Acquisitions and Divestitures
On July 4, 2009, we completed an asset exchange transaction with Oclaro, Inc. (Oclaro), pursuant to which we acquired certain assets and assumed certain liabilities related to Oclaro's New Focus business, and we sold certain assets and transferred certain liabilities related to our diode laser operations based in Tucson, Arizona to Oclaro. The New Focus business expands our current product offerings to include a number of new high-performance products, including opto-electronics, high-resolution actuators, opto-mechanics, tunable lasers, and custom-engineered solutions designed for OEMs.
The fair value of the New Focus business on the acquisition date was $14.1 million and the purchase price was paid by the transfer to Oclaro of our diode laser assets and liabilities, which had a fair value of $11.1 million, and the payment of $3.0 million in cash. We incurred $0.2 million in acquisition related expenses, which have been expensed as incurred and are included in selling, general and administrative expenses in the accompanying statements of operations.
Below is a summary of the purchase price, assets acquired and liabilities assumed:

               Current assets                             $  9,631
               Goodwill                                        690
               Purchased intangible assets                   4,830
               Other assets                                  1,247
               Current liabilities                          (2,298 )

                                                          $ 14,100

Our diode laser assets had a net book value of $14.6 million, which resulted in a loss of $4.1 million after considering the fair value of these assets of $11.1 million and selling costs of $0.6 million. This loss has been included in continuing operations under loss on disposal of diode laser assets and related costs in our consolidated statements of operations. These assets had previously been included in our Lasers Division.
Adoption of Financial Accounting Standards Board (FASB) Staff Position (FSP) APB 14-1
During the first quarter of 2009, we adopted FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the non-convertible debt borrowing rate for interest expense recognition. In addition, direct issuance costs associated with the convertible debt instruments are required to be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as debt issuance costs and equity issuance costs, respectively. These provisions have been applied retrospectively upon adoption. In accordance with FSP APB 14-1, we have recorded a debt discount of $27.5 million and a deferred tax liability of $10.6 million and have allocated $0.9 million of issuance costs to the equity component. Such amounts were calculated using an income approach and assumed a non-convertible debt borrowing rate of 6.25%, which is also the effective interest rate used to calculate interest expense. Due to the valuation allowance maintained against our deferred tax assets, the recording of the deferred tax liability resulted in a reduction to this valuation allowance rather than in a reduction in capital in excess of par value. Upon the adoption of FSP APB 14-1, the amortization of the debt discount resulted in an increase in non-cash interest expense of $4.2 million and $4.9 million for our fiscal years 2008 and 2007, respectively. The cumulative effect of adopting FSP APB 14-1 was an increase in stockholders' equity of $14.6 million as of January 3, 2009. Our consolidated statement of operations for the three and six months ended June 28, 2008 has been retrospectively adjusted compared with previously reported amounts as follows:

                                                     Three Months       Six Months
                                                         Ended            Ended
                                                       June 28,          June 28,
  (In thousands)                                         2008              2008
  Additional non-cash interest expense               $       1,309     $      2,608
  Reduction in amortization of debt issuance costs             (73 )           (136 )

  Retrospective decrease in net income               $       1,236     $      2,472


  Change to basic earnings per share                 $       (0.03 )   $      (0.07 )
  Change to diluted earnings per share               $       (0.03 )   $      (0.07 )

Stock-Based Compensation
During the six months ended July 4, 2009, we granted 1.2 million restricted
stock units and 1.0 million stock appreciation rights with a weighted average
grant date fair value of $4.18 and $1.64, respectively.
The total stock-based compensation expense included in our consolidated
statements of operations was as follows:

                                                      Three Months Ended                  Six Months Ended
                                                   July 4,          June 28,          July 4,          June 28,
(In thousands)                                      2009              2008             2009              2008
Cost of sales                                     $      33         $     117        $      59        $      162
Selling, general and administrative expenses            534               588              912             1,238
Research and development expense                         65               142              110               204

                                                  $     632         $     847        $   1,081        $    1,604

Results of Operations for the Three and Six Months Ended July 4, 2009 and
June 28, 2008
The following table presents our results of operations for the periods indicated
as a percentage of net sales:

