Prepared by MERRILL CORPORATION

10-Q 1 a2049083z10-q.htm 10-Q Prepared by MERRILL CORPORATION
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2001

/ /	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.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

94-1622541
(I.R.S. Employer Identification No.)

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

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

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

The number of shares outstanding of registrant's common stock, par value $.01 per share, at May 2, 2001 was 27,671,864 shares.

COHERENT, INC.

INDEX

		Page No.
Part I.	Financial Information
Item I.	Financial Statements
	Condensed Consolidated Statements of Income—Three months and six months ended March 31, 2001 and April 1, 2000	3
	Condensed Consolidated Balance Sheets—March 31, 2001 and September 30, 2000	4
	Condensed Consolidated Statements of Cash Flows—Three months and six months ended March 31, 2001 and April 1, 2000	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Part II.	Other Information
Item I.	Legal Proceedings	31
Item 2.	Changes in Securities and Use of Proceeds	31
Item 3.	Defaults Upon Senior Securities	31
Item 4.	Submission of Matters to a Vote of Security Holders	31
Item 5.	Other Information	31
Item 6.	Exhibits and Reports on Form 8-K	31
Signatures		33

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited; in thousands, except per share data)

			Three Months Ended						Six Months Ended
			March 31, 2001			April 1, 2000			March 31, 2001			April 1, 2000
Net Sales			$	129,788		$	91,671		$	241,601		$	176,082
Cost of Sales				71,838			49,083			132,237			95,009

Gross Profit				57,950			42,588			109,364			81,073

Operating Expenses:
	Research and development			13,257			10,088			24,412			18,475
	Selling, general and administrative			27,540			22,634			53,192			42,867
	Intangibles amortization			784			723			1,552			1,405

Total Operating Expenses				41,581			33,445			79,156			62,747

Income from Operations				16,369			9,143			30,208			18,326
Other Income (Expense):
	Interest and dividend income			3,340			1,080			7,560			2,563
	Interest expense			(1,262	)		(1,479	)		(2,589	)		(3,117	)
	Foreign exchange gain (loss)			(47	)		165			(314	)		(355	)
	Other - net			1,089			811			1,528			289

Total Other Income (Expense), Net				3,120			577			6,185			(620	)

Income from Continuing Operations
	Before Income Taxes and Minority Interest			19,489			9,720			36,393			17,706
Provision for Income Taxes				6,556			3,116			12,296			5,556

Income from Continuing Operations Before
	Minority Interest			12,933			6,604			24,097			12,150
Minority Interest in Subsidiaries Earnings				(1,605	)		(333	)		(3,017	)		(970	)

Income from Continuing Operations				11,328			6,271			21,080			11,180
Discontinued Operations (Note 2):
	Income from Discontinued Operations of
		Medical Segment (Net of income taxes of $1,522, $1,366, $3,031 and $2,212)		3,384			2,132			5,697			3,896

Income Before Accounting Change				14,712			8,403			26,777			15,076
Cumulative Effect of Accounting Change
	(Net of income taxes of $94)									166

Net Income			$	14,712		$	8,403		$	26,943		$	15,076

Net Income Per Basic Share:
	Income from continuing operations		$	0.41		$	0.25		$	0.77		$	0.45
	Income from discontinued operations, net of income taxes			0.13			0.09			0.21			0.16
	Cumulative effect of accounting change									0.01

	Net Income		$	0.54		$	0.34		$	0.99		$	0.61

Net Income Per Diluted Share:
	Income from continuing operations		$	0.39		$	0.23		$	0.73		$	0.42
	Income from discontinued operations, net of income taxes			0.12			0.08			0.20			0.15
	Cumulative effect of accounting change									0.01

	Net Income		$	0.51		$	0.31		$	0.94		$	0.57

Shares Used in Computation:
	Basic			27,397			24,892			27,313			24,705
	Diluted			28,736			27,412			28,636			26,594

See Accompanying Notes to Condensed Consolidated Financial Statements

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited; in thousands, except par value)

			March 31, 2001			September 30, 2000
Assets
Current Assets:
	Cash and equivalents		$	84,458		$	156,521
	Short-term investments			118,511			99,681
	Accounts receivable—net of allowances of $2,848 in 2001 and $3,553 in 2000			86,576			73,525
	Inventories			100,652			84,793
	Net current assets of discontinued operations			70,882			66,594
	Prepaid expenses and other assets			14,055			21,019
	Deferred tax assets			20,984			18,996

Total Current Assets				496,118			521,129

Property and Equipment				213,359			163,138
Accumulated Depreciation and Amortization				(75,145	)		(66,687	)

	Property and equipment—net			138,214			96,451

Goodwill—net of accumulated amortization of $13,044 in 2001 and $11,821 in 2000				16,269			12,908
Net Non-Current Assets of Discontinued Operations				49,354			51,773
Other Assets				70,897			27,418

			$	770,852		$	709,679

Liabilities and Stockholders' Equity
Current Liabilities:
	Short-term borrowings		$	21,699		$	4,211
	Current portion of long-term obligations			7,685			7,687
	Accounts payable			27,887			23,013
	Income taxes payable			695			5,415
	Other current liabilities			74,875			57,939

Total Current Liabilities				132,841			98,265

Long-Term Obligations				67,327			68,647
Other Long-Term Liabilities				23,516			32,143
Minority Interest in Subsidiaries				51,857			48,855
Stockholders' Equity:
	Common stock, par value $.01:
		Authorized—50,000 shares
		Outstanding 27,505 (2001) and 27,102 shares (2000)		273			270
	Additional paid-in capital			236,502			227,973
	Notes receivable from stock sales			(1,189	)		(1,392	)
	Accumulated other comprehensive loss			(7,893	)		(5,757	)
	Retained earnings			267,618			240,675

Total Stockholders' Equity				495,311			461,769

			$	770,852		$	709,679

See Accompanying Notes to Condensed Consolidated Financial Statements.

COHERENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; in thousands)

			Six Months Ended
			March 31, 2001			April 1, 2000
Cash Flows from Continuing Operating Activities:
	Income from continuing operations after accounting change		$	21,246		$	11,180
	Adjustments to reconcile income from continuing operations to net cash provided by continuing operating activities:
		Purchases of short-term trading investments		(123,480	)		(115,032	)
		Proceeds from sales of short-term trading investments		113,843			96,850
		Cumulative effect of accounting change		(166	)
		Changes in operating assets and liabilities		(13,488	)		(15,848	)
		Depreciation and amortization		8,731			6,506
		Intangibles amortization		1,552			1,405
		Other adjustments		4,991			2,060

Net Cash Provided by (Used for) Continuing Operating Activities				13,229			(12,879	)

Cash Flows from Investing Activities:
	Purchases of property and equipment, net			(49,122	)		(9,364	)
	Purchases of available-for-sale securities			(34,562	)
	Proceeds from sales of available-for-sale securities			487
	Acquisition of businesses, net of cash acquired			(27,052	)		(3,109	)
	Other—net			1,356			(5,422	)

Net Cash Used for Investing Activities				(108,893	)		(17,895	)

Cash Flows from Financing Activities:
	Long-term debt borrowings			25			2,926
	Long-term debt repayments			(1,042	)		(1,579	)
	Short-term borrowings			24,444			21,208
	Short-term repayments			(7,721	)		(11,388	)
	Cash overdrafts			(4,737	)		2,653
	Collection of notes receivable from stock sales			433			344
	Sales of shares under employee stock plans			6,259			10,975

Net Cash Provided by Financing Activities				17,661			25,139

Net Cash Provided by (Used for) Discontinued Operations				3,828			(7,705	)
Effect of Exchange Rate Changes On Cash and Equivalents				2,112			2,874

	Net decrease in cash and equivalents			(72,063	)		(10,466	)
	Cash and equivalents, beginning of period			156,521			37,478

Cash and Equivalents, End of Period			$	84,458		$	27,012

Noncash Investing and Financing Activities:
	Issuance of notes related to sale of common stock		$	230		$	736

See Accompanying Notes to Condensed Consolidated Financial Statements.

COHERENT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.: 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 30, 2000. All adjustments necessary for a fair presentation have been made which comprise only of 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 with the current period presentation. Such reclassification had no impact on net income or retained earnings for any period presented.

On February 25, 2001, we entered into a definitive agreement to sell our Medical segment to 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 ESC common stock. We have estimated the total value of this consideration as $236.0 million. The agreement provides for an adjustment to the notes received if the actual net assets sold are more or less than a predetermined amount. 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. We expect to record a resulting after-tax gain of approximately $60.0 to $80.0 million in the third quarter of fiscal 2001.

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 Occuring Events and Transactions." Accordingly, results of these operations have been classified as discontinued and prior periods have been restated.

Income from discontinued operations during the three months ended March 31, 2001 includes approximately $7.2 million, net of tax, for operating income during the phase-out period.

Income from discontinued operations consisted of the following (in thousands):

	Three Months Ended				Six Months Ended
	March 31, 2001		April 1, 2000		March 31, 2001		April 1, 2000
	(In thousands)
Net Sales	$	54,006	$	50,842	$	101,911	$	97,922
Income from Operations		4,940		3,306		8,591		5,835
Income before Income Taxes		4,906		3,498		8,728		6,108
Provision for Income Taxes		1,522		1,366		3,031		2,212
Income from Discontinued Operations	$	3,384	$	2,132	$	5,697	$	3,896

Net current assets and net non-current assets of discontinued operations consisted of the following (in thousands):

		March 31, 2001			September 30, 2000
Net current assets (liabilities):
	Cash	$	1,696		$	1,967
	Accounts receivable		42,823			38,876
	Net inventories		45,244			41,823
	Deferred income taxes		18,864			19,890
	Other current assets		1,913			1,971
	Accounts payable		(7,778	)		(6,269	)
	Other current liabilities		(31,880	)		(31,664	)

		$	70,882		$	66,594

Net non-current assets (liabilities):
	Property and equipment	$	5,340		$	6,139
	Goodwill		24,736			25,885
	Other intangibles		13,086			15,137
	Other non-current assets		8,559			7,083
	Deferred income and other liabilities		(2,367	)		(2,471	)

		$	49,354		$	51,773

Net current assets of discontinued operations include $1.7 million and $2.0 million of cash at March 31, 2001 and April 1, 2000, respectively, that will not be sold to ESC Medical Systems Ltd.

3.: Effective October 1, 2000, we adopted Statement of Financial Accounting Standards No.133, "Accounting for Derivative Instruments and Hedging Activities," (SFAS 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 earnings.

