2002, we decided to terminate the activities of our Coherent Telecom-Actives Group (CTAG), an operating segment that had been aggregated with our Photonics Group in our Electro-Optics reportable segment. Based on new market information and insights and the status of our development projects at CTAG obtained subsequent to September 28, 2002, we determined that our return on investment for at least the next several years would have been unsatisfactory and, therefore, additional investments were no longer justified The charge related to our CTAG operating segment results from the $6.5 million write-down of equipment and leasehold improvements to net realizable value, a $4.8 million accrual for the estimated contractual obligation for lease and other facility costs of the building, net of estimated sublease income, in San Jose, California, formerly occupied by CTAG, the $1.4 million write-off of our option to purchase Picometrix, Inc. and $0.7 million of other restructuring costs.

As of December 28, 2002, land, buildings and improvements included costs (before impairment charges) of $12.4 million related to facilities in Lincoln, California. During fiscal 2001, construction on these facilities was suspended. In the fourth quarter of fiscal 2002, management decided that, given our exit from the passive telecom market and the outsourcing of the production of printed circuit boards, this facility was not needed to support our operations and put the building up for sale. As of September 28, 2002, the proposed sale of the building did not meet the necessary criteria to be classified as held for sale under Statement of Financial Accounting Standards (SFAS No. 121), “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and, as a result, is classified as held for use in the balance sheet at September 28, 2002. Effective September 29, 2002, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, and upon adoption, the Lincoln facility continued to be classified as held for use. During the quarter ended December 28, 2002, the proposed sale of the building met the necessary criteria to be classified as held for sale. We determined the estimated net realizable value of the land, building and improvements to be $9.1 million and the estimated net realizable value of equipment to be $0.2 million. As a result, we recorded an impairment loss of $3.1 million ($2.7 million after-tax) during the quarter ended December 28, 2002 to write-down the land, buildings, improvements and equipment to their estimated net realizable value at December 28, 2002.

At December 28, 2002, we had $4.8 million accrued as a current liability on our balance sheet for restructuring charges. The following table sets forth an analysis of the components of the fiscal 2003 first quarter restructuring charges and the payments made against the accrual through December 28, 2002 (in thousands):

	Severance Related			Facilities- related Charges			Other Restructuring Costs			Total

Balance at September 28, 2002	$	—		$	—		$	—		$	—

Provision	139			4,765			447			5,351
Deductions	(139		)	(253		)	(171		)	(563		)

Balance at December 28, 2002	$	—		$	4,512		$	276		$	4,788

The remaining restructuring accrual balance of approximately $4.8 million at December 28, 2002 is expected to result in cash expenditures through fiscal 2007 for facilities-related charges, net of estimated sublease income, and through fiscal 2003 for other restructuring costs.

The severance related costs are comprised of severance pay, outplacement services, medical and other related benefits for 6 employees terminated due to the termination of activities in CTAG. Long-term asset write-downs include items identified as no longer needed to support our ongoing operations. The facilities-related charges include the estimated $4.8 million contractual obligations for the lease and other facility costs of the building in San Jose, California, net of estimated sublease income. Other restructuring costs primarily include expenses associated with terminating other contractual arrangements.

12. COMMITMENTS AND CONTINGENCIES

payment of $21.3 million. We occupied the building in July 1998 and commenced lease payments at that time. The lease requires us to maintain specified financial covenants including maintaining a minimum tangible net worth and minimum quick ratio, debt to tangible net worth ratio and leverage ratio as well as limiting the number of quarters per year in which net losses are allowed, all of which we were in compliance with as of December 28, 2002. At December 28, 2002, we did not carry any liability in respect of this lease on our books.

Certain claims and lawsuits have been filed or are pending against us. In the opinion of management, all such matters have been adequately provided for, are without merit, or are of such kind that if disposed of unfavorably, would not have a material adverse effect on our consolidated financial position or results of operations.

We, along with several other companies, have been named as a party to a remedial action order issued by the California Department of Toxic Substance Control relating to soil and groundwater contamination at and in the vicinity of the Stanford Industrial Park in Palo Alto, California, where our former headquarters facility is located. The responding parties to the Regional Order (including Coherent) have completed Remedial Investigation and Feasibility Reports, which were approved by the State of California. The responding parties have installed four remedial systems and have reached agreement with responding parties on final cost sharing.

We were also named, along with other parties, to a remedial action order for the Porter Drive facility site itself in Stanford Industrial Park. The State of California has approved the Remedial Investigation Report, Feasibility Study Report, Remedial Action Plan Report and Final Remedial Action Report, prepared by us for this site. We have been operating remedial systems at the site to remove subsurface chemicals since April 1992. During fiscal 1997, we settled with the prior tenant and neighboring companies, on allocation of the cost of investigating and remediating the site at 3210 Porter Drive, Palo Alto, and the bordering site at 3300 Hillview Avenue, Palo Alto.

Management believes that our probable, nondiscounted net liability at December 28, 2002 for remaining costs associated with the above environmental matters is $0.6 million, which has been previously accrued. This amount consists of total estimated probable costs of $0.7 million ($0.1 million included in other current liabilities and $0.6 million included in other long-term liabilities) reduced by estimated minimum probable recoveries of $0.1 million included in other assets from other parties named to the order.

13. SEGMENT INFORMATION

We are organized around three separately managed business units: the Photonics Group, the Telecom-Actives Group and Lambda Physik, which we have identified as operating segments. On November 6, 2002, we decided to terminate the activities of the Telecom-Actives Group (see Note 11), an operating segment that had been aggregated with our Photonics Group in our Electro-Optics reportable segment, but is reported in our results from continuing operations. Consistent with the guidance of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” we have aggregated these three operating segments into two reportable segments. The Telecom-Actives Group is aggregated with the Photonics Group in the Electro-Optics segment as they have similar economic characteristics and are similar in the following: nature of products/services, nature of production process, type/class of customer, distribution methods and nature of regulatory environment. The Electro-Optics segment focuses on markets such as semiconductor and related manufacturing, materials processing, OEM laser components, scientific research, biotechnology, medical OEMs, advanced packaging and interconnect, thermal imaging, printing and reprographics. The Lambda Physik segment focuses on markets including lasers for the production of flat panel displays, lithography, GPS systems, mobile telephones, ink jet printers, automotive, environmental research, refractive surgery, scientific research, medical OEMs, materials processing and micro-machining applications.

Our Chief Executive Officer and Chief Financial Officer have been identified as the chief operating decision makers (CODMs) for SFAS 131 purposes as they assess the performance of the business units and decide how to allocate resources to the business units. Pretax income is the measure of profit and loss that our CODMs use to assess performance and make decisions. Pretax income represents the sales less the cost of sales and direct operating expenses incurred within the operating segments. In addition, our corporate expenses, except for depreciation of corporate assets and general legal expenses, are allocated to the operating segments and are included in the results below. Corporate expenses not allocated to the groups (depreciation of corporate assets and general legal expenses) are included in Corporate and Other in the reconciliation of operating results. Furthermore, the write-down of our Lumenis investment, interest expense and interest income are included in Corporate and Other in the reconciliation of operating results.

	THREE MONTHS ENDED
	December 28, 2002			December 29, 2001
	(in thousands)
Net Sales:
Electro-Optics	$	77,897		$	73,918
Lambda Physik	24,133			22,701
Total Net Sales	$	102,030		$	96,619

Intersegment Net Sales:
Electro-Optics	$	7		$	76
Lambda Physik	220			226
Total Intersegment Sales	$	227		$	302

Income (Loss) Before Income Taxes, Including Tax-effected Minority Interest:
Electro-Optics	$	(15,957	)	$	4,176
Lambda Physik	123			141
Corporate and other	(9,999		)	(215		)
Total Income (Loss) Before Income Taxes, Including Tax-Affected Minority Interest	$	(25,833	)	$	4,102

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

This quarterly report on Form 10-Q contains forward-looking statements that are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, without limitation, predictions regarding our future:

• net sales;

• results of operations;

• gross profits;

• research and development projects and expenses;

• selling, general and administrative expenses;

• restructuring and other charges;

• the effect of recent accounting pronouncements on our financial condition or results of operations;

• liquidity and sufficiency of existing cash, cash equivalents and short-term investments for near-term requirements;

• development of new technology and intellectual property;

• write-downs for excess or obsolete inventory;

• amount of after-tax restructuring and impairment charges;

• customer concentration;

• competitors and competitive pressures;

• purchase order commitments;

• inventory reserves;

• impairment loss on equipment;

• compliance with covenants in our financing arrangements;

• compliance with environmental regulations;

• write-down of investment in Lumenis, Inc. (Lumenis) common stock;

• sublease rental income;

• opportunities with high potential;

• leveraging of our technology leadership position;

• leadership position;

• collaborative customer and industry relationships;

• opportunities to expand semiconductor laser market;

• development and acquisition of new technologies;

• emphasis on supply chain management;

• growth of direct digital imaging applications;

• use of financial market instruments;

• simplify our international legal entity structure and reduce our presence in certain countries; and

• focus on long-term improvement of return on assets.