                                                                  Percentage of Net Sales
                                                    Three Months Ended                 Six Months Ended
                                                 July 4,         June 28,          July 4,         June 28,
                                                  2009             2008             2009             2008
Net sales                                         100.0 %          100.0 %          100.0 %          100.0 %
Cost of sales                                      63.3             59.8             62.5             59.9

Gross profit                                       36.7             40.2             37.5             40.1

Selling, general and administrative
expenses                                           30.5             25.6             30.6             25.7
Research and development expense                   10.3             10.5             10.4             10.2
Loss on disposal of diode laser assets
and related costs                                   4.7                -              2.3                -

Operating income (loss)                            (8.8 )            4.1             (5.8 )            4.2

Write-down of note receivable and other
amounts related to previously
discontinued operations                               -             (6.0 )              -             (3.0 )
Interest and other expense, net                    (2.5 )           (1.2 )           (2.4 )           (1.4 )

Loss before income taxes                          (11.3 )           (3.1 )           (8.2 )           (0.2 )

Income tax (benefit) provision                     (0.9 )            0.3             (0.3 )            0.5

Net loss                                          (10.4 )%          (3.4 )%          (7.9 )%          (0.7 )%

In the following discussion regarding our net sales, certain prior period amounts have been reclassified between end markets to conform to the current period presentation.
Net Sales
Net sales for the three months ended July 4, 2009 decreased $30.1 million, or 25.6%, compared with the corresponding period in 2008. Net sales for the six months ended July 4, 2009 decreased $55.8 million, or 24.0%, compared with the corresponding period in 2008. For the three months ended July 4, 2009, net sales by our Lasers Division decreased $13.9 million, or 27.9%, and net sales by our PPT Division decreased $16.3 million, or 23.9%, compared with the prior year period. For the six months ended July 4, 2009, net sales by our Lasers Division decreased $24.4 million, or 25.1%, and net sales by our PPT Division decreased $31.4 million, or 23.2%, compared with the prior year period. We experienced decreases in net sales during the three and six months ended July 4, 2009 compared with the corresponding periods of 2008 due primarily to decreased sales to all of our end markets, other than life and health sciences, resulting from the continued poor worldwide macro-economic conditions and the ongoing cyclical downturn in the semiconductor equipment industry.
Net sales to the scientific research, aerospace and defense/security markets for the three months ended July 4, 2009 decreased $4.3 million, or 11.7%, compared with the same period in 2008. Net sales to these markets for the six months ended July 4, 2009 decreased $4.8 million, or 6.4%, compared with the same period in 2008. The decrease in sales to these markets during both periods in 2009 compared with the prior year periods was due primarily to decreased sales to research customers, including universities, resulting from lower funding from governmental entities, corporations and private foundations. Generally, our net sales to these markets by each of our divisions may fluctuate from period to period due to changes in overall research and defense spending levels and the timing of large sales relating to major research and aerospace/defense programs and, in some cases, these fluctuations may be offsetting between our divisions or between such periods.
Net sales to the microelectronics market for the three months ended July 4, 2009 decreased $15.2 million, or 41.1%, compared with the same period in 2008. Net sales to this market for the six months ended July 4, 2009 decreased $34.0 million, or 45.8%, compared with the same period in 2008. The decrease in sales to this market during the three and six months ended July 4, 2009 compared with the same periods in 2008 was due primarily to a significant decline in sales to our semiconductor manufacturing equipment customers as a result of the severe cyclical downturn in that industry, as well as lower sales of laser-based disk texturing systems, offset in part by an increase in sales to solar cell manufacturing customers.
Net sales to the life and health sciences market for the three months ended July 4, 2009 increased $0.7 million, or 3.3%, compared with the same period in 2008. Net sales to this market for the six months ended July 4, 2009 decreased $0.2 million, or 0.3%, compared with the same period in 2008. The increase in sales to customers in this market in the second quarter of 2009 compared with the same period in 2008 was due primarily to higher sales of products for bioimaging applications, offset in part by decreased sales of products for bioinstrumentation applications and for cosmetic and other elective treatment applications. The decrease in sales to this market during the six months ended July 4, 2009 compared with the same periods in 2008 was due primarily to decreased sales of products for bioinstrumentation applications and for cosmetic and other elective treatment applications, offset in part by higher sales of products for bioimaging applications.
Net sales to our industrial manufacturing and other end markets for the three months ended July 4, 2009 decreased $11.4 million, or 52.8%, compared with the same period in 2008. Net sales to these markets for the six months ended July 4, 2009 decreased $16.9 million, or 41.9%, compared with the same period in 2008. The decrease in sales to this market during the three and six months ended July 4, 2009 compared with the same periods in 2008 was due primarily to the continued poor macro-economic climate worldwide.