The transition adjustment to implement this new standard on October 1, 2000, which is presented as a cumulative effect of change in accounting principle, increased earnings by $166,000 (net of income taxes of $94,000) and decreased OCI by $275,000 (net of income taxes of $150,000). The net derivative losses included in OCI as of October 1, 2000 were comprised of hedges on backlog which will be reclassified into earnings during the twelve months ended September 29, 2000 and a hedge related to a building purchase option which will be amortized into earnings through December 2020.

We are exposed to foreign currency exchange rate risk inherent in forecasted sales and assets and liabilities denominated in currencies other than the US dollar. We are also exposed to market risk inherent in our securities investments. Our objectives of holding derivatives are to minimize the

risks of currency and market 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. Options and 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 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 133, only the intrinsic value of the option based on spot rates is used in assessing hedge effectiveness. The time value of the option is excluded in calculating effectiveness and reported in earnings immediately. This amount was not significant for the six months and quarter ended March 31, 2001.

The net gain on derivative instruments of $358,000 as of March 31, 2001 included in other comprehensive income will be reclassified into earnings within the next twelve months for backlog hedges and 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 the 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 March 31, 2001, the loan balance of $515,000 did not exceed the firm commitment. The effect on earnings is recorded to other income (expense) and was not significant for the six months and quarter ended March 31, 2001.

Options and forwards not designated as hedging instruments under SFAS 133 are also used to hedge the market risks relating to marketable equity securities classified as available-for-sale and 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).

4.: In December 1999, the staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101). SAB 101, as amended, summarizes certain of the SEC's views in applying GAAP to revenue recognition in financial statements. We are required to adopt SAB 101 in the fourth quarter of fiscal 2001. Although we believe our revenue recognition policies are in accordance with GAAP, we are currently studying SAB 101 and have not determined its impact, if any, on our financial statements.
5.: In November 2000, we acquired Crystal Associates, Inc. of East Hanover, New Jersey for approximately $7.1 million in cash. Crystal Associates manufactures exotic crystals, which are utilized in a wide variety of photonics applications. The acquisition was accounted for as a purchase, and, accordingly, we recorded the $5.9 million excess of the purchase price over the fair value of net assets acquired as goodwill and other intangibles, which are primarily amortized over 10 years.

6.: The components of comprehensive income, net of tax, are as follows:

	Three Months Ended						Six Months Ended
	March 31, 2001			April 1, 2000			March 31, 2000			April 1, 2000
	(In thousands)
Net income	$	14,712		$	8,403		$	26,943		$	15,076
Cumulative effect of accounting change (See Note 3)								(275	)
Translation adjustment		(4,881	)		(742	)		(1,340	)		(1,968	)
Net gain (loss) on derivative instruments		(453	)					633
Changes in unrealized loss on investment		(1,073	)					(1,154	)

Total comprehensive income	$	8,305		$	7,661		$	24,807		$	13,108

The following summarizes activity in accumulated comprehensive income related to derivatives, net of tax, held by the Company (in thousands):

Balance, September 30, 2000	$	—
Cumulative effect of adopting SFAS 133		(275	)
Changes in fair value of derivatives		1,163
Net gains reclassified from OCI		(77	)

Balance, December 30, 2000		811
Changes in fair value of derivatives		(5	)
Net gains reclassified from OCI		(448	)

Balance, March 31, 2001	$	358

Accumulated other comprehensive loss (net of tax) at March 31, 2001 is comprised of accumulated translation adjustments of ($7,155,000), net gain on derivative instruments of $358,000 and unrealized loss on investments of ($1,096,000), respectively. Accumulated other comprehensive loss at September 30, 2000 is comprised of accumulated translation adjustments of ($5,815,000) and unrealized gain on investments of $58,000.

Net income per basic share is computed based on the weighted average number of shares outstanding during the period. Net income per diluted 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 net income per basic and diluted share:

		Three Months Ended		Six Months Ended
		March 31, 2001	April 1, 2000	March 31, 2001	April 1, 2000
		(In thousands)
Weighted average shares outstanding—Basic		27,397	24,892	27,313	24,705
	Common stock equivalents	1,312	2,277	1,301	1,702
	Employee stock purchase plan equivalents	27	243	22	187

Weighted average shares and equivalents—Diluted		28,736	27,412	28,636	26,594

A total of 1,231,000 and 5,000 anti-dilutive weighted shares have been excluded from the dilutive share equivalents calculation for the three months ended March 31, 2001 and April 1, 2000, respectively. A total of 1,266,000 and 316,000 anti-dilutive weighted shares have been excluded from the dilutive share equivalents calculation for the six months ended March 31, 2001 and April 1, 2000, respectively.

8.: Balance Sheet Details:

Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories are as follows:

	March 31, 2001		September 30, 2000
	(In thousands)
Purchased parts and assemblies	$	39,765	$	27,483
Work-in-process		42,897		37,024
Finished goods		17,990		20,286

Net inventories	$	100,652	$	84,793

Prepaid expenses and other assets consist of the following:

	March 31, 2001		September 30, 2000
	(In thousands)
Prepaid income taxes	$	796	$	10,777
Prepaid expenses and other		13,259		10,242

Prepaid expenses and other assets	$	14,055	$	21,019

Other assets consist of the following:

	March 31, 2001		September 30, 2000
	(In thousands)
Available-for-sale securities	$	23,171
Other assets		22,825	$	22,136
Advance payment of acquisition purchase price (See note 11)		19,902
Intangible assets		3,857		4,104
Assets held for investment		1,142		1,178