You can identify these and other forward-looking statements by use of the words such as “may,” “will,” “could,” “would,” “should,” “expects,” “plans,” “anticipates,” “relies,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below in “Management’s Discussion and Analysis of Results of Operations and Financial Condition” and under the heading “Business Environment and Industry Trends”. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statement.

The following discussion should be read in conjunction with the condensed consolidated financial statements and the related notes that appear elsewhere in this document.

COMPANY OVERVIEW

We are one of the world’s leading suppliers of photonics-based solutions in a broad range of commercial and scientific research applications. We design, manufacture and market lasers, laser-based systems, precision optics 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 technologies, intellectual property, manufacturing processes and product offerings.

We have two reportable business segments: Electro-Optics and Lambda Physik, which work with customers to provide cost-effective photonics-based solutions. The Electro-Optics segment focuses on markets such as semiconductor and related manufacturing, materials processing, OEM laser components, scientific research, biotechnology, medical OEMs, advanced packaging and interconnect, thermal imaging, printing and reprographics. Lambda Physik, our 60% owned subsidiary with headquarters located in Göttingen, Germany, focuses on markets including lasers for the production of flat panel displays, lithography, GPS systems, mobile telephones, ink jet printers, automotive, environmental research, refractive surgery, scientific research, medical OEMs, materials processing and micro-machining applications.

As lasers become less expensive, smaller and more reliable, they are increasingly replacing conventional tools and enabling technological advances in a variety of applications and industries, including microtechnologies and nanotechnologies, semiconductor inspection, microlithography, measurement, test and repair of electronic circuits, medical, biotechnology, consumer electronics, industrial process and quality control, materials processing, printing, and research and development. UV lasers are profiting from the trend towards miniaturization, which is a driver of innovation and growth in many markets. The short wavelength of these lasers that emit light in the ultraviolet spectral region makes it possible to produce extremely small structures with maximum precision consistent with the latest state of the art technology.

Our products address a broad range of applications. Both of our reportable segments are focused on several areas of the photonics market: scientific and government programs, microelectronics, materials processing, OEM components and instrumentation and graphic arts and displays. In November 2002, we announced that we were exiting a substantial portion of the optical telecommunications market.

Scientific and government programs – This market includes sales primarily to government laboratories, research centers and universities. Current applications for lasers in the research and development market include pump lasers for ultrafast systems, confocal microscopy systems and seed lasers in amplifier systems. Scientists are continuing to develop new applications with our research lasers in the areas of spectroscopy, imaging and biochemistry. The scientific market historically has provided an ideal test market for leading-edge laser technology, such as ultrafast, high power visible and UV lasers as well as tunable lasers.

Microelectronics – This market includes most sales to high-tech manufacturers of electronic goods, including semiconductor capital equipment, flat panel display, printed circuit boards and other micro-machining applications. Photonics solutions are increasing in importance in semiconductor manufacturing, as the industry adapts three drivers to reduce feature size and improve product yield. These three drivers are (1) 90 and sub-90 nanometer node processes; (2) copper, rather than aluminum interconnects; and (3) 300 millimeter wafer diameters. Our lasers enable non-destructive and non-invasive testing during key stages of the manufacturing process, from wafer inspection to packaging, marking to measurement. Optical lithography, micro via drilling, laser direct writing of printed circuit boards, cutting micro-fluidic devices and component trimming applications all rely on our products, as manufacturers transition to new generation tools to reduce feature sizes, improve performance and improve yields.

Materials processing– This market focuses on machine tools processes including marking, engraving, metal cutting, plastics macro welding and sales of laser diodes to other laser companies for use in their products. Lasers are widely accepted today as part of many important manufacturing applications. While many laser companies have developed high power lasers for the increasingly competitive area of metal processing, we have chosen to concentrate our efforts on developing compact low to medium power lasers specifically for the growing area of nonmetals processing. This includes such applications as the cutting and joining of plastics using both our CO₂ and semiconductor lasers, and the cutting, perforating and scoring of paper and packaging materials.

OEM components and instrumentation – This market includes sales primarily to the medical, bioinstrumentation, thermal imaging and military markets. One of the opportunities with high potential for us is in bioinstrumentation, where our lasers are displacing legacy technologies and enabling new applications in the fields of proteomics, genomics and drug discovery.

Graphic arts and display – The conversion from analog to digital printing, along with the sensitivity for using environmentally correct “green” products, is driving the adoption of photonics solutions in the graphics arts and displays market. We are a key supplier of light sources used in laser-based digital imaging solutions that are employed in computer-to-plate applications, helping print professionals to eliminate process steps by writing directly to printer plates. Equally significant is the emergence and projected growth of direct digital imaging applications, which eliminates plates entirely by using lasers to write directly on press. Digital photo finishing, digital film writing and holographic printing are other applications where we are helping to accelerate the transition from the analog world.

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 leadership to grow with rapidly expanding markets – We have targeted the semiconductor and related manufacturing markets.

• Maintain 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 maintain our position as a market leader in these areas.

• 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 that are industry leaders and work together with these customers to design and develop innovative product systems and solutions as they develop new technologies.

• Expand semiconductor laser market opportunities – We are working to expand the range and technical capabilities of, and markets for, our semiconductor lasers. We continue to develop new lasers to supply a broad range of wavelengths and power capabilities. These new products enable us to open up markets for new applications based on their efficiency, increased reliability and smaller size compared with conventional lasers.

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

• Emphasize supply chain management – We will continue to focus on operational efficiency through an emphasis on supply chain management with the explicit intent of improving gross margins at the current revenue level and reducing inventory turns.

• Focus on long-term improvement of Return on Assets – We will continue to focus on long-term improvement of return on assets (ROA) with a goal of achieving a level of assets that will drive a 10% ROA exiting fiscal 2005.

We conduct a significant portion of our business internationally. International sales accounted for 63% of net sales for the first quarter of fiscal 2003 and 60% of net sales for all of fiscal 2002. We anticipate that international sales will continue to account for a significant portion of our net sales in the foreseeable future. A portion of our international sales occurs through our international sales subsidiaries and the remainder of our international sales results from exports to foreign distributors and resellers and customers. As a result, our international sales and operations are subject to the risks of conducting business internationally. We are also subject to the risks of fluctuating foreign exchange rates, which could materially adversely affect the sales price of our products in foreign markets as well as the costs and expenses of our international subsidiaries. This may cause us to simplify our international legal entity structure and reduce our presence in certain countries, which may negatively affect the overall level of business in such countries. While we use forward exchange contracts, currency swap contracts, currency options and other risk management techniques to hedge our currency exposure, we remain exposed to the economic risks of foreign currency fluctuations. There can be no assurance that such factors will not adversely impact our operations in the future or require us to modify current business practices.

On December 6, 2002, we acquired Molectron Detector, Inc. (Molectron) of Portland, Oregon for approximately $11.5 million in cash. Molectron designs and manufactures laser test and measurement equipment used across all photonics-based applications and markets. We expect that the acquisition will enable us to leverage Molectron’s well-regarded power and energy management products into our next generation products in both the scientific and commercial markets. The acquisition was accounted for as a purchase and, accordingly, we recorded $3.2 million as goodwill and $6.1 million as other intangibles for the excess of the purchase price over the fair value of net tangible assets acquired. The other intangibles, principally existing technology, customer base and trade name, are amortized over the estimated useful lives of 1 to 10 years.

On November 22, 2002, we terminated our option to purchase Picometrix and wrote-off the value of the option ($1.4 million) in our after-tax restructuring and other charges of $13.4 million for our CTAG operating segment, as noted above. As a result of our decision to terminate our option, the note receivable from Picometrix is now payable to us in full on May 26, 2003. We evaluated the collectibility of the Picometrix note receivable, including the ability of Picometrix to make the required interest and principal payments. We determined that the estimated net realizable value of the note at December 28, 2002 was $1.0 million, and accordingly recorded an impairment loss of $3.7 million ($2.3 million after-tax) during the quarter ended December 28, 2002.

During the quarter ended December 28, 2002, the proposed sale of the building in Lincoln, California, met the necessary criteria to be classified as held for sale under Statement of Financial Accounting Standards (SFAS No. 144), “Accounting for the Impairment or Disposal of Long-Lived Assets”. We determined the estimated net realizable value of the land, building and improvements to be $9.1 million and the estimated net realizable value of equipment to be $0.2 million. As a result, we recorded an impairment loss of $3.1 million ($2.7 million after-tax) during the quarter ended December 28, 2002 to write-down the land, buildings, improvements and equipment to their estimated net realizable value at December 28, 2002.

As of December 28, 2002 the market value of our investment in Lumenis, Ltd. Common stock had declined to $9.9 million. This decline was deemed to be other-than-temporary and an additional impairment loss of $10.2 million was recognized in the quarter ended December 28, 2002. We recorded no net tax benefit related to the $10.2 million impairment loss as we recorded a $10.2 million valuation allowance against this capital loss deferred tax asset.