Geographically, net sales were as follows:

                            Three Months Ended                          Percentage
                           July 4,      June 28,        Increase         Increase
         (In thousands)     2009          2008         (Decrease)       (Decrease)
         United States    $  42,287     $  53,911     $    (11,624 )          (21.6 )%
         Europe              23,804        31,727           (7,923 )          (25.0 )
         Pacific Rim         16,541        26,962          (10,421 )          (38.7 )
         Other                4,909         5,064             (155 )           (3.1 )

                          $  87,541     $ 117,664     $    (30,123 )          (25.6 )%




                             Six Months Ended                           Percentage
                           July 4,      June 28,        Increase         Increase
         (In thousands)     2009          2008         (Decrease)       (Decrease)
         United States    $  79,277     $ 106,380     $    (27,103 )          (25.5 )%
         Europe              47,237        59,817          (12,580 )          (21.0 )
         Pacific Rim         39,576        56,335          (16,759 )          (29.7 )
         Other               10,987        10,375              612              5.9

                          $ 177,077     $ 232,907     $    (55,830 )          (24.0 )%

The decrease in sales to customers in the United States during the three and six months ended July 4, 2009 compared with the corresponding periods in 2008 was due primarily to lower sales to our semiconductor manufacturing equipment and industrial manufacturing customers. The decrease in sales to customers in Europe during the three and six months ended July 4, 2009 compared with the corresponding periods in 2008 was due primarily to lower sales to our industrial manufacturing, research and semiconductor manufacturing equipment customers. The decrease in sales to customers in the Pacific Rim during the three and six months ended July 4, 2009 compared with the corresponding periods in 2008 was due primarily to lower sales to our semiconductor equipment manufacturing customers, lower sales of laser-based disk texturing systems and lower sales to our industrial manufacturing customers.
Gross Margin
Gross margin was 36.7% and 40.2% for the three months ended July 4, 2009 and June 28, 2008, respectively, and was 37.5% and 40.1% for the six months ended July 4, 2009 and June 28, 2008, respectively. The decrease in gross margin in the 2009 periods was due primarily to increased inventory reserves due to decreased demand resulting from the current economic downturn, under absorption of overhead costs in our Tucson facility due to lower manufacturing volume and costs associated with profit improvement initiatives that were included in cost of sales.
Selling, General and Administrative (SG&A) Expenses SG&A expenses totaled $26.7 million, or 30.5% of net sales, and $30.1 million, or 25.6% of net sales, for the three months ended July 4, 2009 and June 28, 2008, respectively. The decrease in SG&A expenses in absolute dollars in the current year period was due primarily to decreases in personnel costs, consulting expenses, travel expenses and advertising costs, offset in part by an increase in bad debt expense.
SG&A expenses totaled $54.2 million, or 30.6% of net sales, and $59.9 million, or 25.7% of net sales, for the six months ended July 4, 2009 and June 28, 2008, respectively. The decrease in SG&A expenses in absolute dollars in the current year period was due primarily to decreases in personnel costs, consulting expenses, travel expenses, shipping costs and advertising costs, offset in part by increased rent and utilities expenses.