Other assets	$	70,897	$	27,418

Other current liabilities consist of the following:

	March 31, 2001		September 30, 2000
	(In thousands)
Accrued expenses and other	$	27,556	$	18,173
Accrued payroll and benefits		24,975		22,511
Reserve for warranty		11,157		9,590
Customer deposits		7,338		3,439
Deferred income		3,849		4,226

Other current liabilities	$	74,875	$	57,939

Other long-term liabilities consist of the following:

	March 31, 2001		September 30, 2000
	(In thousands)
Deferred compensation	$	18,498	$	16,940
Deferred income and other		2,212		2,217
Environmental remediation costs		917		917
Deferred tax liabilities		1,889		12,069

Other long-term liabilities	$	23,516	$	32,143

9.: 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 March 31, 2001 for remaining costs associated with the above environmental matters is $0.8 million which has been previously accrued. This amount consists of total estimated probable costs of $1.0 million ($0.1 million included in other current liabilities and $0.9 million included in other long-term liabilities) reduced by estimated minimum probable recoveries of $0.2 million included in other assets from other parties named to the order.

10.: We are organized around three separately managed business units: the Photonics Group, the Telecom-Actives Group and Lambda Physik. Consistent with the rules of SFAS No. 131, we have aggregated these three business units into two reportable segments. The Telecom-Actives Group was combined 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 optical telecommunications, micromachining, material processing, scientific research, graphic arts and advanced packaging. The Lambda Physik segment focuses on lithography, with other target markets including lasers for the production of flat panel displays, inkjet printers and fiber bragg gratings, refractive surgery, scientific research, materials processing and micromachining applications.

Our corporate expenses, except for administrative costs previously allocated to our discontinued Medical segment, depreciation of corporate assets, and general legal expenses, are allocated to the operating segments and are included in Corporate and other in the reconciliation of operating results. Furthermore, interest expense and interest income are included in Corporate and other in

the reconciliation of operating results. Information on reportable segments is as follows (in thousands):

		Three Months Ended						Six Months Ended
		March 31, 2001			April 1, 2000			March 31, 2001		April 1, 2000
Net Sales:
	Electro-Optics	$	95,349		$	70,895		$	178,291	$	134,429
	Lambda Physik		34,439			20,776			63,310		41,653

	Total Net Sales	$	129,788		$	91,671		$	241,601	$	176,082

Intersegment Net Sales:
	Electro-Optics	$	320		$	1,806		$	466	$	3,814
	Lambda Physik		47			283			340		590

	Total Intersegment Sales	$	367		$	2,089		$	806	$	4,404

Pretax Income (Loss) from Continuing Operations Including Tax-effected Minority Interest:
	Electro-Optics	$	14,008		$	9,145		$	25,245	$	15,004
	Lambda Physik		5,118			1,222			8,027		4,249
	Corporate and other		(1,242	)		(980	)		104		(2,517	)

	Total Pretax Income (Loss) from Continuing Operations Including Tax-effected Minority Interest	$	17,884		$	9,387		$	33,376	$	16,736

11.: In April 2001, we acquired DeMaria ElectroOptics Systems, Inc. (DEOS) for approximately $22.5 million in cash. DEOS, located in Bloomfield, Connecticut, designs and manufactures carbon dioxide lasers used in electronics packaging, material processing and research applications. The acquisition will be accounted for as a purchase.

In April 2001, our Lambda Physik subsidiary acquired a 44% interest in the joint venture MicroLas Laser System GmbH (MicroLas) for approximately $24 million in cash, of which $19.9 million was advanced and recorded in other assets at March 31, 2001. Lambda Physik previously held 46% of MicroLas and will now be the majority owner with 90% ownership. MicroLas manufactures optical components such as lenses and beam guidance systems that are used in connection with Lambda Physik lasers in the production of the TFT flat-panel displays and inkjet printers. The acquisition will be accounted for as a purchase.

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

FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

This discussion contains forward-looking statements that relate to future events or Coherent's future performance such as statements set forth below in this Item 2 under the heading "Our Strategy" and statements relating to future international sales and the potential effects of foreign currency fluctuation on our financial condition. Actual results, events and performance may differ materially as a result of various factors, including those described in the Form 10-Q under the heading "Risk Factors" and elsewhere in this document. We also refer you to our Annual Report on Form 10-K for the fiscal year ended September 30, 2000 under the heading "Risk Factors" in Part I. Item 1. Business. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to release publicly the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

COMPANY OVERVIEW

During the quarter, we took the steps we considered necessary to strategically focus on those high growth markets, technologies and opportunities that are best complemented by our core competencies. On April 30, 2001, we completed the sale of our Medical segment to ESC Medical Systems Ltd. for a combination of cash, notes and ESC stock with an estimated value of $236.0 million plus a potential earnout of an additional $25 million. The sale will result in a one-time after-tax gain of approximately $60.0 million to $80.0 million to be reflected in our results for our third fiscal quarter ending June 30, 2001.

As a result, the operations of our Medical segment are presented as net assets of discontinued operations on our balance sheets and as income from discontinued operations on our condensed Consolidated Statements of Income and Cash Flows.

We are one of the world's leading suppliers of photonics-based solutions in a broad range of commercial, scientific and telecom markets. 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 a combination of internal expansion and strategic acquisitions of companies with related technologies and products.