RESULTS OF OPERATIONS

CONSOLIDATED SUMMARY

Net loss for the current quarter was $20.5 million ($0.70 per diluted share) including restructuring and other charges of $30.4 million ($23.5 million after-tax or $0.80 per diluted share). The restructuring and other charges include a $13.4 million ($8.3 million after-tax) restructuring and impairment charge related to the termination of activities in our Telecom-Actives Group, a $10.2 million ($10.2 million after-tax) impairment charge related to the write-down of our shares of Lumenis, Ltd., a $3.7 million ($2.3 million after-tax) allowance against a note receivable and a $3.1 million ($2.7 million after-tax) write-down of our Lincoln, California facility to estimated net realizable value at December 28, 2002. For the same quarter in the prior year, net income was $2.7 million ($0.09 per diluted share) including a non-recurring favorable inventory adjustment of $1.6 million ($0.7 million after-tax and net of minority interest) or $0.02 per diluted share.

The decrease in net income was primarily attributable to the impairment charges mentioned above, partially offset by lower research and development expenses.

NET SALES:

	THREE MONTHS ENDED
	December 28, 2002		December 29, 2001
	(in thousands)
Consolidated:
Domestic	$	38,173	$	40,681
International	63,857		55,938
Total	$	102,030	$	96,619

Electro-Optics:
Domestic	$	33,760	$	36,074
International	44,137		37,844
Total	$	77,897	$	73,918

Lambda Physik:
Domestic	$	4,413	$	4,607
International	19,720		18,094
Total	$	24,133	$	22,701

Consolidated

Net sales for the fiscal quarter ended December 28, 2002 increased $5.4 million (6%) to $102.0 million from $96.6 million one year ago, primarily as a result of increased sales volumes in both of our reportable segments. During the current quarter, international sales increased $7.9 million (14%) and increased to 63% of net sales, while domestic sales decreased $2.5 million (6%) to 37% of net sales.

Electro-Optics

Electro-Optics net sales for the first fiscal quarter increased $4.0 million (5%) to $77.9 million from $73.9 million one year ago. International net sales increased $6.3 million (17%) to $44.1 million from $37.8 million one year ago and increased to 57% of net sales. Domestic net sales decreased $2.3 million (6%) to $33.8 million from $36.1 million one year ago and decreased to 43% of net sales. Net sales increased primarily due to higher sales volumes in our commercial CO₂ and solid-state products, including lasers to the materials processing market.

Lambda Physik

Lambda Physik net sales for the first fiscal quarter increased $1.4 million (6%) to $24.1 million from $22.7 million one year ago and decreased to 18% of net sales. International net sales increased $1.6 million (9%) to $19.7 million from $18.1 million one year ago and increased to 82% of net sales. Domestic net sales decreased $0.2 million (4%) to $4.4 million from $4.6 million one year ago. Net sales increased primarily due to higher sales volumes in the lithography market, following a period of decline caused by the downturn of the semiconductor industry.

GROSS PROFIT

Consolidated

The consolidated gross profit rate decreased to 39.6% in the current quarter compared to 43.5% in the same quarter one year ago. The decrease was primarily due to lower sales of higher margin commercial solid-state products in the Electro-Optics segment as well as lower margins on service revenue and higher manufacturing expenses due to Lambda Physik’s acquisition of Optomech in the third quarter of 2002 and the start-up of optics assembly operations in our Lambda Physik segment.

Electro-Optics

The gross profit rate decreased to 41.1% from 43.7% for the current quarter compared to the same quarter one year ago. The current quarter decrease was primarily due to lower sales of higher margin commercial solid-state products.

Lambda Physik

The gross profit rate decreased to 35.0% from 42.9% in the current quarter compared to the same quarter one year ago. The decrease was primarily due to lower margins on service revenue and higher manufacturing expenses due to the acquisition of Optomech in the third quarter of 2002 and the start-up of optics assembly operations.

OPERATING EXPENSES:

	THREE MONTHS ENDED
	December 28, 2002		December 29, 2001
	(in thousands)
Research and development	$	11,672	$	13,928
Selling, general and administrative	23,664		22,719
Restructuring and other charges	20,059
Intangibles amortization	835		908
Total operating expenses	$	56,230	$	37,555

Total operating expenses increased $18.7 million (50%) from one year ago and as a percentage of sales, operating expenses increased to 55.1% from 38.9% one year ago. Exclusive of the current quarter restructuring and other charges, total operating expenses decreased $1.4 million (4%) and decreased as a percentage of sales to 35.5% from 38.9% in the comparable fiscal quarter one year ago.

Research and development (R&D) expenses decreased $2.2 million (16%) to $11.7 million from $13.9 million in the comparable fiscal quarter one year ago. As a percentage of sales, R&D expenses decreased to 11.4% from 14.4% in the comparable fiscal quarter one year ago. The decrease is primarily due to the implementation of cost savings programs in our Lambda Physik segment and the termination of our Telecom-Actives Group (CTAG) operations in the Electro-Optics segment.

Selling, general and administrative (SG&A) expenses increased $0.9 million (4%) to $23.6 million from $22.7 million in the comparable fiscal quarter one year ago. As a percentage of sales, SG&A expenses decreased to 23.2% from 23.5% in the comparable fiscal quarter one year ago. The increase in absolute dollars is primarily due to consulting and depreciation expense related to our investments in information technology systems, partially offset by cost containment efforts.

Our restructuring and other charges during the quarter ended December 28, 2002 consist of (1) a $13.4 million restructuring and impairment charge related to termination of our CTAG operations for the write-down of equipment to net realizable value, an accrual for the estimated contractual obligation for lease and other facility costs of the building formerly occupied by CTAG, net of sublease income, and the write-down of our option to purchase Picometrix, Inc.; (2) a $3.7 million impairment charge to write-down our loan to Picometrix, Inc. to net realizable value at December 28, 2002; (3) an impairment loss of $3.1 million to write-down our Lincoln, California land, buildings, improvements and equipment to their estimated net realizable value at December 28, 2002; and (4) recoveries of $0.1 million in excess of estimated net realizable value for assets previously impaired and classified as held for sale.

Intangibles amortization decreased $0.1 million (8%) from the comparable fiscal quarter one year ago primarily due to the completion of amortization of order backlog related to Lambda Physik’s acquisition of MicroLas acquisition, partially offset by amortization of intangibles related to our acquisition of Molectron during the quarter ended December 28, 2002.

OTHER INCOME (EXPENSE)

Other expense, net increased by $9.6 million to $9.8 million during the current quarter from $0.2 million in the comparable fiscal quarter one year ago. The increase is due to the current quarter $10.2 million charge related to the write-down of our investment in Lumenis common stock due to an other-than-temporary impairment, partially offset by an increase of $0.6 million primarily due to lower interest expense due to principal payments on debt.

INCOME TAXES

The effective tax rate on income (loss) before minority interest for the current quarter was (20.9%) compared to 32.3% for the same quarter last year. The effective tax rate decreased primarily as a result of valuation allowances recorded on the write-down of Lumenis stock and impairment of the Lincoln, California facility due to capital loss limitations (including a $4.1 million valuation allowance provided on the Lumenis-related capital loss deferred tax asset and a $0.8 million valuation allowance provided on the Lincoln-related deferred tax asset).

MINORITY INTEREST IN SUBSIDIARIES

Minority interest in subsidiaries earnings decreased $0.1 million for the current quarter compared to the corresponding prior year quarter. The increase was primarily due to the increased profitability of our Lambda Physik subsidiary.

FINANCIAL CONDITION

Liquidity and Capital Resources

At December 28, 2002, our primary sources of liquidity were cash, cash equivalents and short-term trading investments of $230.0 million. In addition, we held $9.9 million of restricted Lumenis common stock. The Lumenis common stock is unregistered and its trading is subject to restrictions under Rule 144 of the Securities Act of 1933 and other contractual restrictions as defined in the definitive agreement. Additional sources of liquidity were a multi-currency line of credit and bank credit facilities totaling $65.5 million as of December 28, 2002, of which $60.5 million was unused and available. These credit facilities were used in the United States, Japan and Europe. We believe that cash generated from operations, together with the liquidity provided by existing cash balances and financing capacity, is sufficient to satisfy liquidity requirements for the next 12 months. We are subject to certain financial covenants related to our lines of credit. At December 28, 2002, we were in compliance with these covenants.

During the second quarter of fiscal 2002, we renewed a lease for 216,000 square feet of office, research and development and manufacturing space in Santa Clara, California, a portion of which we are subleasing to our former Medical segment, which is a part of Lumenis. The lease expires in February 2007. Upon expiration of the lease, we have an option to purchase the property for $24.6 million, renew the lease for an additional five years or at the end of the lease arrange for the sale of the property to a third party with Coherent retaining an obligation to the owner for the difference between the sale price, if less than $24.6 million, and $21.3 million, subject to certain provisions of the lease. If we do not purchase the property or arrange for its sale as discussed above, we would be obligated for an additional lease payment of $21.3 million. We occupied the building in July 1998 and commenced lease payments at that time. The lease requires us to maintain specified financial covenants including maintaining a minimum tangible net worth, minimum quick ratio, debt to tangible net worth ratio and leverage ratio as well as limiting the number of quarters per year in which net losses are allowed, all of which we were in compliance with as of December 28, 2002.