In general, we expect that SG&A expense will vary as a percentage of sales in the future based on our sales level in any given period. Because the majority of our SG&A expense is fixed in the short term, changes in SG&A expense will likely not be in proportion to the changes in net sales. Research and Development (R&D) Expense
R&D expense totaled $9.0 million, or 10.3% of net sales, and $12.3 million, or 10.5% of net sales, for the three months ended July 4, 2009 and June 28, 2008, respectively. R&D expense totaled $18.4 million, or 10.4% of net sales, and $23.8 million, or 10.2% of net sales, for the six months ended July 4, 2009 and June 28, 2008, respectively. The decrease in R&D expense in absolute dollars in the current year periods was due to decreased spending in both our PPT Division and our Lasers Division. The decreased R&D expense in our PPT Division in the 2009 periods was due primarily to lower spending related to solar cell manufacturing applications, as the design and development of certain products was completed during 2008.
We believe that the continued development and advancement of our key products and technologies is critical to our success, and we intend to continue to invest in key R&D initiatives, while working to ensure that the efforts are focused and the funds are deployed efficiently. In general, we expect that R&D expense as a percentage of net sales will vary in the future based on our sales level in any given period. Because of our commitment to continued product development, and because the majority of our R&D expense is fixed in the short term, changes in R&D expense will likely not be in proportion to the changes in net sales. Interest and Other Expense, Net
Interest and other expense, net totaled $2.2 million and $1.4 million for the three months ended July 4, 2009 and June 28, 2008, respectively and $4.3 million and $3.2 million for the six months ended July 4, 2009 and June 28, 2008, respectively. In the current year periods, interest and other income was negatively impacted by a decrease in interest income earned due to lower interest rates and by an increase in other expense due to currency fluctuations, offset in part by reduced interest expense due to the extinguishment of $28 million of our convertible subordinated notes in the fourth quarter of 2008. Income Taxes
Our effective tax rate was a benefit of 7.6% and expense of (10.7)% for the three months ended July 4, 2009 and June 28, 2008, respectively, and a benefit of 4.0% and an expense of (220.0)% for the six months ended July 4, 2009 and June 28, 2008, respectively. The effective tax rate for the three and six months ended July 4, 2009 reflects income tax expense applicable to certain foreign jurisdictions, income tax benefit for losses incurred in certain foreign jurisdictions, state taxes and refundable research tax credits, offset in part by an allocation of tax to other comprehensive income.
Under Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting, we are required to adjust our effective tax rate each quarter to be consistent with the estimated annual effective tax rate. We are also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings compared with annual projections. We have maintained a valuation allowance against substantially all of our gross deferred tax assets pursuant to Statement of Financial Accounting Standard (SFAS) No. 109, Accounting for Income Taxes, due to the uncertainty as to the timing and ultimate realization of those assets. As a result, until such valuation allowance is reversed, the U.S. tax provision relating to future earnings will be offset substantially by a reduction in the valuation allowance. Accordingly, current and future tax expense will consist of taxes in certain foreign jurisdictions, required state income taxes, the federal alternative minimum tax and the impact of discrete items.

As of July 4, 2009, our valuation allowance was $58.5 million. We will continue to monitor our actual results, refine forecasted data and assess the need for retaining a valuation allowance against a portion of our gross deferred tax assets. In the event it is determined that a valuation allowance is no longer required, substantially all of the reversal will be recorded as a discrete item in the appropriate period.
Liquidity and Capital Resources
Our cash and cash equivalents and marketable securities balances increased to a total of $149.5 million as of July 4, 2009 from $148.4 million as of January 3, 2009. This increase was attributable primarily to cash generated from operations and investing activities in the second quarter of 2009, offset in part by cash used in financing activities during the quarter.
Net cash provided by our operating activities of $9.8 million for the six months ended July 4, 2009 was attributable primarily to cash provided by our operations and increased collections on our accounts receivable, offset in part by purchases of inventory and payments for accounts payable and payroll related expenses. In connection with our asset exchange transaction with Oclaro, we transferred $8.7 million of inventory related to our diode laser manufacturing operations to Oclaro, and acquired $6.0 million of inventory related to the New Focus business. In addition, inventory related to our existing product lines increased by $6.3 million. The cash outflows related to accounts payable and payroll related expenses was due primarily to the timing of payments. Net cash provided by investing activities of $7.2 million for the six months ended July 4, 2009 was attributable to net sales of marketable securities of . . .