We have two reportable business segments: Electro-Optics and Lambda Physik, which work with customers to provide cost-effective photonics-based solutions. In addition to the semiconductor and related manufacturing and optical telecommunications markets, the Electro-Optics segment focuses on markets such as materials processing, micromachining, scientific research, graphic arts and advanced packaging. Lambda Physik focuses on lithography, as well as other target markets including lasers for the production of flat panel displays, ink jet printers, fiber bragg gratings, refractive surgery, scientific research, 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 semiconductor inspection, measurement, test and repair, optical telecommunications, biotechnology, consumer electronics, industrial process control, materials processing, printing, and research and development. Examples include:

Semiconductor and related manufacturing—Lasers are increasingly being used in multiple steps in the semiconductor manufacturing process, including DUV lithography, a process that is used to print a master image of a circuit layer onto a semiconductor wafer. Lasers are also used in the inspection, test and measurement of semiconductors during the manufacturing process.

Optical telecommunications—Driven by the Internet and the surge of data-intensive applications, fiber optic networks constantly require greater bandwidth. Lasers and optical components enable this increased bandwidth by allowing multiple wavelengths to travel across the same fiber.

OUR STRATEGY

We strive to develop innovative and proprietary products and solutions that meet the needs of our customers 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 and optical telecommunications 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, and develop new, relationships 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.

We conduct a significant portion of our business internationally. International sales accounted for 59% of net sales for fiscal 2000 and were 57% and 56% of total sales for the current quarter and six months ended March 31, 2001, respectively. 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. 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. 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.

RESULTS OF OPERATIONS

CONSOLIDATED SUMMARY

Income from continuing operations before the cumulative effect of a change in accounting principle for the current quarter and six months ended March 31, 2001 was $11.35 million ($0.39 per diluted share) and $21.1 million ($0.73 per diluted share) compared to income from continuing operations of $6.3 million ($0.23 per diluted share) and $11.2 million ($0.42 per diluted share) in the corresponding prior year periods. The increase in income from continuing operations was primarily attributable to increases in sales volumes, lower selling, general and administrative expenses as a percentage of sales and higher interest income.

NET SALES

		Three Months Ended				Six Months Ended
		March 31, 2001		April 1, 2000		March 31, 2001		April 1, 2000
				(in thousands)
Net Sales
Consolidated
	Domestic	$	55,937	$	35,596	$	106,968	$	71,696
	International		73,851		56,075		134,633		104,386

	Total	$	129,788	$	91,671	$	241,601	$	176,082

Electro-Optics:
	Domestic	$	44,011	$	31,607	$	84,893	$	61,283
	International		51,338		39,288		93,398		73,146

	Total	$	95,349	$	70,895	$	178,291	$	134,429

Lambda Physik:
	Domestic	$	11,926	$	3,989	$	22,075	$	10,413
	International		22,513		16,787		41,235		31,240

	Total	$	34,439	$	20,776	$	63,310	$	41,653

Consolidated

Net sales for the current fiscal quarter and six months ended March 31, 2001 increased $38.1 million (42%) and $65.5 million (37%), respectively, from the same periods a year ago. Sales increases were strong in both the Electro-Optics and Lambda segments. During the current quarter, international sales increased $17.8 million (32%) but decreased to 57% of net sales, while domestic sales increased $20.3 million (57%). Year to date, international sales increased $30.2 million (29%) but decreased to 56% of net sales, while domestic sales increased $35.3 million (49%).

Electro-Optics

Electro-Optics net sales increased $24.5 million (34%) and $43.9 million (33%) for the second quarter and six months ended March 31, 2001, respectively, compared to the corresponding prior year periods. Domestic sales increased $12.4 million (39%) while international sales increased $12.1 million (31%) during the current quarter. Year to date, domestic sales increased $23.6 million (39%) while international sales increased $20.3 million (28%). Net sales increased primarily due to higher sales volumes in commercial solid state products, such as sales of semiconductor lasers to the non-metal

printed circuit board, or PCB, hole drilling, optical telecommunications and bio-instrumentation markets. Optical telecommunications sales increased $7.7 million (494%) and $12.8 million (470%) for the current quarter and six months ended March 31, 2001 compared to amounts in the corresponding prior year periods.

Lambda Physik

Lambda Physik net sales increased $13.7 million (66%) and $21.7 million (52%) for the second quarter and six months ended March 31, 2001, respectively, compared to the corresponding prior year periods. Domestic sales increased $8.0 million (199%) while international sales increased $5.7 million (34%) during the current quarter. Year to date, domestic sales increased $11.7 million (112%) while international sales increased $10.0 million (32%). Sales increased primarily due to increased shipments of commercial products, especially lasers used in lithography and in the manufacture of flat panel display systems and production of ink jet systems.

GROSS PROFIT

Consolidated

The consolidated gross profit rate decreased to 44.6% from 46.5% in the current quarter compared to the same quarter one year ago and decreased to 45.3% from 46.0% for the six months ended March 31, 2001, compared to the same period one year ago. The decrease was primarily due to lower margins on Lambda's lithography systems, the strengthening of the US dollar, increased sales of lower margin commercial solid-state products as well as higher inventory provisions in the Electro-Optics segment.

Electro-Optics

The gross profit rate decreased to 46.5% from 48.0% in the current quarter compared to the same quarter one year ago, but increased slightly to 46.7% from 46.3% for the six months ended March 31, 2001, compared to the same period one year ago. The current quarter decrease was primarily due to the strengthening of the US dollar, increased sales of lower margin commercial solid-state products and higher inventory provisions.