During fiscal 2002, we modified the covenants associated with the notes used to finance our acquisition of Star Medical (Star notes). This amendment included the modification of the covenants associated with the Star notes. The Star notes include financial covenants such as maintaining a minimum tangible net worth and minimum consolidated debt to capitalization and fixed charge coverage ratios as well as non-financial covenants such as providing quarterly statements to the bondholders. In connection with the modification of covenant terms, we agreed to prepay $7.3 million of the Star notes, with no prepayment penalty, and made such payment in October 2002. At December 28, 2002, we were in compliance with these covenants.

Contractual Obligations

At December 28, 2002, we have committed $2.2 million in building improvements for our Electro-Optics facilities in San Jose, California, Bloomfield, Connecticut and Lubeck, Germany. We have also committed $1.2 million to purchase equipment for our facilities in San Jose, California and Bloomfield, Connecticut.

Information regarding our long-term debt, long-term purchase commitments and operating leases is provided in the Consolidated Financial Statements for the fiscal year ended September 28, 2002. See “Notes to Consolidated Financial Statements, Note 13 — Commitments and Contingencies.” Information regarding our other financial commitments at

December 28, 2002 is provided in the Notes to the Condensed Consolidated Financial Statements. See “Notes to Condensed Consolidated Financial Statements, Note 12 —Commitments and Contingencies”.

Changes in Financial Condition

Cash, cash equivalents and short-term investments (excluding our investment in Lumenis common stock) decreased $13.9 million (6%) from $243.9 million at September 28, 2002 to $230.0 million at December 28, 2002. Cash and cash equivalents at December 28, 2002 decreased $19.0 million (15%) from September 28, 2002 resulting from cash used for investing activities of $15.4 million and cash used for financing activities of $6.1 million, partially offset by $2.3 million provided by changes in exchange rates and $0.2 million provided by operating activities.

Cash provided by operating activities during the quarter ended December 28, 2002 of $0.2 million included income (net of restructuring and impairment charges, the write-down of our investment in Lumenis and the write-down of notes receivable) of $9.9 million, depreciation and amortization of $7.8 million and other adjustment of $0.5 million, partially offset by $11.3 million of deferred taxes, net purchases of short-term investments of $5.1 million and $1.6 million used for operating assets and liabilities. Cash used for investing activities during the quarter ended December 28, 2002 of $15.4 million included $11.4 million used to purchase Molectron (net of cash acquired) and $5.8 million used to acquire property and equipment, partially offset by $1.0 million provided by other investing activities and $0.8 million provided by proceeds from dispositions of property and equipment. Cash used for financing activities during the quarter ended December 28, 2002 of $6.1 million included net debt of repayments of $10.0 million offset by $3.1 million from the sale of shares under our employee stock plans and an increase in cash overdraft of $0.8 million. Changes in exchange rates during the quarter ended December 28, 2002 provided $2.3 million.

Prepaid expenses and other assets increased $6.7 million (17%) from September 28, 2002 to December 28, 2002 primarily due to the reclassification to assets held for sale of the Lincoln, California facility and telecom-actives equipment, partially offset by payments received on our notes receivable from Lumenis, Ltd.

Deferred tax assets increased $9.5 million (17%) from September 28, 2002 to December 28, 2002 primarily due to deferred tax benefits provided on net federal operating losses during the current quarter.

Property and equipment, net, decreased $18.0 million (10%) from September 28, 2002 to December 28, 2002 primarily due to the write-down to net realizable value and the reclassification to assets held for sale of the Lincoln, California, facility and Telecom-Actives equipment as well as depreciation and amortization during the quarter.

Total long-term obligations, including current portion, decreased $6.8 million (12%) from September 28, 2002 to December 28, 2002 primarily due to principal payments on the notes used to finance our acquisition of Star Medical.

ADOPTION OF ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations”. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. The adoption of SFAS No. 141 did not have a material impact on our financial position, results of operations or cash flows.

Effective October 1, 2001 we adopted SFAS No. 142, “Goodwill and Other Intangible Assets” which establishes new standards for goodwill acquired in a business combination and other intangible assets, eliminates amortization of existing goodwill balances, and requires annual evaluation of goodwill for impairment. SFAS No. 142 was effective for fiscal years beginning after December 15, 2001, with early adoption allowed for companies with fiscal years beginning after March 15, 2001. Upon adoption of SFAS No. 142, we stopped the amortization of goodwill with a net carrying value of $32.1 million at September 30, 2001 and annual amortization of $4.1 million, including amortization resulting from the acquisitions of Crystal Associates, Inc. in November 2000 and DeMaria Electro-Optics Systems, Inc. and MicroLas Laser System GmbH in April 2001, that resulted from business combinations initiated prior to the adoption of SFAS No. 141, “Business Combinations”.

On an ongoing basis (absent any impairment indicators), we perform our impairment tests during the fourth quarter (based on our third quarter financial statements), in conjunction with our annual budgeting process. As part of our adoption of SFAS No. 142, we completed the initial impairment tests during the second quarter of fiscal 2002 and the annual impairment tests during the fourth quarter of fiscal 2002 and these tests resulted in no impairment charges.

RECENT ACCOUNTING STANDARDS

In November 2002, the EITF reached a consensus on Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into after June 15, 2003. We are currently determining what effect, if any, the provisions of EITF Issue No. 00-21will have on our operating results or financial condition.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. We adopted the disclosure requirements of FIN 45 in the first quarter of fiscal 2003. The recognition and measurement provisions will be applied to guarantees issued or modified after December 31, 2002. We do not expect the adoption of the recognition and measurement provisions to have a material effect on our operating results or financial condition.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” The statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We will adopt the disclosure provisions of SFAS No. 148 in the second quarter of fiscal 2003. We have not yet determined the effect that the transition provisions of SFAS No. 148 would have on our operating results or financial position, if any.

prospectively for all variable interest entities created after January 31, 2003. For variable interest entities created before January 31, 2003, we will be required to consolidate all entities in which it was deemed to be the primary beneficiary beginning in the fourth quarter of fiscal 2003. If it is reasonably possible an enterprise will consolidate or disclose information about a variable interest entity when FIN 46 becomes effective, the enterprise shall disclose information about those entities in all financial statements issued after January 31, 2003.

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 (GAAP). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, accounting for our marketable equity securities, accounting for long-lived assets, inventory reserves, warranty reserves, accounting for notes receivable and accounting for income taxes.

Revenue Recognition

We recognize revenue in accordance with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” (SAB 101). Accordingly, revenue is recognized when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed or determinable and collection is probable. Delivery is generally considered to have occurred when shipped.

Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. Failure to obtain anticipated orders due to delays or cancellations of orders could have a material adverse effect on our revenue. In addition, pressures from customers to reduce our prices, or to modify our existing sales terms may result in material adverse effects on our revenue in future periods. Our products typically include a one-year warranty. The estimated cost of product warranty claims is accrued at the time the sale is recognized, based on historical experience.

is completed or, if the installation services are inconsequential or perfunctory, we accrue installation costs at the time that product revenue is recognized. We defer revenue on training services until training services are provided.

Sales to end-users in the scientific market typically require installation and, thus, involve post-delivery obligations, however, our post-delivery installation obligations are not essential to the functionality of our products. For a limited number of products or arrangements where management considers installation to be significant in comparison to the value of the product sold, we defer revenue related to installation services until completion of these services.

Marketable Equity Securities

We classify our marketable equity investments, primarily consisting of our 5,432,099 shares of Lumenis stock, as short-term available-for-sale investments. These investments are carried at fair value, based on quoted market prices, and unrealized gains and losses, net of taxes, are included as a component of other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity. Gains are recognized in our statement of operations when realized, and losses are recognized at the earlier of realization and management’s determination that a decline in value is other-than-temporary.

In determining if and when a decline in the value of our Lumenis stock is other-than-temporary, management evaluates the length of time that the market value has been below cost, the severity of the decline relative to cost, current and expected future market conditions, the financial condition of Lumenis and other relevant criteria. As of June 29, 2002, the market value of our investment in Lumenis had declined from our initial valuation of $124.4 million to $20.2 million. This decline was deemed to be other-than-temporary and an impairment loss of $104.2 million ($79.2 million after income taxes of $25.0 million) was recognized in the quarter ended June 29, 2002. As of December 28, 2002, the market value of our investment in Lumenis had declined from June 29, 2002 value of $20.2 million to $9.9 million. This decline was deemed to be other-than-temporary and an impairment loss of $10.2 million ($10.2 million after income taxes) was recognized in the quarter ended December 28, 2002. Unrealized gains and losses from the new cost basis of $9.9 million at December 28, 2002 will be recorded in accumulated other comprehensive income (loss). If the market value of the Lumenis stock continues to decline in the remainder of fiscal 2003 or beyond, we may recognize additional losses on this investment.

Accounting for Long-Lived Assets

We evaluate long-lived assets, including goodwill and purchased intangible assets, whenever events or changes in business circumstances or our planned use of assets indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. At December 28, 2002, we had $63.9 million of goodwill and purchased intangible assets on the balance sheet, the value of which we believe is reasonable based on the estimated future cash flows of the associated products and technologies. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required.

