COMPANY OVERVIEW

BUSINESS BACKGROUND

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

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

Effective as of the beginning of the first quarter of fiscal 2009, in order to align all of our diode-pumped solid state ("DPSS") technology into the same reportable operating segment, management moved the DPSS Germany and Crystal product families from the CLC segment into the SLS segment. This allows for leverage and efficiencies in many parts of the business. Crystal is primarily an internal supplier that supports the DPSS product family. This concentrates all DPSS product families in the SLS segment effective as of the first quarter of fiscal 2009. All of reporting has been aligned to reflect the revised reportable operating segments (CLC and SLS) and prior periods have been restated.

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

MARKET APPLICATIONS

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

OUR STRATEGY

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

† Leverage our technology portfolio and application engineering to lead the proliferation of photonics into broader markets-We will continue to identify opportunities in which our technology portfolio and application engineering can be used to offer innovative solutions and gain access to new markets.

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

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

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

† Focus on long-term improvement of adjusted EBITDA expressed as a percentage of net sales-We define adjusted EBITDA as earnings before interest, taxes, depreciation, amortization, stock compensation expenses and certain other non-operating income and expense items.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We have identified the following as the items that require the most significant judgment and often involve complex estimation:
revenue recognition, accounting for long-lived assets (including goodwill and intangible assets), inventory valuation, warranty reserves, stock-based compensation and accounting for income taxes.

Revenue Recognition

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

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

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

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

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

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

Long-Lived Assets

We evaluate long-lived assets and amortizable intangible assets whenever events or changes in business circumstances or our planned use of assets indicate that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. Reviews are performed to determine whether the carrying values of assets are impaired based on comparison to the undiscounted expected future cash flows identifiable to such long-lived and amortizable intangible assets. If the comparison indicates that impairment exists, the impaired asset is written down to its fair value.

In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142") goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired (see Note 6 in the Notes to Condensed Consolidated Financial Statements). During the three months ended December 27, 2008, our stock price declined substantially, which, after considering the underlying circumstances, we concluded represented a triggering event for review for potential goodwill impairment. Accordingly, as of December 27, 2008, we have performed an interim goodwill impairment evaluation, as required under SFAS No. 142. Under SFAS No. 142, goodwill is tested for impairment first by comparing each reporting unit's fair value to its respective carrying value. If such comparison indicates a potential impairment, then the impairment is determined as the difference between the recorded value of goodwill and its fair value. The performance of this test is a two-step process.

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

The reporting units we evaluated for goodwill impairment have been determined to be the same as our operating segments in accordance with SFAS No. 142 for determining reporting units and include Commercial Lasers and Components ("CLC") and Specialty Lasers and Systems ("SLS"). We determined the fair value of our reporting units for the Step 1 test using a weighting of the Income (discounted cash flow), Market and Transaction approach valuation methodologies. We have completed Step 1 of the impairment test. Management has reviewed the results of the Step 1 analysis and concluded that a Step 2 analysis was required only for the CLC reporting unit. The preliminary results of the Step 2 assessment for CLC indicate that the entire balance of goodwill in the CLC reporting unit at that date is impaired. The estimated fair value of our SLS reporting unit exceeded its carrying value so no further impairment analysis was required for this reporting unit.

We will finalize the Step 2 analysis during the second quarter of fiscal 2009 and make any necessary adjustments. The non-cash impairment of goodwill of $19.3 million was recorded in the three months ended December 27, 2008.

At December 27, 2008, we had $90.2 million of goodwill and purchased intangible assets on our condensed consolidated balance sheet. At December 27, 2008, we had $102.5 million of property and equipment on our condensed consolidated balance sheet.

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

Inventory Valuation

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

Warranty Reserves

We provide warranties on certain of our product sales and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs

to repair or replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line. The weighted average warranty period covered is nearly 15 months. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to cost of sales may be required in future periods.

Stock-Based Compensation

We account for share-based compensation using the fair value recognition provisions of SFAS 123(R). We estimate the fair value of stock options granted using the Black-Scholes Merton model. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. We amortize the fair value of stock options on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods. We value restricted stock units using the intrinsic value method. We amortize the value of restricted stock units on a straight-line basis over the restriction period.

SFAS 123(R) requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the option's expected life, the expected price volatility of the underlying stock and an estimate of expected forfeitures. Our computation of expected volatility considers historical volatility and market-based implied volatility. Our estimate of expected forfeitures is based on historical employee data and could differ from actual forfeitures.

See Note 9 in the Notes to the Condensed Consolidated Financial Statements for a description of our share-based employee compensation plans and the assumptions we use to calculate the fair value of share-based employee compensation.

Income Taxes

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

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

Effective September 30, 2007, we adopted the provisions of FIN 48, which creates a single model to address accounting for uncertainty in tax positions by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. FIN 48 establishes a two-step approach for evaluating tax positions. The first step, recognition, occurs when a company concludes (based solely on the technical aspects of the matter) that a tax position is more likely than not to be sustained upon examination by a taxing authority. The second step, measurement, is only considered after step one has been satisfied and measures any tax benefit at the largest amount that is deemed more likely than not to be realized upon ultimate settlement of the uncertainty. These determinations involve significant judgment by management. Tax positions that fail to qualify for initial recognition are recognized in the first subsequent interim period that they meet the more likely than not standard or when they are resolved through negotiation or litigation with factual interpretation, judgment and certainty. Tax laws and regulations themselves are complex and are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court filings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially to reverse previously recorded tax liabilities.

