COHERENT INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes included in Item 8, "Financial Statements and Supplementary Data" in this annual report. This discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in Item 1A,"Risk Factors" and elsewhere in this annual report. Please see the discussion of forward-looking statements at the beginning of this annual report under "Special Note Regarding Forward-Looking Statements." KEY PERFORMANCE INDICATORS Below is a summary of some of the quantitative performance indicators (as defined below) that are evaluated by management to assess our financial performance. Some of the indicators are non-GAAP measures and should not be considered as an alternative to any other measure for determining operating performance or liquidity that is calculated in accordance with generally accepted accounting principles.

Fiscal 2012 2011 2010 (Dollars in thousands) Bookings $ 773,199 $ 895,017 $ 695,954 Book-to-bill ratio 1.01 1.11 1.15 Net Sales-Commercial Lasers and Components $ 220,240 $ 283,098 $ 208,691 Net Sales-Specialty Lasers and Systems $ 548,848 $ 519,736 $ 396,276 Gross Profit as a Percentage of Net Sales-Commercial Lasers and Components 36.7 % 41.1 % 36.2 % Gross Profit as a Percentage of Net Sales-Specialty Lasers and Systems 43.2 % 45.4 % 47.0 % Research and Development Expenses as a Percentage of Net Sales 10.2 % 10.1 % 12.0 % Income Before Income Taxes $ 90,622 $ 123,829 $ 57,979 Net Cash Provided by Operating Activities $ 64,771 $ 86,676 $ 78,813 Days Sales Outstanding in Receivables 67.6 63.2 65.6 Fourth Quarter Inventory Turns 2.8 3.1 3.4 Capital Spending as a Percentage of Net Sales 4.7 % 4.6 % 2.5 % Adjusted EBITDA as a Percentage of Net Sales 18.4 % 19.5 % 17.0 % Definitions and analysis of these performance indicators are as follows: Bookings and Book-to-Bill Ratio 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 cannot assure all bookings will be converted to net sales.

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

Fiscal 2012 bookings decreased from record bookings in fiscal 2011. Although we maintained a positive book-to-bill of 1.01, the book-to-bill ratio declined to 0.90 in the fourth quarter of fiscal 2012. Bookings decreased 13.6% from fiscal 2011, with decreases in all markets. Bookings decreases by market compared to fiscal 2011 were microelectronics (16%), OEM components and instrumentation (14%), scientific (13%) and materials processing (2%). Although fiscal 2012 bookings decreased in all markets, decreases in bookings in the fourth quarter of fiscal 2012 in the microelectronics market due to timing of large orders were partially offset by increases in the OEM components and instrumentation, scientific and materials processing markets.

Fiscal 2011 bookings reached a new record for us. Bookings increased 28.6% from fiscal 2010, with a significant increase in the microelectronics market.

Bookings increases by market compared to fiscal 2010 were microelectronics (62%), 36-------------------------------------------------------------------------------- Table of Contents materials processing (22%) and scientific (3%), partially offset by a decrease in the OEM components and instrumentation market (3%). Although fiscal 2011 bookings were a record, bookings in the fourth quarter of fiscal 2011 decreased from the third quarter of fiscal 2011, with a fourth quarter book-to-bill of 0.94, primarily due to timing of large orders in the microelectronics market.

Microelectronics Fiscal 2012 bookings decreased 16% from record-setting bookings in fiscal 2011 and the book-to-bill ratio for the year was 1.05.

Flat panel display orders for fiscal 2012 decreased 10% from record orders in fiscal 2011, but orders continued to be strong. In response to the increased demand, we invested in manufacturing capacity in Göttingen and South Korea during fiscal 2012. In the third quarter of fiscal 2012, we received record laser annealing system orders to be used for liquid crystal display ("LCD") and active-matrix organic light emitting diode ("AMOLED") production from integrators for flat panel display manufacturers in Japan, Korea and China as well as strong service orders. We expect follow-on system orders as well as increasing service orders in fiscal 2013 and continued fluctuations in order volumes on a quarterly basis as evidenced by lower orders in the fourth quarter of fiscal 2012. During the third quarter of fiscal 2012, we shipped our first Gen 8 system, a device that sets a new throughput standard for laser annealing tools.

Advanced packaging ("API") orders decreased significantly for the full fiscal year as the overall market was very soft. In addition, the market was impacted by tight credit in China where it has been difficult for customers to establish letters of credit for new equipment purchases. Although the API market remains slow, we are seeing increasing signals for a recovery later in calendar 2013.

Part of the market growth in mobile packaging has been satisfied by utilizing the capacity freed up by slow orders in personal computer applications, but we believe integrators will need to place replenishment orders later in calendar 2013.

Orders from semiconductor capital equipment OEMs increased 11% in fiscal 2012 reflecting increased orders for inspection applications and strong service orders. Orders for sales and service of semiconductor lasers trended down towards the end of fiscal 2012, which is consistent with indications that the semiconductor business is slowing down. Data from industry reports suggests that calendar 2013 semiconductor business will decrease from calendar 2012 and will increase in calendar 2014, which should favorably impact orders later in calendar 2013. On the product development front, we continue to advance the state of the art in support of 450mm and EUV inspection and metrology applications.

OEM Components and Instrumentation Bookings in fiscal 2012 decreased 14% from fiscal 2011 and the book-to-bill ratio for the year was 0.96. Although bookings declined for the full fiscal year primarily due to decreased government spending on life sciences and closer inventory management by customers resulting in smaller batch orders rather than semi-annual or annual orders in the first three quarters of fiscal 2012, orders in the fourth quarter of fiscal 2012 were strong due to the timing of certain large orders and strength in the instrumentation market.

Instrumentation orders in the fourth quarter of fiscal 2012 increased significantly from the third quarter of fiscal 2012 due to the timing of large orders from key accounts in the flow cytometry market, including higher bookings for our OBIS™ portfolio. We expect OBIS adoption to further strengthen throughout fiscal 2013 and will also expand our offering of OBIS-based subsystems that will provide customers with a broad range of customizable solutions.

Orders from the medical OEM market benefitted during fiscal 2012 from strong consumer demand for vision and aesthetic procedures in emerging markets.