During the year ended September 28, 2002, we recorded a charge of $11.0 million for the write-down of equipment resulting primarily from management’s decision to cease most of the Company’s activities related to the telecom passives components market.

During the quarter ended December 28, 2002, we recorded a charge of $6.5 million to write down equipment and leasehold improvements of our terminated CTAG operations to net realizable value and a charge of $3.1 million to write down the value of land, buildings, improvements and equipment at our Lincoln, California facility to net realizable value.

Inventory Reserves

We record our inventory at the lower of cost (computed on a first-in, first-out basis) or market. We record inventory reserves equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. Inventory reserves are generally recorded, within guidelines set by management, when the inventory for a device exceeds 12 months of demand for the device and when individual parts have been in inventory for greater than 12 months. If actual market conditions are less favorable than those projected by management, additional inventory reserves may be required which could materially affect our future results of operations. We record reserves on demo inventory by amortizing the cost of demo inventory over a two-year period from the fourth month it is placed in service. During the year ended September 29, 2001, we recorded a charge of $13.9 million for excess inventory and open purchase order commitments due to decreased marketability resulting from the slowdown in the Lithography business at Lambda Physik, which was reflected in postponed delivery dates, cancelled orders and further expected order cancellations from customers. Due to rapidly changing forecasts and orders, additional write-downs for excess or obsolete inventory, while not currently expected, could be required in the future. Differences between actual results and previous estimates of excess and obsolete inventory could result in material adverse effects on our future results of operations.

Warranty Reserves

We provide warranties on certain of our product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

Accounting for Notes Receivable

We evaluate notes receivable whenever events or changes in business circumstances indicate that the carrying amount of the notes may not be fully recoverable. Reviews are performed to determine whether the carrying value of notes is impaired based on the ability of the debtor to make the required payments of principal and interest on the note. If the review indicates that there is impairment, the impaired note is written down to estimated net realizable value. At December 28, 2002, our assets include notes receivable with a book value of $11.8 million. Differences between estimated and actual future collections on notes receivable could result in material adverse effects on our future results of operations.

On November 22, 2002, we terminated our option to purchase Picometrix and, as a result, the note is payable to us in full on May 26, 2003. As a result of this decision, we evaluated the collectibility of the Picometrix note receivable, including the ability of Picometrix to make the required interest and principal payments. We determined that the estimated net realizable value of the note at December 28, 2002 was $1.0 million, and accordingly recorded an impairment loss of $3.7 million ($2.3 million after-tax) during the quarter ended December 28, 2002.

Income Taxes

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

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

In the quarter ended December 28, 2002, our valuation allowance to reduce deferred tax assets increased by $5.1 million. In making the determination to record the valuation allowance, management considered the likelihood of future taxable income and feasible and prudent tax planning strategies to realize deferred tax assets. In the future, if we determine that we

expect to realize more or less of the deferred tax assets, an adjustment to the valuation allowance will affect income in the period such determination is made.

Federal income taxes have not been provided for on a portion of the unremitted earnings of foreign subsidiaries either because such earnings are intended to be permanently reinvested or because foreign tax credits are available to offset any planned distributions of such earnings.

BUSINESS ENVIRONMENT AND INDUSTRY TRENDS

Industry trends and specific risks may affect our future business and results in our business. Some of the factors that could cause results to materially differ from past results or those described in forward looking matters include the matters discussed below.

Risks Related to our Business

We may experience quarterly and annual fluctuations in our net sales and operating results in the future, which may result in volatility in our stock price.

Our net sales and operating results may vary significantly from quarter to quarter and from year to year in the future. A number of factors, many of which are outside of our control, may cause these variations, including:

• general economic uncertainties;

• fluctuations in demand for, and sales of, our products or prolonged downturns in the industries that we serve;

• ability of our suppliers to produce and deliver components and parts, including sole or limited source components, in a timely manner, in the quantity and quality desired and at the prices we have budgeted;

• timing or cancellation of customer orders and shipment scheduling;

• fluctuations in our product mix;

• foreign currency fluctuations;

• introductions of new products and product enhancements by our competitors, entry of new competitors into our markets, pricing pressures and other competitive factors;

• our ability to develop, introduce, manufacture and ship new and enhanced products in a timely manner without defects;

• rate of market acceptance of our new products;

• delays or reductions in customer purchases of our products in anticipation of the introduction of new and enhanced products by us or our competitors;

• our ability to control expenses;

• level of capital spending of our customers;

• potential obsolescence of our inventory; and

• costs related to acquisitions of technology or businesses.

In addition, we often recognize a substantial portion of our sales in the last month of the quarter. Our expenses for any given quarter are typically based on expected sales and if sales are below expectations in any given quarter, the adverse impact of the shortfall on our operating results may be magnified by our inability to adjust spending quickly to compensate for the shortfall. We also base our manufacturing on our forecasted product mix for the quarter. If the actual product mix varies significantly from our forecast, we may not be able to fill some orders during that quarter, which would result in delays in the shipment of our products. Accordingly, variations in timing of sales, particularly for our higher priced, higher margin products, can cause significant fluctuations in quarterly operating results.

Due to these and other factors, we believe that quarter-to-quarter and year-to-year comparisons of our past operating results may not be meaningful. You should not rely on our results for any quarter or year as an indication of our future performance. Our operating results in future quarters and years may be below public market analysts’ or investors’ expectations, which would likely cause the price of our common stock to fall. In addition, over the past several quarters, the stock market has experienced extreme price and volume fluctuations that have affected the stock prices of many technology companies. These factors, as well as general economic and political conditions or investors’ concerns regarding the credibility of corporate financial statements and the accounting profession, may have a material adverse affect on the market price of our stock in the future.

The successful completion of the upgrade to our information systems is critical to our ability to effectively and efficiently operate our business in the future.

Our success in navigating the current market will depend heavily upon our ability to assemble the necessary information to make informed decisions and implement those decisions quickly and effectively. We have been working on a major upgrade to our technology infrastructure and information systems. This upgrade will result in a consolidation from multiple critical legacy systems to primarily one fully integrated enterprise system. While we are taking great care to properly plan this implementation and to test the solution fully prior to the conversion, there can be no guarantees given that the conversion will not disrupt our operations.

Our business has been adversely impacted by the general worldwide economic slowdown and related uncertainties affecting markets in which we operate.

Adverse economic conditions worldwide have contributed to the current technology industry slowdown and impacted our business resulting in:

• reduced demand for some of our products;

• increased risk of excess and obsolete inventories;

• increased rate of order cancellations or delays;

• excess manufacturing capacity under current market conditions;

• continued downturn in the semiconductor industry; and

• higher overhead costs, as a percentage of revenues.

Recent political and social turmoil in many parts of the world, including terrorist and military actions, may continue to put pressure on global economic conditions. These political, social and economic conditions are making it very difficult for us, our customers and our vendors to forecast and plan future business activities. This level of uncertainty severely challenges our ability to operate profitably or to grow our business. In particular, it is difficult to develop and implement strategy, sustainable business models, efficient operations and effectively manage supply chain relationships.

If the economic or market conditions continue or further deteriorate, this may have a material adverse impact on our financial position, results of operations and cash flow.

We depend on sole source or limited source suppliers for some of the key components and materials, including exotic materials and crystals, in our products, which makes us susceptible to supply shortages or price fluctuations that could adversely affect our business.

We currently purchase several key components and materials used in the manufacture of our products from sole source or limited source suppliers. Some of these suppliers are relatively small private companies that may discontinue their operations at any time. We typically purchase our components and materials through purchase orders and we have no guaranteed supply arrangement with any of these suppliers. We may fail to obtain these supplies in a timely manner in the future. We may experience difficulty identifying alternative sources of supply for certain components used in our products. We would experience further delays while identifying, evaluating and testing the products of these potential alternative suppliers. Furthermore, financial or other difficulties faced by these suppliers or significant changes in demand for these components or materials could limit their availability. Any interruption or delay in the supply of any of these components or materials, or the inability to obtain these components and materials from alternate sources at acceptable prices and within a reasonable amount of time, would impair our ability to meet scheduled product deliveries to our customers and could cause customers to cancel orders.

We rely exclusively on our own production capability to manufacture certain strategic components, optics and optical systems, crystals, semiconductor lasers, lasers and laser-based systems. Because we manufacture, package and test these components, products and systems at our own facilities, and such components, products and systems are not readily available from other sources, any interruption in manufacturing would adversely affect our business. In addition, our failure to achieve adequate manufacturing yields of these items at our manufacturing facilities may materially and adversely affect our operating results and financial condition.

Our future success depends on our ability to increase our sales volumes and decrease our costs to offset anticipated declines in the average selling prices of our products and, if we are unable to realize greater sales volumes and lower costs, our operating results may suffer.

Our future success depends on the continued growth of the markets for lasers, laser systems, precision optics and related accessories, as well as our ability to identify, in advance, emerging markets for laser-based systems. We cannot assure you that we will be able to successfully identify, on a timely basis, new high-growth markets in the future. Moreover, we cannot assure you that new markets will develop for our products or our customers’ products, or that our technology or pricing will enable such markets to develop. Future demand for our products is uncertain and will depend to a great degree on the continued technological development and the introduction of new or enhanced products. If this does not continue, sales of our products may decline and our business will be harmed.