Lambda Physik

The gross profit rate decreased to 40.1% from 41.0% in the current quarter compared to the same quarter one year ago and decreased to 41.5% from 44.9% for the six months ended March 31, 2001, compared to the same period one year ago. The decrease was primarily due to lower margins on Lambda's lithography systems and the strengthening of the US dollar.

OPERATING EXPENSES

	Three Months Ended				Six Months Ended
	March 31, 2001		April 1, 2000		March 31, 2001		April 1, 2000
			(in thousands)
Research & development	$	13,257	$	10,088	$	24,412	$	18,475
Selling, general & administrative		27,540		22,634		53,192		42,867
Intangibles amortization		784		723		1,552		1,405

Total operating expenses	$	41,581	$	33,445	$	79,156	$	62,747

Total operating expenses increased $8.1 million (24%) during the second quarter compared to the same period last year, but as a percentage of sales decreased to 32.0% from 36.5%. Year to date, total operating expenses increased $16.4 million (26%), but as a percentage of sales decreased to 32.8% from 35.6%.

Research and development (R&D) expenses increased $3.2 million (31%) during the second quarter compared to the same period last year, but as a percentage of sales decreased to 10.2% from 11.0%. Year to date, R&D expenses increased $5.9 million (32%), but as a percentage of sales decreased to 10.1% from 10.5%. The absolute dollar increase was primarily due to increased spending in lithography, optical telecommunications and other projects and an increased number of employees.

Selling, general and administrative (SG&A) expenses increased $4.9 million (22%) during the second quarter compared to the same period last year, but as a percentage of sales decreased to 21.2% from 24.7%. Year to date, SG&A expenses increased $10.3 million (24%), but as a percentage of sales decreased to 22.0% from 24.3%. The absolute dollar increase was primarily due to higher commissions as a result of higher sales, increased investments in information technology, higher costs for the Lambda segment to comply with legal and stock exchange requirements and higher payroll related expenses.

Intangibles amortization increased $0.1 million in both the current quarter and year to date periods compared to the same periods last year. The increase was primarily due to the acquisitions of Lasertec in May 2000 and Crystal Associates in November 2000, partially offset by lower amortization of intangibles previously written off as impaired.

OTHER INCOME (EXPENSE)

Other income, net increased $2.5 million to net other income of $3.1 million from net other income of $0.6 million during the current quarter and increased $6.8 million to net other income of $6.2 million from net other expense of $0.6 million for the six months ended March 31, 2001 compared to the corresponding prior year periods. The increases were primarily due to increased interest income, dividends and gains on increased investments as a result of both our public offering and our subsidiary Lambda Physik's initial public offering.

INCOME TAXES

Our effective tax rate on income from continuing operations (before minority interest) for the current quarter was 33.6% compared to 32.1% for the same quarter last year. Our effective tax rate on income from continuing operations (before minority interest) for the six months ended March 31, 2001 was 33.8% compared to 31.4% for the same prior year period. The effective tax rate increased as a result of higher profit before income taxes and changes in the distribution of taxable income among jurisdictions with varying rates offset by higher foreign tax credits.

MINORITY INTEREST IN SUBSIDIARIES

Minority interest in subsidiaries earnings increased $1.3 million and $2.0 million for the current quarter and six months ended March 31, 2001, respectively, compared to the corresponding prior year periods. The increase was primarily due to the increased profitability of our Lambda Physik subsidiary as well as the increase in the minority ownership percentage of this subsidiary in connection with its initial public offering.

CUMULATIVE EFFECT OF ACCOUNTING CHANGE

The year to date cumulative effect of accounting change of $0.2 million (net of income tax of $0.1 million) was recognized as a transition adjustment as of October 1, 2000 due to the implementation of SFAS No. 133, "Accounting for Derivative Investments and Hedging Activities".

FINANCIAL CONDITION

Liquidity and Capital Resources

At March 31, 2001 our primary sources of liquidity were cash, cash equivalents, short-term investments and available-for-sale securities of $203.0 million. Additional sources of liquidity were our multi-currency line of credit and bank credit facilities totaling $66.8 million as of March 31, 2001, of which $44.7 million was unused and available. In addition, we owned $25.3 million of marketable equity and debt securities classified as non-current as we do not intend to sell these securities within the next 12 months.

During the first quarter of fiscal 1997, we signed a lease for 216,000 square feet of office, research and development and manufacturing space in Santa Clara, California, which we are subleasing to our former Medical segment, doing business as Lumenis. The lease expires in December 2001. We have an option to purchase the property for $24.0 million, or at the end of the lease arrange for the sale of the property to a third party while retaining an obligation to the owner for the difference between the sale price, if less than $20.8 million, and $20.8 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 approximately $20.8 million. We occupied the building in July 1998 and commenced lease payments at that time. The lease requires that we maintain specified financial covenants. At March 31, 2001, we were in compliance with these convenants.

During the first quarter of fiscal 2001, we signed a lease for 40,000 square feet of office, research and development and manufacturing space for our Telecom-Actives Group in San Jose, California. The lease commenced February 1, 2001 and expires in February 2007 and has annual lease payments of approximately $1.8 million.

We have committed approximately $39 million to build an additional building at our Electro-Optics facility in Auburn, California to enable us to expand our manufacturing capacity for optical telecommunications products and to provide coating equipment at this facility. We have committed to spend approximately $18.2 million for improvements to buildings purchased in Lincoln, California, near our existing Auburn Electro-Optics facilities. We have committed approximately $10 million at our Electro-Optics facility in Tampere, Finland to set-up a separate facility for the growth and development of telecommunications products.