Customers in the refractive markets are projecting good growth rates for calendar 2013, which led to semiannual or annual orders for low-power excimer lasers during the fourth quarter of fiscal 2012. The home-based aesthetic market continues to expand as more individuals are turning towards laser-based hair reduction and skin treatment, resulting in solid bookings for our semiconductor lasers in fiscal 2012.

Materials Processing Although annual bookings decreased 2% from fiscal 2011 and fiscal 2012's book-to-bill ratio was 1.00, bookings in the fourth quarter of fiscal 2012 increased slightly from the previous quarter. Although materials processing orders in the first quarter of fiscal 2012 were negatively impacted by the tight credit policies in China and sovereign debt issues in Europe, they were strong in the remainder of fiscal 2012 in spite of the difficult macroeconomic conditions.

Our materials processing business is comprised of multiple applications whose results often offset each other. In the fourth quarter of fiscal 2012, we had record bookings for our Meta™ laser workstations following the release of a new model utilizing a Diamond™ E-1000 CO2 laser. Meta orders were strongest in North America and we plan to augment the platform 37-------------------------------------------------------------------------------- Table of Contents by introducing a fiber laser equipped version later in fiscal 2013.

During fiscal 2012, marking and engraving application orders were strong and in the second half of fiscal 2012, led all applications with continued demand for ultraviolet lasers used in consumer electronics manufacturing. In the second half of fiscal 2012, traditional low power CO2 marking exhibited seasonal softness.

We formally released our first kilowatt class fiber laser, the Highlight™ 1000FL and received our first order from a commercial customer in the fourth quarter of fiscal 2012. Our goals for fiscal 2013 are three-fold: capture additional seed orders for the 1000FL, drive cost reduction in our semiconductor pumps and demonstrate the scalability of the architecture by moving up the power scale into the multi-kilowatt regime.

Scientific and Government Programs Fiscal 2012 orders decreased 13% from record-setting bookings in fiscal 2011 primarily due to the completion of stimulus programs and the book-to-bill ratio for the year was 0.93. Although orders in the first quarter of fiscal 2012 carried over from the fiscal 2011 strength particularly due to investment in biological research in China, orders softened in the middle of fiscal 2012 before increasing in the typically stronger fourth quarter.

Multiphoton imaging was the leading application within the scientific market for the fourth quarter and the full fiscal 2012 and has proven to be very resilient to funding changes. Part of the strength comes from continued adoption of imaging techniques worldwide. The market has also benefitted from the emergence of specialty microscope suppliers that focus on niche and leading-edge applications, thereby complementing the larger established scope manufacturers.

Funding for physical sciences research has experienced a larger decline from the stimulus levels of fiscal 2011, especially for high-end systems priced over $500,000. We have now reverted to normalized funding where researchers have to draw upon multiple sources to make the same purchases. The strength of our portfolio and customer support network allowed us to maintain market share.

Net Sales Net sales include sales of lasers, laser tools, related accessories and service contracts. Net sales for fiscal 2012 decreased 4.2% from fiscal 2011. Net sales for fiscal 2011 increased 32.7% from fiscal 2010. For a description of the reasons for changes in net sales refer to the "Results of Operations" section below.

Gross Profit as a Percentage of Net Sales Gross profit as a percentage of net sales ("gross profit percentage") is calculated as gross profit for the period divided by net sales for the period.

Gross profit percentage for CLC decreased to 36.7% in fiscal 2012 from 41.1% in fiscal 2011 and increased from 36.2% in fiscal 2010. Gross profit percentage for SLS decreased to 43.2% in fiscal 2012 from 45.4% in fiscal 2011 and from 47.0% in fiscal 2010. For a description of the reasons for changes in gross profit refer to the "Results of Operations" section below.

Research and Development as a Percentage of Net Sales Research and development as a percentage of net sales ("R&D percentage") is calculated as research and development expense for the period divided by net sales for the period. Management considers R&D percentage to be an important indicator in managing our business as investing in new technologies is a key to future growth. R&D percentage increased to 10.2% from 10.1% in fiscal 2011 and decreased from 12.0% in fiscal 2010. For a description of the reasons for changes in R&D spending refer to the "Results of Operations" section below.

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

Days Sales Outstanding in Receivables We calculate days sales outstanding ("DSO") in receivables as net receivables at the end of the period divided by net sales during the period and then multiplied by the number of days in the period, using 360 days for years. DSO in receivables 38-------------------------------------------------------------------------------- Table of Contents indicates how well we are managing our collection of receivables, with lower DSO in receivables resulting in higher working capital availability. The more money we have tied up in receivables, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business. Our DSO in receivables for fiscal 2012 increased 4.4 days from fiscal 2011 to 67.6 days. The increase in DSO in receivables is primarily due to the higher mix of revenue and related receivables in Asia where customary payment terms result in higher DSOs than the average DSO for the Company taken as a whole as well as a higher concentration of sales in the last month of the fiscal year.

Annualized Fourth Quarter Inventory Turns We calculate annualized fourth quarter inventory turns as cost of sales during the fourth quarter annualized and divided by net inventories at the end of the fourth quarter. This indicates how well we are managing our inventory levels, with higher inventory turns resulting in more working capital availability and a higher return on our investments in inventory. The more money we have tied up in inventory, the less money we have available for research and development, acquisitions, expansion, marketing and other activities to grow our business.

Our annualized inventory turns for fiscal 2012 decreased 0.3 turns from fiscal 2011 to 2.8 turns. The deterioration in inventory turns is primarily due to the impact of decreased sales volumes in relation to inventory levels in certain businesses as well as increased inventory to support a sizable backlog of flat panel laser annealing systems.

Capital Spending as a Percentage of Net Sales Capital spending as a percentage of net sales ("capital spending percentage") is calculated as capital expenditures for the period divided by net sales for the period. Capital spending percentage indicates the extent to which we are expanding or improving our operations, including investments in technology and equipment. Management monitors capital spending levels as this assists management in measuring our cash flows, net of capital expenditures. Our capital spending percentage increased to 4.7% in fiscal 2012 from 4.6% in fiscal 2011 and 2.5% in fiscal 2010. The fiscal 2012 increase was primarily due to building improvements and purchases of production-related assets to support our expansion in Asia (South Korea and Singapore) and Germany. The fiscal 2011 increase was primarily due to purchases of production-related assets and building improvements to support higher sales volumes. We expect capital spending for fiscal 2013 to be approximately 3.5% of net sales.