We have historically been the industry’s high quality, high priced supplier of laser systems. We have in the past experienced decreases in the average selling prices of some of our products. We anticipate that as competing products become more widely available, the average selling price of our products may decrease. If we are unable to offset the anticipated decrease in our average selling prices by increasing our sales volumes, our net sales will decline. In addition, to maintain our gross margins, we must continue to reduce the cost of our products. Further, as average selling prices of our current products decline, we must develop and introduce new products and product enhancements with higher margins. If we cannot maintain our gross margins, our operating results could be seriously harmed, particularly if the average selling prices of our products decrease significantly.

Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers.

Our current products address a broad range of commercial and scientific research applications in the photonics markets. We cannot assure you that the market for these applications will continue to generate significant or consistent demand for our products. Demand for our products could be significantly diminished by new technologies or products that replace them or render them obsolete.

During the quarter ended December 28, 2002, our research and development expenses were 11% of net sales. Over the last three fiscal years, our research and development expenses have been in the range of 11% to 13% of net sales. Our future success depends on our ability to anticipate our customers’ needs and develop products that address those needs. Introduction of new products and product enhancements will require that we effectively transfer production processes from research and development to manufacturing and coordinate our efforts with those of our suppliers to achieve volume production rapidly. If we fail to effectively transfer production processes, develop product enhancements or introduce new products in sufficient quantities to meet the needs of our customers as scheduled, our net sales may be reduced and our business may be harmed.

We face risks associated with our international sales that could harm our financial condition and results of operations.

For the quarter ended December 28, 2002, 63% of our net sales were derived from international sales. For fiscal years 2002, 2001 and 2000, 60%, 55% and 59%, respectively, of our net sales were derived from international sales. We anticipate that international sales will continue to account for a significant portion of our revenues in the foreseeable future. The recent global economic slowdown has already had and is likely to continue to have a negative effect on various international markets in which we operate. This may cause us to simplify our international legal entity structure and reduce our presence in certain countries, which may negatively affect the overall level of business in such countries. A portion of our international sales occurs through our international sales subsidiaries and the remainder of our international sales result from exports to foreign distributors, resellers and customers. Our international operations and sales are subject to a number of risks, including:

• longer accounts receivable collection periods;

• the impact of recessions in economies outside the United States;

• unexpected changes in regulatory requirements;

• certification requirements;

• reduced protection for intellectual property rights in some countries;

• potentially adverse tax consequences;

• political and economic instability; and

• preference for locally produced products.

We are also subject to the risks of fluctuating foreign exchange rates, which could materially adversely affect the sales price of our products in foreign markets as well as the costs and expenses of our international subsidiaries. While we use forward exchange contracts, currency swap contracts, currency options and other risk management techniques to hedge our foreign

currency exposure, we remain exposed to the economic risks of foreign currency fluctuations. For additional discussion about our foreign currency risks, see “Item 3—Quantitative and Qualitative Disclosures About Market Risk.”

We may not be able to protect our proprietary technology, which could adversely affect our competitive advantage.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We cannot assure you that our patent applications will be approved, that any patents that may be issued will protect our intellectual property or that any issued patents will not be challenged by third parties. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

We could become subject to litigation regarding intellectual property rights, which could seriously harm our business.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. In the future, we may be a party to litigation to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages or invalidation of our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one or more of the following:

• stop manufacturing, selling or using our products that use the infringed intellectual property;

• obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, although such license may not be available on reasonable terms, or at all; or

• redesign the products that use the technology.

If we are forced to take any of these actions, our business may be seriously harmed. We do not have insurance to cover potential claims of this type.

We may in the future initiate claims or litigation against third parties for infringement of our proprietary rights to protect these rights or to determine the scope and validity of our proprietary rights or the proprietary rights of competitors. These claims could result in costly litigation and the diversion of our technical and management personnel.

We depend on skilled personnel to operate our business effectively in a rapidly changing market, and if we are unable to retain existing or hire additional personnel when needed, our ability to develop and sell our products could be harmed.

Our future success depends upon the continued services of our executive officers and other key engineering, sales, marketing, manufacturing and support personnel. None of our officers or key employees in the United States are bound by an employment agreement for any specific term and these personnel may terminate their employment at any time. In addition, we do not have “key person” life insurance policies covering any of our employees.

In addition, the significant downturn in our business environment has had a negative impact on our operations, and as a result, we have restructured our operations to reduce our workforce and implement other cost reduction activities. Although we believe these various changes and actions will improve our organizational effectiveness and competitiveness, they could lead, in the short term, to disruptions in our business, reduced employee morale and productivity, increased attrition and problems with retaining existing employees and recruiting future employees and increased financial costs.

Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future. Recruiting and retaining highly skilled personnel continues to be difficult. At certain locations where we operate, the cost of living is extremely high and it may be difficult to retain key employees and management at a reasonable cost. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs. Our failure to attract additional employees and retain our existing employees could adversely affect our growth and our business.

Our assets may fluctuate based on the stock price of Lumenis.

Our assets may also be affected by any fluctuations in the stock price of Lumenis, which we received in 2001 as consideration for the sale of our Medical segment. At April 30, 2001, we estimated the value of the Lumenis stock at $124.4 million. As of June 29, 2002, the market value of our investment in Lumenis had declined from our initial valuation of $124.4 million to $20.2 million. The decline was deemed to be other-than-temporary and an impairment loss of $79.2 million (net of income taxes of $25.0 million) was recognized in the quarter ended June 29, 2002. As of December 28, 2002 the market value of our investment in Lumenis had declined to $9.9 million. This decline was deemed to be other-than-temporary and an additional impairment loss of $10.2 million was recognized in the quarter ended December 28, 2002. Currently, we do not hedge our investment in Lumenis stock. The Lumenis stock received is unregistered and its trading is subject to restrictions under the Securities and Exchange Commission Rule 144 and other restrictions. Any further reduction in the stock price of Lumenis could decrease our total assets.

In addition, the stock market has recently experienced extreme volatility that has often been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our performance.

The long sales cycles for our products may cause us to incur significant expenses without offsetting revenues.

Customers often view the purchase of our products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our products before making a decision to purchase them, resulting in a lengthy initial sales cycle. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses to customize our products to the customer’s needs. We may also expend significant management efforts, increase manufacturing capacity and order long- lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our products. As a result, these long sales cycles may cause us to incur significant expenses without ever receiving revenue to offset those expenses.

The markets in which we sell our products are intensely competitive and increased competition could cause reduced sales levels, reduced gross margins or the loss of market share.

Competition in the various photonics markets in which we provide products is very intense. We compete against a number of companies, including Thermo Electron Corporation’s Spectra-Physics Lasers business unit, JDS Uniphase, Inc., Cymer, Inc., Gigaphoton, Rofin-Sinar, Lightwave Electronics and Excel Technology. Some of our competitors are large companies that have significant financial, technical, marketing and other resources. These competitors may be able to devote greater resources than we can to the development, promotion, sale and support of their products. Several of our competitors that have large market capitalizations or strong cash reserves are much better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines. Any of these acquisitions could give our competitors a strategic advantage. Any business combinations or mergers among our competitors, forming larger competitors with greater resources, could result in increased competition, price reductions, reduced margins or loss of market share, any of which could materially and adversely affect our business, results of operations and financial condition.

Additional competitors may enter the market and we are likely to compete with new companies in the future. We may encounter potential customers that, due to existing relationships with our competitors, are committed to the products offered by these competitors. As a result of the foregoing factors, we expect that competitive pressures may result in price reductions, reduced margins and loss of market share.

Some of our laser systems are complex in design and may contain defects that are not detected until deployed by our customers, which could increase our costs and reduce our revenues.

Laser systems are inherently complex in design and require ongoing regular maintenance. The manufacture of our lasers, laser products and systems involves a highly complex and precise process. As a result of the technical complexity of our products, changes in our or our suppliers’ manufacturing processes or the inadvertent use of defective materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve such yields or product reliability, our business, operating results, financial condition and customer relationships would be adversely affected. We provide warranties on certain of our product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. If actual return rates and/or repair and

replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

Our customers may discover defects in our products after the products have been fully deployed and operated under peak stress conditions. In addition, some of our products are combined with products from other vendors, which may contain defects. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:

• loss of customers;

• increased costs of product returns and warranty expenses;

• damage to our brand reputation;

• failure to attract new customers or achieve market acceptance;

• diversion of development and engineering resources; and

• legal actions by our customers.

The occurrence of any one or more of the foregoing factors could seriously harm our business, financial condition and results of operations.

If we fail to accurately forecast component and material requirements for our products, we could incur additional costs and incur significant delays in shipments, which could result in loss of customers.

We use rolling forecasts based on anticipated product orders and material requirements planning systems to determine our product requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. We depend on our suppliers for most of our product components and materials. Lead times for components and materials that we order vary significantly and depend on factors including the specific supplier requirements, the size of the order, contract terms and current market demand for components. For substantial increases in our sales levels, some of our suppliers may need at least six months lead-time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales, business and operating results.