Changes in Financial Condition

Cash and cash equivalents (excluding cash held by our discontinued operations), at March 31, 2001, decreased $72.1 million (46%) from September 30, 2000. Operations and changes in exchange rates provided $15.3 million, including $9.6 million, net, used to purchase short-term investments. Investing activities used $108.9 million, including $49.1 million used to acquire property and equipment, net, $27.1 million used to acquire businesses and $34.1 million, net, to purchase available-for-sale securities. Financing activities provided $17.7 million with $6.3 million from the sale of shares under employee stock plans and net debt borrowings of $11.4 million. Net cash provided by discontinued operations was $3.8 million.

Short-term borrowings increased $17.5 million, or 415%, from September 30, 2000 to March 31, 2001 primarily due to increased outside borrowings by Lambda Physik for payment of amounts due to Coherent, Inc.

RISK FACTORS

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:

•: 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;
•: timing of regulatory approvals and changes in domestic and regulatory environments;
•: level of capital spending of our customers;
•: economic conditions, especially in the Asia-Pacific market;
•: 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. As a result of all these factors, our operating results in one or more future periods may fail to meet the expectations of market analysts or investors. In that event, the trading price of our common stock would likely decline.

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.

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 make 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. Once identified, we would experience further delays from 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, 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 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 and other photonic solutions. We cannot assure you that we will be able to successfully identify 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, medical and scientific 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.

Over the last three fiscal years, our research and development expenses have been in the range of 10% to 11% 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 have very little experience in providing optical components to the optical telecommunications market segment; we do not currently have the ability to package active components; and, even if successful in developing this packaging, we still may not meet the stringent Telcordia specifications, any of which could limit our ability to succeed in this market.

We have only recently begun to develop products for the optical telecommunications market. Sales to that market accounted for only $15.6 million, or 6%, of net sales during the first six months of fiscal 2001 and accounted for $11.3 million, or 3%, of net sales during fiscal 2000. Our lack of prior experience in this market could put us at a competitive disadvantage. In addition, we have not yet developed qualified packaging for our active components. Even as we develop this packaging, we still may not meet the stringent Telcordia specifications. Telcordia specifications are worldwide industry telecommunications standards established by an industry consortium. Most potential telecommunications customers demand that we meet these specifications. We do not anticipate that we will have a Telcordia-qualified product before early fiscal 2002. Our failure to develop qualified packaging or to meet the Telcordia specifications would seriously harm our future sales of our active optical telecommunications products.

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

For the fiscal years ended October 2, 1999 and September 30, 2000 and the six months ended March 31, 2001, 59%, 59% and 56%, 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. 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 and resellers. 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 sales 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.

The laser industry is characterized by a very large number of patents, many of which are of questionable validity and some of which appear to overlap with other issued patents. As a result, there is a significant amount of uncertainty in the industry regarding patent protection and infringement. 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, which 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, 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 is 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.

While we currently do not intend to hire a significant number of additional employees during the next 12 months, 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. Competition for highly skilled personnel is intense, especially in the Silicon Valley, where one of our major operating facilities is located. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs. This is particularly challenging for a mature public company such as Coherent, as many employees are seeking jobs with pre-public and newly public companies. Our failure to attract additional employees and retain our existing employees could adversely affect our growth and our business.

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 laser markets in which we provide products is very intense. In the semiconductor and related manufacturing, materials processing, scientific research and printing markets, we compete against a number of companies, including SDL, Inc., Spectra-Physics Lasers, Inc., Cymer, Inc. and Gigaphoton. In the optical telecommunications market, we compete, or expect to compete, against JDS Uniphase Corporation, GSI Lumonics, Inc. and Spectra-Physics Lasers, Inc., among others. 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 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 expect to 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 or contaminated 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.

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.

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, financial and managerial controls, 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 or 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, amortization of goodwill and other intangible assets.

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.

RISKS RELATED TO OUR INDUSTRY

Our market is unpredictable and is 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.

We incurred expenditures for research and development of $24.4 million, or 10%, of net sales, during the first two quarters of fiscal 2001. For our fiscal years ended September 30, 2000, October 2, 1999 and September 26, 1998, our research and development costs were $40.7 million, or 11%, of net sales, $30.6 million, or 10%, of net sales, and $28.6 million or 10%, 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 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. If a downturn should occur in the semiconductor industry in the future, we believe this would result in decreased demand for semiconductor manufacturing equipment and consequently a decreased demand for our products. Although such a downturn would reduce our sales, we would not be able to reduce expenses commensurately, due in part to the need for continual development in research and development and the need to maintain extensive ongoing customer service and support capability. Accordingly, any downturn in the semiconductor industry could have a material adverse effect on our financial condition and results of operations.

A new accounting pronouncement may cause our operating results to fluctuate.

In December 1999, the staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," or SAB 101. SAB 101, as amended, summarizes certain of the SEC's views in applying generally accepted accounting principles, or GAAP, to revenue recognition in financial statements. We are required to adopt SAB 101 in the fourth quarter of fiscal 2001. Although we believe that our revenue recognition policies are in accordance with GAAP, we are currently studying SAB 101 and have not determined its impact, if any, on our financial statements.