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

SIGNIFICANT EVENTS Restructuring Activities During fiscal 2008, we initiated restructuring plans to decrease costs by consolidating facilities and reducing our workforce. As of September 29, 2012, we had made payments in connection with the restructuring plans in the amount of $27.7 million. We completed payments for substantially all anticipated costs related to the restructuring plans in the third quarter of fiscal 2011. In the second quarter of fiscal 2011, we ceased manufacturing operations in our Finland facility and recognized a $6.1 million gain, primarily in other income (expense), due to a non-recurring translation adjustment related to the dissolution of our Finland operations.

Acquisitions On October 13, 2009, we acquired all the assets and certain liabilities of StockerYale's laser module product line in Montreal and its specialty fiber product line in Salem, New Hampshire for $15.0 million in cash. StockerYale designs, develops and manufactures low power laser modules, light emitting diode (LED) systems and specialty optical fiber products. These assets and liabilities have been included in our Commercial Lasers and Components segment.

On April 29, 2010, we acquired Beam Dynamics for $6.25 million, excluding transaction fees. Beam Dynamics manufactures flexible laser cutting tools for the materials processing market. These assets and liabilities have been included in our Commercial Lasers and Components segment.

On January 5, 2011, we acquired all the assets and assumed certain liabilities of Hypertronics Pte Ltd for $14.5 million, excluding transaction fees.

Hypertronics designs and manufactures laser- and vision-based tools for flat panel display, storage, semiconductor and solar applications at facilities in Singapore and Malaysia. These assets and liabilities have been included in our Specialty Lasers and Systems segment. During the fourth quarter of fiscal 2012, we decided to no longer pursue orders of Hypertronics legacy products and we performed an impairment analysis of Hypertronics' intangible assets and determined that 39-------------------------------------------------------------------------------- Table of Contents such assets were impaired. As a result, we recorded a $4.0 million non-cash intangibles amortization charge and a $0.3 million inventory write-off in the fourth quarter of fiscal 2012.

On July 23, 2012, we acquired all of the outstanding shares of MiDaZ Lasers Limited "Midaz" for $3.8 million in cash, excluding transaction fees. Midaz was a technology based-acquisition and we intend to utilize the acquired technology in low cost, compact pulsed solid state lasers. These assets and liabilities have been included in our Specialty Lasers and Systems segment.

On October 30, 2012, we acquired all of the outstanding shares of Innolight Innovative Laser and Systemtechnik GmbH for approximately $18.4 million, excluding transaction costs. See Note 19 "Subsequent Events" in the notes to the Consolidated Financial Statements under Item 15 of this annual report for further information.

Stock Repurchases In the second half of fiscal 2010, we repurchased and retired 1,195,829 shares of outstanding common stock for a total of $43.3 million, excluding expenses.

In March 2011, we repurchased and retired 454,682 shares of outstanding common stock at an average price of $59.00 per share for a total of $26.8 million, excluding expenses. During the third and fourth quarters of fiscal 2011, we repurchased and retired 1,024,409 shares of outstanding common stock at an average price of $47.03 per share for a total of $48.2 million, excluding expenses.

On August 25, 2011, we announced that the Board of Directors had authorized the repurchase of up to $50.0 million of our common stock. During fiscal 2011, we repurchased and retired 586,200 shares of outstanding common stock at an average price of $42.67 per share for a total of $25.0 million excluding expenses.

During fiscal 2012, we repurchased and retired 543,200 shares of outstanding common stock at an average price of $45.99 per share for a total of $25.0 million, excluding expenses. There were no funds remaining authorized for repurchase at September 29, 2012 under that repurchase program.

On October 4, 2012, the Board of Directors authorized a buyback program whereby we are authorized to repurchase up to $25 million of our common stock. This buyback program is discussed in Note 19 "Subsequent Events" in the notes to the Consolidated Financial Statements under Item 15 of this annual report.

RESULTS OF OPERATIONS-FISCAL 2012, 2011 AND 2010 Fiscal 2012, 2011 and 2010 consist of 52 weeks.

Consolidated Summary The following table sets forth, for the years indicated, the percentage of total net sales represented by the line items reflected in our consolidated statement of operations: Fiscal 2012 2011 2010 (As a percentage of net sales) Net sales 100.0 % 100.0 % 100.0 % Cost of sales 58.9 % 56.3 % 56.9 % Gross profit 41.1 % 43.7 % 43.1 % Operating expenses: Research and development 10.2 % 10.1 % 12.0 % Selling, general and administrative 18.0 % 18.6 % 20.4 % Amortization of intangible assets 1.3 % 1.0 % 1.3 % Total operating expenses 29.5 % 29.7 % 33.7 % Income from operations 11.6 % 14.0 % 9.4 % Other income (net) 0.2 % 1.4 % 0.2 % Income before income taxes 11.8 % 15.4 % 9.6 % Provision for income taxes 3.6 % 3.8 % 3.5 % Net income 8.2 % 11.6 % 6.1 % Refer to Item 6 "Selected Financial Data" for a description of significant events that impacted the results of operations for 40-------------------------------------------------------------------------------- Table of Contents fiscal years 2012, 2011 and 2010.

Net Sales Market Application The following table sets forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by market application (dollars in thousands): Fiscal 2012 Fiscal 2011 Fiscal 2010 Percentage Percentage Percentage of total of total of total Amount net sales Amount net sales Amount net sales Consolidated: Microelectronics $ 373,696 48.6 % $ 377,331 47.0 % $ 230,763 38.1 % OEM components and instrumentation 143,729 18.7 % 164,508 20.5 % 151,243 25.0 % Materials processing 108,666 14.1 % 104,497 13.0 % 82,181 13.6 % Scientific and government programs 142,997 18.6 % 156,498 19.5 % 140,880 23.3 % Total $ 769,088 100.0 % $ 802,834 100.0 % $ 605,067 100.0 % During fiscal 2012, net sales decreased by $33.7 million, or 4%, compared to fiscal 2011, including a decrease of $2.4 million due to the impact of foreign currency exchange rates, with sales decreases in the OEM components and instrumentation, scientific and government program and microelectronics markets partially offset by increases in the materials processing market.