Our increased reliance on contract manufacturing and our excess manufacturing capacity may adversely impact our financial results and operations.

We have changed our manufacturing strategy so that more of our products will be sourced from contract manufacturers. We are in the process of transfering our printed circuit board manufacturing activities in Auburn, California, to a global electronics contract manufacturer who has factories in North America, Asia and Europe. The transition should be completed by June 2003. Our ability to resume internal manufacturing operations for those products will be severely limited. The cost, quality, performance and availability of contract manufacturing operations are and will be essential to the successful production and sale of many of our products. The inability of any contract manufacturer to meet our cost, quality, performance and availability standards could adversely impact our financial condition or results of operations. We may not be able to provide contract manufacturers with product volumes that are high enough to achieve sufficient cost savings. If shipments fall below forecasted levels, we may incur increased costs or be required to take ownership of the inventory. Also, our ability to control the quality of products produced by contract manufacturers may be limited and quality issues may not be resolved in a timely manner, which could adversely impact our financial condition or results of operations. The smooth transition from internal manufacturing to contract manufacturing by a third party is critical to our success. Failure to implement and manage a successful transition may cause severe disruptions in our supply chain that will affect the cost, quality and availability of products.

Furthermore, because we have outsourced some manufacturing operations to contract manufacturers, have experienced lower sales volumes and have exited the passive telecom business, we now have excess manufacturing capacity in existing facilities. As of December 28, 2002, we have land, buildings and improvements (before impairment charges) of $12.4 million related to facilities in Lincoln, California which are held for sale. During fiscal 2001, construction on these facilities was suspended. In the fourth quarter of fiscal 2002, management decided that, given our exit from the passive telecom market and the outsourcing of the production of printed circuit boards, this facility was not needed to support our operations and put the building up for sale. During the quarter ended December 28, 2002, we determined the estimated net realizable value of the land, building and improvements to be $9.1 million and the estimated net realizable value of equipment to be $0.2 million. As a

result, we recorded impairment loss of $3.1 million ($2.7 million after-tax) during the quarter ended December 28, 2002 to write-down the land, buildings, improvements and equipment to their estimated net realizable value at December 28, 2002.

We are currently restructuring our operations, including the consolidation of CO₂ manufacturing operations at our Bloomfield, Connecticut facility, and implementing cost reduction activities to eliminate this excess capacity. Our ability to reduce our excess manufacturing capacity and to consolidate facilities may be made more difficult by further weakening of the seminconductor industry and worsening of general economic conditions in the United States and globally. If we are unable to reduce our excess manufacturing capacity and facilities, this may negatively impact our operations, cost structure and financial performance.

Cost containment and expense reductions are critical to maintaining positive cash flow from operations and profitability.

We are continuing efforts to reduce our expense structure. We believe strict cost containment and expense reductions are essential to maintaining positive cash flow from operations in future quarters and maintaining profitability (excluding impairment charges), especially since the outlook for future quarters is subject to numerous challenges. Additional measures to contain costs and reduce expenses may be undertaken if revenues and market conditions do not improve. A number of factors could preclude us from successfully bringing costs and expenses in line with our revenues, such as our inability to accurately forecast business activities and further deterioration of our revenues. If we are unable to continue to reduce expenses and contain our costs, this could harm our operating results.

If we fail to manage our growth effectively, our business could be disrupted, which could harm our operating results.

Our ability to successfully offer our products and implement our business plan in evolving markets requires an effective planning and management process. We continue to expand the scope of our operations domestically and internationally. The growth in employee headcount and in sales, combined with the challenges of managing geographically-dispersed operations, has placed, and our anticipated growth in future operations will continue to place, a significant strain on our management systems and resources, particularly our information technology systems. We expect that we will need to continue to improve our information technology systems, reporting systems and procedures and continue to expand, train and manage our work force worldwide. The failure to effectively manage our growth could disrupt our business and harm our operating results.

Any acquisitions we make could disrupt our business and harm our financial condition.

We have in the past made strategic acquisitions of other corporations, and we continue to evaluate potential strategic acquisitions of complementary companies, products and technologies. In the event of any future acquisitions, we could:

• issue stock that would dilute our current stockholders’ percentage ownership;

• pay cash;

• incur debt;

• assume liabilities; or

• incur expenses related to in-process research and development, impairment of goodwill and amortization and

These purchases also involve numerous risks, including:

• problems combining the acquired operations, technologies or products;

• unanticipated costs or liabilities;

• diversion of management’s attention from our core businesses;

• adverse effects on existing business relationships with suppliers and customers; and

• potential loss of key employees, particularly those of the purchased organizations.

We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, which may harm our business. Refer further discussion on acquisitions in Management’s Discussion and Analysis of Results of Operations and Financial Condition.

We use standard laboratory and manufacturing materials that could be considered hazardous and we could be liable for any damage or liability resulting from accidental environmental contamination or injury.

Although most of our products do not incorporate hazardous or toxic materials and chemicals, some of the gases used in our excimer lasers and some of the liquid dyes used in some of our scientific laser products are highly toxic. In addition, our operations involve the use of standard laboratory and manufacturing materials that could be considered hazardous. Also, if a facility fire were to occur at our Tampere, Finland site and spread to a reactor used to grow semiconductor wafers, it could release highly toxic emissions. We believe that our safety procedures for handling and disposing of such materials comply with all federal, state and offshore regulations and standards; however, the risk of accidental environmental contamination or injury from such materials cannot be entirely eliminated. In the event of such an accident involving such materials, we could be liable for any damage and such liability could exceed the amount of our liability insurance coverage and the resources of our business.

If our facilities were to experience catastrophic loss, our operations would be seriously harmed.

Our facilities could be subject to a catastrophic loss from fire, flood, earthquake or terrorist activity. A substantial portion of our research and development activities, manufacturing, our corporate headquarters and other critical business operations are located near major earthquake faults in Santa Clara, California, an area with a history of seismic events. Any such loss at any of our facilities could disrupt our operations, delay production, shipments and revenue and result in large expenses to repair or replace the facility. While we have obtained insurance to cover most potential losses, after reviewing the costs and limitations associated with earthquake insurance, we have decided not to procure such insurance. We believe that this decision is consistent with decisions reached by numerous other companies located nearby. We cannot assure you that our existing insurance coverage will be adequate against all other possible losses.

Provisions of our charter documents, Delaware law, our Common Shares Rights Plan and our Change-of-Control Severance Plan may have anti-takeover effects that could prevent or delay a change in control.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition or make removal of incumbent directors or officers more difficult. These provisions may discourage takeover attempts and bids for our common stock at a premium over the market price. These provisions include:

• the ability of our board of directors to alter our bylaws without stockholder approval;

• limiting the ability of stockholders to call special meetings;

• limiting the ability of our stockholders to act by written consent; and

• establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

We are subject to Section 203 of the Delaware General Corporation Law, which prohibits a publicly held Delaware corporation from engaging in a merger, asset or stock sale or other transaction with an interested stockholder for a period of three years following the date such person became an interested stockholder, unless prior approval of our board of directors is obtained or as otherwise provided. These provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us without obtaining the prior approval of our board of directors, which may cause the market price of our common stock to decline. In addition, we have adopted a change of control severance plan, which provides for the payment of a cash severance benefit to each eligible employee based on the employee’s position and years of service to us. If a change of control occurs, our successor or acquirer will be required to assume and agree to perform all of our obligations under the change of control severance plan.

Our common shares rights agreement permits the holders of rights to purchase shares of our common stock to exercise the stock purchase rights following an acquisition of or merger by us with another corporation or entity, following a sale of 50% or more of our consolidated assets or earning power, or the acquisition by an individual or entity of 20% or more of our common stock. Our successor or acquirer is required to assume all of our obligations and duties under the common shares rights agreement, including in certain circumstances the issuance of shares of its capital stock upon exercise of the stock purchase rights. The existence of our common shares rights agreement may have the effect of delaying, deferring or preventing a change of control and, as a consequence, may discourage potential acquirers from making tender offers for our shares.

Risks related to our industry

Our market is unpredictable and characterized by rapid technological changes and evolving standards, and, if we fail to address changing market conditions, our business and operating results will be harmed.

The photonics industry is characterized by extensive research and development, rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. Because this market is subject to rapid change, it is difficult to predict its potential size or future growth rate. Our success in generating revenues in this market will depend on, among other things:

• maintaining and enhancing our relationships with our customers;

• the education of potential end-user customers about the benefits of lasers, laser systems and precision optics; and

• our ability to accurately predict and develop our products to meet industry standards.

For the quarter ended December 28, 2002, our research and development costs were $11.7 million, or 11%, of net sales. For our fiscal years 2002, 2001 and 2000, our research and development costs were $52.6 million, or 13%, $53.0 million, or 11%, and $40.7 million, or 11%, of net sales, respectively. We cannot assure you that our expenditures for research and development will result in the introduction of new products or, if such products are introduced, that those products will achieve sufficient market acceptance. Our failure to address rapid technological changes in our markets could adversely affect our business and results of operations.

A continued downturn in the semiconductor manufacturing industry could adversely affect our business, financial condition and results of operations.