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, a facility fire at the Tampere, Finland site, that spreads to a reactor used to grow semiconductor wafers, could release highly toxic emissions. Although we believe that our safety procedures for handling and disposing of such materials comply with all federal and state regulations and standards, 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 such as fire, flood, earthquake or power outgage. 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 and replace the facility. While we have obtained insurance to cover most potential losses at our facilities, we cannot assure you that our existing insurance coverage will be adequate against all possible losses. California has recently experienced issues with its power supply. As a result, we could experience unexpected interruptions in our power supply or significant price increases that could have material adverse effect on our sales, results of operations and financial condition.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 March 31, 2001, the fair value of the portfolio 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.

As of March 31, 2001, the fair value of the trading and available-for-sale debt securities were $158.8 million and $18.5 million, respectively.

At March 31, 2001, we had fixed rate long-term debt of approximately $70.8 million, and a hypothetical 10 percent decrease in interest rates would not have a material impact on the fair market value of this debt. 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 sell and manufacture 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 hedge instruments, primarily forward contracts with maturities of twelve months or less, to manage our exposure associated with firm intercompany and third-party transactions and net asset and liability positions denominated in non-functional currencies. 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, we had $28.5 million of short-term forward exchange contracts, denominated in major foreign currencies, which approximated the fair value of such contracts and their underlying transactions at March 31, 2001. Net gains related to these instruments at March 31, 2001 were $1.0 million.

The following table provides information about our foreign exchange forward contracts at March 31, 2001. The table presents the value of the contracts in U.S. dollars at the contract exchange rate as of the contract maturity date. Due to the short-term nature of these contracts, the fair value approximates the weighted average contractual foreign currency exchange rate value of the contracts at March 31, 2001.

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

	Average Contract Rate	U.S. Notional Amount		Fair Value
Euro	0.9071	$	17,545	$	17,134
British Pound Sterling	1.4678		6,825		6,688
Japanese Yen	105.4095		4,298		3,613
Swedish Krone	9.4375		932		851
Norwegian Kroner	8.7195		229		219

Lambda Physik had 38.6 million German Marks of short-term forward exchange contracts which approximated the fair value and underlying transactions at March 31, 2001. Net loss related to these instruments at March 31, 2001 were not material. The following table provides information about Lambda Physik's foreign exchange forward contracts as of March 31, 2001. The table presents the value of the contracts in German Marks at the contract exchange rate as of the contract maturity date. Due to the short-term nature of these contracts, the fair value approximates the weighted average contractual foreign currency exchange rate value of the contracts at March 31, 2001.

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

		Average Contract Rate		DEM Notional Amount		DEM Fair Value
Japanese Yen		0.0208		8,319		7,044
US Dollars		2.1531		30,801		31,588

EQUITY PRICE RISK

We have investments in publicly-traded equity securities. 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. As of March 31, 2001, the fair market value of these securities was $13.9 million and unrealized loss on these securities was $1.1 million (net of $0.6 million tax). A 10% decline in the market price of these investments would cause the fair value of the investments to decrease by an immaterial amount. We utilize collars to manage our exposure associated with available-for-sale securitites.

COHERENT, INC.
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

On March 23, 2001, the Annual Meeting of Shareholders of Coherent, Inc. was held in Santa Clara, California.

The following individuals were elected to the Board of Directors of Coherent, Inc.:

Bernard J. Couillaud		Henry E. Gauthier
Charles W. Cantoni		Frank P. Carrubba
John H. Hart		Jerry E. Robertson

Other matters voted upon at the meeting and the number of affirmative and negative votes cast with respect to each such matter were as follows:

		Affirmative Votes	Negative Votes
1.	Proposal to approve an amendment of the Company's Certificate of Incorporation to increase the number of authorized shares of common stock, $0.01 per value, by 450,000,000 shares, from 50,000,000 shares to 500,000,000 shares.	13,805,135	12,712,148
2.	To approve an amendment to the Company's 1995 Plan to increase the number of shares of common stock reserved for issuance thereunder by 5,000,000 shares from 5,500,000 shares to 10,500,000 shares.	9,096,757	13,082,755
3.	To ratify the appointment of Deloitte and Touche LLP as independent public accountants to the Company for the fiscal year ending September 29, 2001.	25,720,286	419,113

ITEM 5. Other Information

N/A

ITEM 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

10.1: Asset Purchase Agreement by and among ESC Medical Systems Ltd., Energy Systems Holdings Inc., and Coherent, Inc., dated as of February 25, 2001, incorporated by reference from the Annual Report on Form 8-K filed by the Company on March 5, 2001.
10.2: First Amendment to Asset Purchase Agreement by and among ESC Medical Systems, Ltd., Energy Systems Holdings Inc., and Coherent, Inc., dated as of April 30, 2001,

incorporated by reference from the Schedule 13D/A filed by the Company on May 10, 2001.

10.3: Registration Rights Agreement by and between ESC Medical Systems Ltd. and Coherent, Inc., dated as of April 30, 2001.

(b)

Reports on Form 8-K

(1): The Company filed a report on Form 8-K on March 5, 2001 relating to its sale of the Medical segment to ESC Medical Systems Ltd.
(2): The Company filed a report on Form 8-K on March 13, 2001 relating to a change in the certifying accountant of its majority-owned Lambda Physik subsidiary.

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)
Date: May 14, 2001		By: /s/ ROBERT J. QUILLINAN Robert J. Quillinan Executive Vice President and Chief Financial Officer

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 1. 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