Microelectronics sales decreased $3.6 million, or 1%, primarily due to lower shipments for advanced packaging and solar applications partially offset by higher sales in flat panel display applications. The decrease in the OEM components and instrumentation market of $20.8 million, or 13%, during fiscal 2012 was primarily due to lower shipments for bio-instrumentation, military and machine vision applications partially offset by higher shipments for medical applications. Materials processing sales increased $4.2 million, or 4%, during fiscal 2012 primarily due to higher shipments for marking and heat treating applications as well as higher shipments of laser system tools. The decrease in scientific and government program market sales of $13.5 million, or 9%, during fiscal 2012 was due to lower demand for advanced research applications used by university and government research groups partly due to lower U.S. stimulus funding.

During fiscal 2011, net sales increased by $197.8 million, or 33%, compared to fiscal 2010, including an increase of $14.9 million due to the impact of foreign currency exchange rates, with sales increasing in all four markets.

Microelectronics sales increased $146.6 million, or 64%, primarily due to higher sales in flat panel display, advanced packaging, semiconductor and solar applications. The increase in the OEM components and instrumentation market of $13.3 million, or 9%, during fiscal 2011 was primarily due to higher shipments for bio-instrumentation, medical and machine vision applications. Materials processing sales increased $22.3 million, or 27%, during fiscal 2011 primarily due to higher shipments for marking, cutting and drilling applications. The increase in scientific and government program market sales of $15.6 million, or 11%, during fiscal 2011 was due to higher demand for advanced research applications used by university and government research groups in part due to Federal stimulus money.

In fiscal 2012, two customers accounted for 11% each of net sales; in 2011 and 2010, no customers accounted for greater than 10% of net sales.

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

The following table sets forth, for the periods indicated, the amount of net sales and their relative percentages of total net sales by segment (dollars in thousands): 41-------------------------------------------------------------------------------- Table of Contents Fiscal 2012 Fiscal 2011 Fiscal 2010 Percentage Percentage Percentage of total of total of total Amount net sales Amount net sales Amount net sales Consolidated: Commercial Lasers and Components (CLC) $ 220,240 28.6 % $ 283,098 35.3 % $ 208,691 34.5 % Specialty Lasers and Systems (SLS) 548,848 71.4 % 519,736 64.7 % 396,276 65.5 % Corporate and other - - % - - % 100 - % Total $ 769,088 100.0 % $ 802,834 100.0 % $ 605,067 100.0 % Net sales for fiscal 2012 decreased $33.7 million, or 4%, compared to fiscal 2011, with decreases of $62.9 million, or 22%, in our CLC segment and increases of $29.1 million, or 6%, in our SLS segment. Net sales for fiscal 2011 increased $197.8 million, or 33%, compared to fiscal 2010, with increases of $123.5 million, or 31%, in our SLS segment and increases of $74.4 million, or 36%, in our CLC segment.

The decrease in our CLC segment sales from fiscal 2011 to fiscal 2012 was primarily due to lower advanced packaging, and certain flat panel display application sales as well as lower instrumentation application sales. The increase in our CLC segment sales from fiscal 2010 to fiscal 2011 was primarily due to higher advanced packaging, materials processing and certain flat panel display application sales.

The increase in our SLS segment sales from fiscal 2011 to fiscal 2012 was primarily due to higher revenue for flat panel display annealing applications partially offset by lower shipments for scientific and government programs, instrumentation and solar applications. The increase in our SLS segment sales from fiscal 2010 to fiscal 2011 was primarily due to higher sales for flat panel display annealing, semiconductor, scientific and advanced packaging applications.

Gross Profit Consolidated Our gross profit rate decreased by 2.6% to 41.1% in fiscal 2012 from 43.7% in fiscal 2011 primarily due to unfavorable product margins (1.6%) due to lower volumes in several business units serving particularly the advanced packaging and components markets, and higher manufacturing expense and start-up costs to expand manufacturing capacity in Germany and Excimer tube production in Korea.

These decreases were net of the favorable impact of foreign exchange rates and favorable product mix in the microelectronics market as well as higher installation and warranty costs (0.9%) including installations and higher service events in flat panel display markets.

Our gross profit rate increased by 0.6% to 43.7% in fiscal 2011 from 43.1% in fiscal 2010 primarily due to a lower manufacturing cost structure and higher sales volumes as well as a favorable product mix due to higher margins within the microelectronics market.

Our gross profit rate has been and will continue to be affected by a variety of factors including market mix, pricing on volume orders, our ability to manufacture advanced and more complex products, manufacturing efficiencies, excess and obsolete inventory write-downs, warranty costs, pricing by competitors or suppliers, new product introductions, production volume, customization and reconfiguration of systems, commodity prices and foreign currency fluctuations.

Commercial Lasers and Components Our CLC gross profit rate decreased by 4.4% to 36.7% in fiscal 2012 from 41.1% in fiscal 2011 primarily due to unfavorable product costs (2.9%) resulting from the impact of lower volumes in a few business units serving primarily the advanced packaging and components markets and unfavorable product mix within the instrumentation and semiconductor markets, higher other costs (1.0%) due to higher inventory provisions and the impact of lower sales volumes and higher warranty and installation costs (0.5%) due to a higher installed base and the impact of lower sales volumes.

Our CLC gross profit rate increased by 4.9% to 41.1% in fiscal 2011 from 36.2% in fiscal 2010 primarily due to favorable product costs (2.4%) due to the impact of increased volumes and favorable product mix within the microelectronics market, lower restructuring costs (2.2%) and lower other costs (0.6%) due to lower inventory provisions partially offset by higher warranty costs (0.3%).

Specialty Lasers and Systems 42-------------------------------------------------------------------------------- Table of Contents Our SLS gross profit rate decreased by 2.2% to 43.2% in fiscal 2012 from 45.4% in fiscal 2011 primarily due to unfavorable product costs (1.4%) due to increased investments in Excimer manufacturing capabilities to support the growing flat panel display revenue net of the favorable impact of exchange rates and favorable product mix within the microelectronics market and higher installation and warranty costs (1.0%) due to higher service events and costs to support installations of a growing number of laser annealing systems in the flat panel display market partially offset by lower other costs (0.3%).

Our SLS gross profit rate decreased by 1.6% to 45.4% in fiscal 2011 from 47.0% in fiscal 2010 primarily due to unfavorable product costs (0.8%) resulting from unfavorable mix within the microelectronics market and the acquisition of Hypertronics net of the impact of increased volumes and cost reduction efforts as well as higher other costs (1.0%) due to higher inventory provisions and higher freight costs partially offset by lower warranty costs (0.2%).