Our net sales depend in part on the demand for our products by semiconductor equipment companies. The semiconductor industry is highly cyclical and has historically experienced periodic and significant downturns, which have often severely affected the demand for semiconductor manufacturing equipment, including laser-based tools and systems. We are currently experiencing such a downturn, which is resulting in decreased demand for semiconductor manufacturing equipment and consequently a decreased demand for our products. Although such a downturn could reduce our sales, we would not be able to reduce expenses commensurately, due in part to the need for continual spending in research and development and the need to maintain extensive ongoing customer service and support capability. Accordingly, any sustained downturn in the semiconductor industry could have a material adverse effect on our financial condition and results of operations.

Our reported results may be adversely affected by changes in accounting principles generally accepted in the United States of America.

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP). GAAP is subject to interpretation by the American Institute of Certified Public Accountants, the Financial Accounting Standards Board (FASB), the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies or interpretations can have a significant effect on our reported results, and may even affect the reporting of transactions completed prior to the announcement of a change.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk disclosures

We are exposed to market risk related to changes in interest rates, foreign currency exchange rates, and equity security price risk. We do not use derivative financial instruments for speculative or trading purposes.

Interest rate sensitivity

A portion of our investment portfolio is composed of income securities. These securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10 percent from levels at December 28, 2002, the fair value of the portfolio, based on quoted market prices, would decline by an immaterial amount. We have the ability to generally hold our fixed income investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. If necessary, we may sell short-term investments prior maturity to meet our liquidity needs.

At December 28, 2002, the fair value of the trading debt securities was $189.2 million, $77.4 million of which is classified as cash and equivalents and $111.8 million is classified as short-term investments on our consolidated balance sheet at December 28, 2002.

At December 28, 2002, we had fixed rate long-term debt of approximately $47.4 million, and a hypothetical 10% decrease in interest rates would not have a material impact on the fair market value of this debt, based on pricing models using current interest rates. We do not hedge any interest rate exposures.

Foreign currency exchange risk

We maintain operations in various countries outside of the United States and foreign subsidiaries that manufacture and sell our products in various global markets. As a result, our earnings and cash flows are exposed to fluctuations in foreign currency exchange rates. We attempt to limit these exposures through operational strategies and financial market instruments. We utilize hedging instruments, primarily forward contracts with maturities of twelve months or less, to manage our exposure associated with anticipated cash flows and net asset and liability positions denominated in non-functional currencies. Gains and losses on the forward contracts are mitigated by gains and losses on the underlying exposures. We do not use derivative financial instruments for trading purposes.

Looking forward, we do not anticipate any material adverse effect on our consolidated financial position, results of operations or cash flows resulting from the use of these instruments. There can be no assurance that these strategies will be effective or that transaction losses can be minimized or forecasted accurately.

Excluding Lambda Physik (discussed separately below), a hypothetical 10 percent appreciation of the forward adjusted US dollar to December 28, 2002 market rates would decrease the unrealized value of our forward contracts by $0.7 million. Conversely, a hypothetical 10 percent depreciation of the forward adjusted US dollar to December 28, 2002 market rates would increase the unrealized value of our forward contracts by $0.9 million.

The following table provides information about our foreign exchange forward contracts at December 28, 2002. The table presents the value of the contracts in US dollars at the contract exchange rate as of the contract maturity date, the weighted average contractual foreign currency exchange rates and fair value. The U.S. notional fair value represents the contracted amount valued at December 28, 2002 rates.

Forward contracts to sell (buy) foreign currencies for U.S. dollars (in thousands, except contract rates):

	Average Contract Rate	US Notional Contract Value			US Notional Fair Value
Fair Value Hedges:

Euro	0.9869	$	8,586		$	8,892
British Pound Sterling	1.5776	1,814			1,837
Japanese Yen	123.0511	(2,438		)	(2,497		)

At Lambda Physik, a hypothetical 10 percent appreciation of the EURO to December 28, 2002 market rates would decrease the unrealized value of our forward contracts by 0.1 million EURO. Conversely, a hypothetical 10 percent depreciation of the EURO to December 28, 2002 market rates would increase the unrealized value of our forward contracts by 0.2 million EURO.

The following table provides information about Lambda Physik’s foreign exchange forward contracts at December 28, 2002. The table presents the value of the contracts in EURO at the contract exchange rate as of the contract maturity date, the weighted average contractual foreign currency exchange rates and fair value. The EURO notional fair value represents the contracted amount valued at December 28, 2002 rates.

Forward contracts to sell foreign currencies for EURO (in thousands, except contract rates):

	Average Contract Rate	EURO Notional Contract Value	EURO Notional Fair Value
Fair Value Hedges:

Japanese Yen	0.0080	1,107	1,123
U.S. Dollar	0.9569	478	487

In addition to forward contracts, we have a variable interest loan to hedge our firm commitment to one EURO customer through June 2004. As December 28, 2002 the fair value of the loan is $564,000 at 3.75%. A hypothetical 10% fluctuation in interest rates and currency exchange rates would not have a material impact on the financial statements.

EQUITY SECURITY PRICE RISK

We have investments in publicly-traded equity securities, primarily our investment in Lumenis. As we account for these securities as available-for-sale, unrealized gains and losses resulting from changes in the fair value of these securities are reflected in stockholders’ equity, and not reflected in earnings until the securities are sold or a decline in value is determined to be other-than-temporary. The market value of our Lumenis shares declined to $20.2 million as of June 29, 2002 from its initial valuation of $124.4 million in April 2001 and its value of $109.1 million at September 29, 2001. During the quarter ended June 29, 2002, we determined that the decline in the market value of our investment in Lumenis as of June 29, 2002 was other-than-temporary and, as a result, we recognized a pretax loss of $104.2 million to reflect this other-than-temporary decline in market value. At December 28, 2002, the market value of our investment in Lumenis was $9.9 million. During the quarter ended December 29, 2002, we determined that decline from the market value of $20.2 million at June 29, 2002 to $9.9 million at December 28, 2002 was other-than-temporary and, as a result, we recognized a pretax loss of $10.2 million to reflect this other-than-temporary decline in market value. We will continue to evaluate the Lumenis investment to determine whether there are additional other-than-temporary impairments. Temporary decreases or increases in the value of the Lumenis investment, if any, will be recorded in accumulated other comprehensive income (loss). In addition, in future periods, we may recognize a gain or loss if we sell our Lumenis shares at a price other than our carrying value. A 20% adverse change in equity prices would result in an approximate $2.0 million decrease in the fair value of our available-for-sale equity investments as of December 28, 2002. The Lumenis common stock is unregistered and its trading is subject to restrictions under Securities and Exchange Commission Rule 144 and other restrictions as defined in the definitive agreement. Currently, we do not hedge our investment in Lumenis stock. Due to the nature and terms of this security, we may continue to experience a material change in the value of our investment related to future price fluctuations of the security.

Item 4. CONTROLS AND PROCEDURES

a. Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer along with the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company’s Chief Executive Officer along with the Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

b. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.

PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings
	N/A

ITEM 2.	Changes in Securities and Use of Proceeds
	N/A

ITEM 3.	Defaults Upon Senior Securities
	N/A

ITEM 4.	Submission of Matters to a Vote of Security Holders
	N/A

ITEM 5.	Other Information
	N/A

ITEM 6.	Exhibits and Reports on Form 8-K

	(a)	Exhibits

		99.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		99.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	(b)	Reports on Form 8-K
			The Company filed a report on Form 8-K on January 15, 2003 relating to the termination of activities of its Telecom-Actives Group.

COHERENT, INC.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Coherent, Inc.
	(Registrant)


February 11, 2003	/s/:	JOHN R. AMBROSEO
		John R. Ambroseo
		President and Chief Executive Officer (Principal Executive Officer)


February 11, 2003	/s/:	HELENE SIMONET
		Helene Simonet
		Executive Vice President and Chief Financial Officer (Principal Accounting Officer)

Form of Sarbanes-Oxley Section 302(a) Certification

I, John R. Ambroseo, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Coherent, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. Coherent Inc.’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Coherent, Inc. and we have:

a. designed such disclosure controls and procedures to ensure that material information relating to Coherent, Inc., including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b. evaluated the effectiveness of Coherent, Inc.’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluations as of the Evaluation Date;

5. Coherent, Inc.’s other certifying officer and I have disclosed, based on our most recent evaluation, to Coherent, Inc.’s auditors and the audit committee of Coherent Inc.’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for Coherent Inc.’s auditors any material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in Coherent Inc.’s internal controls; and

6. Coherent, Inc.’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 11, 2003


	By/s/:	JOHN R. AMBROSEO
		John R. Ambroseo President and Chief Executive Officer

Form of Sarbanes-Oxley Section 302(a) Certification

I, Helene Simonet, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Coherent, Inc.;

b. evaluated the effectiveness of Coherent, Inc.’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluations as of the Evaluation Date;

d. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for Coherent Inc.’s auditors any material weaknesses in internal controls; and

e. any fraud, whether or not material, that involves management or other employees who have a significant role in Coherent Inc.’s internal controls; and

Date: February 11, 2003


	By/s/:	HELENE SIMONET
		Helene Simonet Executive Vice President and Chief Financial Officer