KEY PERFORMANCE INDICATORS



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



                                              Three Months Ended
                                        December 27,      December 29,
                                            2008              2007          Change      % Change
                                                        (Dollars in thousands)

Bookings                               $      103,319    $      154,857    $ (51,538 )     (33.3 )%
Net sales-Commercial Lasers and
Components                             $       37,380    $       47,248    $  (9,868 )     (20.9 )%
Net sales-Specialty Lasers and
Systems                                $       86,983    $       97,023    $ (10,040 )     (10.3 )%
Gross profit as a percentage of net
sales-Commercial Lasers and
Components                                       30.0 %            39.1 %       (9.1 )%    (23.3 )%
Gross profit as a percentage of net
sales-Specialty Lasers and Systems               45.0 %            43.7 %        1.3 %       3.0 %
Research and development as a
percentage of net sales                          11.9 %            12.7 %       (0.8 )%     (6.3 )%
Income (loss) before income taxes      $      (13,476 )  $        7,032    $ (20,508 )    (291.6 )%
Net cash provided by (used in)
operating activities                   $       (9,398 )  $       13,077    $ (22,475 )    (171.9 )%
Days sales outstanding in
receivables                                      68.9              60.5          8.4        13.9 %
Days sales outstanding in
inventories                                      85.4              70.4         15.0        21.3 %
Capital spending as a percentage of
net sales                                         7.2 %             3.2 %        4.0 %     125.0 %

Definitions and analysis of these performance indicators are as follows:

Bookings

Bookings represent orders expected to be shipped within 12 months and services to be provided pursuant to service contracts. While we generally have not experienced a significant rate of cancellation, bookings are generally cancelable by our customers without substantial penalty and, therefore, we can not assure all bookings will be converted to net sales.

First quarter bookings decreased 33.3% from the same quarter one year ago. Bookings decreased in the microelectronics, OEM components and instrumentation and materials processing markets and were flat in the scientific and government programs market.

Microelectronics

Microelectronics bookings decreased 37% from the fourth quarter of fiscal 2008, as the drop in consumer confidence and spending continues to depress the microelectronics market. Non-service orders during the first quarter of fiscal 2009 can be characterized as technology buys or design wins. And while service orders have remained stable, we are very mindful how changes in semi-conductor fabrication plant utilization rates will affect this part of our business.

Orders from semi cap applications remained weak due to further reductions in projected capital spending by our customers and their end customers for 2009. Despite this trend, previous design wins led to key technology buys that, in turn, should lead to market share gain over the next twelve months.

Bookings from advanced packaging users decreased as integrators appear to be using up their existing inventories and end users struggle with excess capacity. We believe this market will remain depressed until broader economic stimuli reignite consumer demand for electronics.

Orders for flat panel display manufacturing were driven by service needs. From an application standpoint, the organic light-emitting diode (OLED) transition across various flat panel display formats is creating new opportunities and has expanded demand for sensitive/mobile touch screens that contributed to the new order activity in the market.

Bookings for solar cell manufacturing reached an all-time high in the first quarter of fiscal 2009. Demand was strongest from crystalline silicon applications where our UV lasers are used in critical process steps that enhance yield and optical-to-electrical

conversion efficiency. We are working closely with customers to push these processes to full-scale manufacturing. The offset to this good news is that tight credit, low energy prices and sagging consumer confidence are slowing the rate of investment in the broader solar and renewable energy markets. All things considered, we are guardedly optimistic about this opportunity.

OEM Components and Instrumentation

Orders for OEM components and instrumentation decreased 27% from the fourth quarter of fiscal 2008. Orders for lasers used in aesthetic and refractive applications continue to be pressured by reductions in consumer spending. Non-refractive ophthalmology continues to show signs of strength, based upon the adoption of the Genesis 577™ laser system for retinal therapies. In general, bioinstrumentation customers remain in healthy condition and are managing inventory and risk by shifting towards smaller, more frequent orders. We expect this pattern to continue for the near-term future.

The OPS portfolio expanded with the introduction at the 2009 Photonics West tradeshow ("Photonics West") of the Genesis™ 532-2000, a continuous wave green laser suitable for a variety of uses including instrumentation and scientific research. The system boasts the same benefits as our other OPS offerings including compactness, power scalability, high wall plug efficiency and long operating lifetimes.

Materials Processing

Materials processing orders decreased 20% from the fourth quarter of fiscal 2008, including a debooking of approximately $3 million of previously scheduled backlog.

In the fourth quarter of fiscal 2008, we had seen a slowdown from domestic customers. In the first quarter of fiscal 2009, the weakening was from Asian and European customers. We believe the two underlying causes are the tightening of credit and the erosion of the Euro relative to the dollar.

While the current market conditions are unfavorable, materials processing remains a key long-term opportunity for the photonics market. We are making targeted investments to increase our participation in the materials processing market. At Photonics West, we introduced the Highlight™ 1000F, which is a fiber-delivered, direct diode system that produces 1 kiloWatt at the end of the fiber and it can be used for a wide range of applications including welding, cladding, brazing and heat treating. Among the many benefits the 1000F offers are outstanding electrical-to-optical efficiency and ease of integration and operation. The evaluation of alpha units has gone very well and we have received our first orders.

Scientific and Government Programs

Scientific and government programs orders decreased 16% from a strong fourth quarter of fiscal 2008 and were flat compared to the first quarter of fiscal 2008. This was a typical first quarter in the scientific market. Europe and Asia posted solid bookings and the U.S. bookings decreased after a very robust fourth . . .