Operating Expenses The following table sets forth, for the periods indicated, the amount of operating expenses and their relative percentages of total net sales by the line items reflected in our consolidated statement of operations (dollars in thousands): Fiscal 2012 2011 2010 Percentage Percentage Percentage of total of total of total Amount net sales Amount net sales Amount net sales (Dollars in thousands) Research and development $ 78,260 10.2 % $ 81,232 10.1 % $ 72,354 12.0 % Selling, general and administrative 138,519 18.0 % 149,499 18.6 % 123,575 20.4 % Amortization of intangible assets 10,376 1.3 % 8,082 1.0 % 8,002 1.3 % Total operating expenses $ 227,155 29.5 % $ 238,813 29.7 % $ 203,931 33.7 % Research and development Fiscal 2012 research and development ("R&D") expenses decreased $3.0 million, or 4%, from fiscal 2011. The decrease was due primarily to lower payroll spending ($4.9 million) due to lower performance-related compensation net of increased headcount partially offset by higher project and other spending ($1.9 million).

As a percentage of sales, the slight increase was primarily due to decreased sales volumes. On a segment basis, CLC spending decreased $2.2 million primarily due to lower payroll spending partially offset by higher project spending. SLS spending increased $0.1 million primarily due to higher project and other spending partially offset by lower payroll spending and the impact of foreign exchange rates. Corporate and other spending decreased $0.8 million.

Fiscal 2011 R&D expenses increased $8.9 million, or 12%, from fiscal 2010. The increase was due primarily to higher payroll spending ($7.0 million) due to increased headcount and higher performance-related compensation and the acquisitions of Hypertronics in the second quarter of fiscal 2011 and Beam Dynamics in the middle of the third quarter of fiscal 2010 ($2.3 million). As a percentage of sales, the decrease was primarily due to increased sales volumes.

On a segment basis, CLC spending increased $1.9 million primarily due to higher payroll spending and the acquisition of Beam Dynamics in the middle of the third quarter of fiscal 2010 partially offset by lower project spending and lower restructuring costs. SLS spending increased $5.9 million primarily due to higher payroll spending, the acquisition of Hypertronics in the second quarter of fiscal 2011, higher project spending and the impact of foreign exchange rates.

Corporate and other spending increased $1.1 million.

Selling, general and administrative Fiscal 2012 selling, general and administrative ("SG&A") expenses decreased $11.0 million, or 7%, from fiscal 2011. The decrease was primarily due to $12.1 million lower payroll spending due to lower performance-related compensation spending net of higher headcount and increased salaries and $1.8 million lower other variable spending partially offset by $2.9 million higher stock-related compensation expense. On a segment basis, CLC spending decreased $4.2 million primarily due to lower payroll spending and lower other variable spending. SLS segment expenses decreased $4.4 million primarily due to lower payroll spending and lower other variable spending. Spending for Corporate and other decreased $2.4 million primarily due to lower payroll spending and lower other variable spending partially offset by higher stock-related compensation expense.

Fiscal 2011 SG&A expenses increased $25.9 million, or 21%, from fiscal 2010. The increase was primarily due to $12.3 million higher payroll spending due to higher performance-related compensation spending, higher headcount and increased salaries, $7.6 million higher other variable spending, $3.8 million higher stock-related compensation expense and the acquisitions of Hypertronics in the second quarter of fiscal 2011 and Beam Dynamics in the middle of the third quarter of fiscal 43-------------------------------------------------------------------------------- Table of Contents 2010 ($2.2 million), partially offset by lower restructuring costs ($2.2 million). In addition, fiscal 2010 SG&A expenses were reduced by a $2.2 million net receipt from the settlement of litigation resulting from our stock option investigation. On a segment basis, CLC spending increased $3.5 million primarily due to higher payroll spending and higher other variable spending partially offset by lower restructuring costs. SLS segment expenses increased $12.6 million primarily due to higher payroll spending, the acquisition of Hypertronics and higher other variable spending. Spending for Corporate and other increased $9.8 million primarily due to higher stock-related compensation expense, the net receipt from the settlement of litigation resulting from our stock option investigation in the first quarter of fiscal 2010, higher payroll spending, higher charges for increases in deferred compensation plan liabilities and higher other variable spending.

Amortization of intangible assets Amortization of intangible assets increased $2.3 million, or 28%, from fiscal 2011 to fiscal 2012 primarily due to the fourth quarter fiscal 2012 impairment of $4.0 million of Hypertronics intangibles partially offset by completion of amortization of certain intangibles related to prior acquisitions.

Amortization of intangible assets increased $0.1 million, or 1%, from fiscal 2010 to fiscal 2011 primarily due to the amortization of intangibles from the acquisition of Hypertronics in the second quarter of fiscal 2011 and Beam Dynamics in the third quarter of fiscal 2010, partially offset by completion of amortization of certain intangibles related to prior acquisitions.

Other income (expense), net Other income (expense), net, decreased $10.0 million from fiscal 2011 to fiscal 2012. The decrease was primarily due to the $6.5 million non-recurring translation adjustment related to the dissolution of our Finland operations in the second quarter of fiscal 2011, lower net foreign currency exchange gains ($1.9 million) and lower gains on our deferred compensation plan assets net of expenses ($1.5 million) including death benefits of $0.2 million in fiscal 2012 and $1.5 million in fiscal 2011.

Other income (expense), net, increased $10.7 million from fiscal 2010 to fiscal 2011. The increase was primarily due to the $6.5 million non-recurring translation adjustment related to the dissolution of our Finland operations, higher net foreign currency exchange gains ($2.9 million) and higher gains on our deferred compensation plan assets net of expenses ($2.4 million) including a $1.5 million death benefit, partially offset by lower interest income ($1.0 million) primarily due to interest on a tax refund in fiscal 2010.

Income taxes The effective tax rate on income before income taxes for fiscal 2012 of 30.5% was lower than the statutory rate of 35.0%. This was primarily due to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates and the benefit of releasing state tax reserves accrued under ASC 740-10 Income Taxes (formerly FASB Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes") and related interest.

During fiscal 2012, we increased our valuation allowance on deferred tax assets by $0.3 million to $9.1 million primarily due to the reduced ability to utilize California research and development tax credits and offset by the net increased ability to utilize foreign tax attributes and net operating losses of our subsidiaries in the fourth quarter. During fiscal 2011, we increased our valuation allowance on deferred tax assets by $1.5 million to $8.8 million, primarily due to the reduced ability to utilize foreign tax attributes and net operating losses and the reduced ability to utilize California research and development tax credits as a result of releasing net unrecognized tax benefits under ASC 740-10 that supported the credits. During fiscal 2010, we increased our valuation allowance on deferred tax assets to $7.4 million, primarily due to a capital loss limitation true-up, the reduced ability to utilize California research and development tax credits as a result of the current apportionment factor and the reduced ability to utilize foreign net operating losses.

In making the determination to record the valuation allowance, management considered the likelihood of future taxable income and feasible and prudent tax planning strategies to realize deferred tax assets. In the future, if we determine that we expect to realize deferred tax assets, an adjustment to the valuation allowance will affect income in the period such determination is made.

The effective tax rate on income before income taxes for fiscal 2011 of 24.7% was lower than the statutory rate of 35.0%. This was primarily due to the benefit of releasing unrecognized tax benefits under ASC 740-10 and related interest, the benefit of federal research and development credits, including additional credits reinstated from fiscal 2010 resulting from the enactment of the "Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Acts of 2010," the benefit of foreign tax credits, the benefit of currency translation adjustments related to closure of Coherent Finland's operations, the benefit from income subject to foreign tax rates that are lower than U.S. tax rates and the benefit from the unrealized gain on life insurance policy investments related to our deferred compensation plans. These amounts are partially offset by state income tax, limitations on the utilization of certain foreign tax attributes and net operating losses, limitations on the deductibility of 44-------------------------------------------------------------------------------- Table of Contents compensation under IRC Section 162(m), deemed dividend inclusions under the Subpart F tax rules and a currency translation adjustment related to a dividend from a foreign subsidiary.

The effective tax rate on income before income taxes for fiscal 2010 of 36.3% was higher than the statutory rate of 35.0%. This was primarily due to stock compensation not deductible for tax purposes and an increase in valuation allowance against capital loss carryforwards, California research and development tax credits as a result of California legislation enacted in February 2009 and certain foreign net operating loss carryforwards. These increases are partially offset by the benefit of income subject to foreign tax rates that are lower than U.S. tax rates and research and development credits.

We operate under tax holiday in Singapore which is effective from fiscal year 2012 through fiscal year 2017 and may be extended if certain additional requirements are satisfied. The tax holiday is conditional upon our meeting certain revenue, business spending and employment thresholds. As a result of a current loss, we did not realize a benefit for the Singapore tax holiday in fiscal year 2012.

FINANCIAL CONDITION Liquidity and capital resources At September 29, 2012, we had assets classified as cash and cash equivalents, as well as time deposits and fixed income securities classified as short-term investments, in an aggregate amount of $224.9 million, compared to $220.2 million at October 1, 2011. At September 29, 2012, approximately $139.4 million of the cash and securities was held in certain of our foreign operations, $46.1 million of which was denominated in currencies other than the U.S. dollar. In January 2012, we converted $89.8 million of assets formerly denominated in Euro to U.S. dollars and invested those funds in U.S. Treasury securities within a European subsidiary whose functional currency is the U.S. dollar. Accordingly, there is no translation adjustment arising from these U.S. dollar denominated investments. The converted funds were not repatriated to the U.S. and no U.S.

tax was triggered on the transfer of these funds to the European subsidiary. We incurred additional foreign income taxes of approximately $0.8 million related to this distribution. We currently have approximately $131 million of cash, including the investment in U.S. Treasury securities, held by foreign subsidiaries. We intend to permanently reinvest our accumulated earnings in these entities and our current plans do not demonstrate a need for these funds to support our domestic operations. If, however, a portion of these funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes. The amount of the taxes due would depend on the amount and manner of repatriation, as well as the location from where the funds are repatriated. We actively monitor the third-party depository institutions that hold these assets, primarily focusing on the safety of principal and secondarily maximizing yield on these assets. We diversify our cash and cash equivalents and investments among various financial institutions, money market funds and sovereign debt in order to reduce our exposure should any one of these financial institutions or financial instruments fail or encounter difficulties. To date, we have not experienced any material loss or lack of access to our invested cash, cash equivalents or short-term investments. However, we can provide no assurances that access to our invested cash, cash equivalents or short-term investments will not be impacted by adverse conditions in the financial markets.

Sources and Uses of Cash Historically, our primary source of cash has been provided by operations. Other sources of cash in the past three fiscal years include proceeds received from the sale of our stock through our employee stock option and purchase plans. Our historical uses of cash have primarily been for the repurchase of our common stock, capital expenditures and acquisitions of businesses and technologies.

Supplemental information pertaining to our historical sources and uses of cash is presented as follows and should be read in conjunction with our Consolidated Statements of Cash Flows and notes thereto (in thousands): Fiscal 2012 2011 2010 Net cash provided by operating activities $ 64,771 $ 86,676 $ 78,813 Sales of shares under employee stock plans 13,288 34,720 33,438 Repurchase of common stock (24,999 ) (100,637 ) (43,335 ) Capital expenditures (36,051 ) (37,117 ) (15,139 ) Acquisition of businesses, net of cash acquired (3,687 ) (14,108 ) (20,745 ) Net cash provided by operating activities decreased by $21.9 million in fiscal 2012 compared to fiscal 2011 and increased by $7.9 million in fiscal 2011 compared to fiscal 2010. The decrease in cash provided by operating activities in fiscal 2012 was primarily due to lower net income, higher tax payments and lower cash flows from other current liabilities including variable 45-------------------------------------------------------------------------------- Table of Contents compensation and accounts payable partially offset by higher cash flows from inventories and accounts receivable. The increase in cash provided by operating activities in fiscal 2011 was primarily due to higher net income partially offset by lower cash flows from inventories, accounts payable and other current liabilities. We believe that our existing cash, cash equivalents and short term investments combined with cash to be provided by operating activities will be adequate to cover our working capital needs and planned capital expenditures for at least the next 12 months to the extent such items are known or are reasonably determinable based on current business and market conditions. However, we may elect to finance certain of our capital expenditure requirements through borrowings under our bank credit facilities or other sources of capital. We continue to follow our strategy to further strengthen our financial position by using available cash flow to fund operations.

We intend to continue pursuing acquisition opportunities at valuations we believe are reasonable based upon market conditions. However, we cannot accurately predict the timing, size and success of our acquisition efforts or our associated potential capital commitments. Furthermore, we cannot assure you that we will be able to acquire businesses on terms acceptable to us. We expect to fund future acquisitions primarily through existing cash balances and cash flows from operations. If required, we will look for additional borrowings or consider the issuance of securities. The extent to which we will be willing or able to use our common stock to make acquisitions will depend on its market value at the time and the willingness of potential sellers to accept it as full or partial payment.

On April 29, 2010, we announced that the Board of Directors had authorized the repurchase of up to $50.0 million of our common stock. During fiscal 2010, we repurchased and retired 1,195,829 shares of outstanding common stock at an average price of $36.21 per share for a total of $43.3 million, excluding expenses.

On January 26, 2011, the Board canceled this program and authorized the repurchase of up to $75.0 million of our common stock. The program was authorized for 12 months from the date of authorization. In March 2011, we repurchased and retired 454,682 shares of outstanding common stock under a modified "Dutch Auction" tender offer at an average price of $59.00 per share for a total of $26.8 million, excluding expenses. During the third and fourth quarters of fiscal 2011, we repurchased and retired an additional 1,024,409 shares of outstanding common stock at an average price of $47.03 per share for a total of $48.2 million, excluding expenses.

On August 25, 2011, we announced that the Board of Directors had authorized the repurchase of up to $50.0 million of our common stock. The program was authorized for 12 months from the date of authorization. During fiscal 2011, we repurchased and retired 586,200 shares of outstanding common stock at an average price of $42.67 per share for a total of $25.0 million, excluding expenses.

During fiscal 2012, we repurchased and retired 543,200 shares of outstanding common stock at an average price of $45.99 per share for a total of $25.0 million, excluding expenses, completing the repurchase.

On October 4, 2012, the Board of Directors authorized a buyback program whereby we are authorized to repurchase up to $25 million of our common stock. This buyback program is discussed in Note 19 "Subsequent Events" in the notes to the Consolidated Financial Statements under Item 15 of this annual report.

During fiscal year 2008, we initiated restructuring plans to decrease costs by consolidating facilities and reducing our workforce. As of September 29, 2012, we had made payments in connection with the restructuring plans in the amount of $27.7 million. We completed payments for substantially all anticipated costs related to the restructuring plans in the third quarter of fiscal 2011.

Additional sources of cash available to us were domestic and international currency lines of credit and bank credit facilities totaling $70.2 million as of September 29, 2012, of which $68.2 million was unused and available. These unsecured credit facilities were used in Europe and Japan during fiscal 2012.

Our domestic line of credit consists of a $50.0 million unsecured revolving credit account with Union Bank of California, which expires on May 31, 2014 and is subject to covenants related to financial ratios and tangible net worth. No amounts have been drawn upon our domestic line of credit and $1.9 million of the international currency lines has been used as guarantees as of September 29, 2012.

Our ratio of current assets to current liabilities was 4.0:1 at September 29, 2012, compared to 3.6:1 at October 1, 2011. The increase in our ratio is primarily due increases in cash and short-term investments and inventories as well as decreases in accounts payable and other current liabilities. Our cash and cash equivalents, short-term investments, working capital and debt obligations are as follows (in thousands): 46-------------------------------------------------------------------------------- Table of Contents Fiscal 2012 2011 Cash and cash equivalents $ 67,761 $ 167,061 Short-term investments 157,168 53,142 Working capital 460,697 418,241 Total debt obligations 19 34 Contractual Obligations and Off-Balance Sheet Arrangements We have no off-balance sheet arrangements as defined by Regulation S-K of the Securities Act of 1933. The following summarizes our contractual obligations at September 29, 2012 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands): Less than More than Total 1 year 1 to 3 years 3 to 5 years 5 years Long-term debt payments $ 19 $ 17 $ 2 $ - $ - Operating lease payments 42,053 8,721 13,297 10,308 9,727 Asset retirement obligations 2,299 - 1,077 38 1,184 Purchase commitments with suppliers 65,543 65,543 - - - Purchase obligations 6,763 6,565 198 - - Total $ 116,677 $ 80,846 $ 14,574 $ 10,346 $ 10,911 Because of the uncertainty as to the timing of such payments, we have excluded cash payments related to our contractual obligations for our deferred compensation plans aggregating $25.7 million at September 29, 2012.

As of September 29, 2012, we recorded gross unrecognized tax benefits of $27.6 million including gross interest and penalties of $1.6 million. As of October 1, 2011, we recorded gross unrecognized tax benefits of $33.7 million including gross interest and penalties of $3.4 million. Both gross unrecognized tax benefits and gross interest and penalties are classified as non-current liabilities in the consolidated balance sheet. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years due to uncertainties in the timing of tax audit outcomes. As a result, these amounts are not included in the table above.

Changes in financial condition Cash provided by operating activities in fiscal 2012 was $64.8 million, which included net income of $63.0 million, depreciation and amortization of $29.6 million, stock-based compensation expense of $16.3 million and the $4.1 million write-off of Hypertronics intangibles partially offset by cash used by operating assets and liabilities of $42.0 million, increases in net deferred tax assets of $4.8 million and $1.4 million other.

Cash used in investing activities in fiscal 2012 of $142.9 million included $103.5 million net purchases of available-for-sale securities, $35.7 million, net, used to acquire property and equipment and improve buildings and $3.7 million used to acquire Midaz.

Cash used in financing activities in fiscal 2012 was $15.0 million, including $25.0 million used to repurchase our common stock and $3.3 million other partially offset by $13.3 million generated from our employee stock purchase plans.

Changes in exchange rates in fiscal 2012 resulted in a decrease in cash balances of $6.1 million.

RECENT ACCOUNTING PRONOUNCEMENTS See Note 2. "Significant Accounting Policies" in the Notes to Consolidated Financial Statements under Item 15 of this annual report for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our consolidated financial position, results of operations and cash flows.

APPLICATION OF CRITICAL ACCOUNTING POLICIES Our discussion and analysis of financial condition and results of operations are based upon our 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 47-------------------------------------------------------------------------------- Table of Contents 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 fair values or a selling price hierarchy, for arrangements entered into subsequent to October 2, 2010, as more fully described in Note 2, "Significant Accounting Policies - Revenue Recognition," in our consolidated financial statements.

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 and integrators 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 as these services are provided.

For multiple element arrangements which include extended maintenance contracts, we allocate and defer the amount of consideration equal to the separately stated price and recognize revenue on a straight-line basis over the contract period.

Long-Lived Assets and Goodwill 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 the 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.

We have determined that our reporting units are the same as our operating segments as each constitutes a business for which discrete financial information is available and for which segment management regularly reviews the operating results. We make this determination in a manner consistent with how the operating segments are managed. Based on this analysis, we have identified two reporting units which are our reportable segments: CLC and SLS.

Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired (see Note 8 "Goodwill and Intangible Assets" in the Notes to Consolidated Financial Statements). We generally perform our annual impairment tests during the fourth quarter of each fiscal year using the opening balance sheet as of the first day of the fourth fiscal quarter, with any resulting impairment recorded in the fourth quarter of the fiscal year.

In September 2011, the FASB amended its guidance to simplify testing goodwill for impairment, allowing an entity to 48-------------------------------------------------------------------------------- Table of Contents first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. If an entity determines as a result of the qualitative assessment that it is more likely than not (> 50% likelihood) that the fair value of a reporting unit is less than its carrying amount, then the quantitative test is required. Otherwise, no further testing is required. We adopted this accounting guidance in the first quarter of fiscal 2012.

For fiscal 2010, we performed our annual goodwill impairment testing during the fourth quarter of fiscal 2010 using the opening balance sheet as of the first day of the fourth fiscal quarter and noted no impairment. Such analysis requires significant judgments and estimates to be made by management in particular related to the forecast. The assumed growth rates and gross margins as well as period expenses were determined based on internally developed forecasts considering our future plans. The assumptions used were management's best estimates based on projected results and market conditions as of the date of testing. Utilizing the Income Approach, we noted no impairment. Based on our evaluation, the fair values of each of the two operating segments significantly exceeded their carrying value. In order to test the sensitivity of these fair values, management further reviewed other scenarios relative to these assumptions to see if the resulting impact on fair values would have resulted in a different conclusion for the CLC and SLS reporting units. Sensitivity was applied to the discount rate used in the Income approach for both the CLC and SLS reporting units. The discount rate for the CLC and SLS reporting units could have been increased by more than 25% and still resulted in no impairment. Based on the outcome of this testing and sensitivity analysis, we decided it would not be necessary to utilize all three testing methods for this annual test.

Under the goodwill standards in effect for fiscal 2011, a company could carry forward the detailed determination of a reporting unit from one year to the next if certain criteria have been met. Those criteria include: the assets and liabilities that make up the reporting unit have not changed significantly since the most recent fair value determination, the most recent fair value determination resulted in an amount that exceeded the carrying amount of the reporting unit by a substantial margin, and based on an analysis of events that have occurred and circumstances that have changed since the most recent fair value determination, the likelihood that a current fair value determination would be less than the current carrying amount of the reporting unit is remote.

Based on our analysis and a review of the criteria, using the opening balance sheet as of the first day of the fourth quarter of fiscal 2011, we determined that we had met the requirements of the goodwill standard for carrying forward our fair value determination from fiscal 2010, and did not perform detailed testing of the fair value of our reporting units for fiscal 2011. Between the completion of that testing and the end of the fourth quarter of fiscal 2011, we noted no indications of impairment or triggering events to cause us to review goodwill for potential impairment; based on our evaluation, the fair values of each of the two operating segments significantly exceeded their carrying value as of that date.

In our fiscal 2012 annual testing, we performed a qualitative assessment of the goodwill by reporting unit during the fourth quarter of fiscal 2012 using the opening balance sheet as of the first day of the fourth quarter and concluded that it was more likely than not that the fair value of each of the reporting units exceeded its carrying amount. In assessing the qualitative factors, we considered the impact of these key factors: macroeconomic conditions, fluctuations in foreign currency, market and industry conditions, our operating and competitive environment, regulatory and political developments, the overall financial performance of our reporting units including cost factors and budgeted-to-actual revenue results. We also considered market capitalization and stock price performance. Based on our assessment, goodwill in the reporting units was not impaired as of the first day of the fourth quarter of fiscal 2012.

As such, it was not necessary to perform the two-step goodwill impairment test at that time.

As no impairment indicators were present during the fourth quarter of fiscal 2012, we believe these values remain recoverable.

At September 29, 2012, we had $77.7 million of goodwill, $9.5 million of purchased intangible assets and $115.1 million of property and equipment on our 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 fiscal 2010. In addition, if the price of our common stock were to significantly decrease combined with any other adverse change in market conditions, thus indicating that the underlying fair value of our reporting units or other long-lived assets may have decreased, 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 49-------------------------------------------------------------------------------- Table of Contents 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 approximately 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 stock-based compensation using fair value. We estimate the fair value of stock options granted using the Black-Scholes Merton model and estimate the fair value of market-based performance restricted stock units granted using a Monte Carlo simulation model. We use historical data to estimate pre-vesting option forfeitures and record stock-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 service-based restricted stock units using the intrinsic value method and amortize the value on a straight-line basis over the restriction period. We value market-based performance restricted stock units using a Monte Carlo simulation model and amortize the value over the performance period, with no adjustment in future periods, based upon the actual shareholder return over the performance period.

U.S. Generally Accepted Accounting Principles ("GAAP") 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 options 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 14 "Employee Stock Option and Benefit Plans" in the notes to the Consolidated Financial Statements under Item 15 of this annual report for a description of our stock-based employee compensation plans and the assumptions we use to calculate the fair value of stock-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 us estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets.

We record a valuation allowance to reduce our deferred tax assets 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 asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the valuation allowance for the deferred tax asset would be charged to income in the period such determination was made.

Federal income taxes have not been provided for on a portion of the unremitted earnings of foreign subsidiaries because such earnings are intended to be permanently reinvested. The total amount of unremitted earnings of foreign subsidiaries for which we have not yet recorded federal and state income taxes was approximately $270 million at fiscal 2012 year-end. The amount of federal and state income taxes that would be payable upon repatriation of such earnings are not practicably 50-------------------------------------------------------------------------------- Table of Contents determinable.

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