SPECTRA PHYSICS LASERS INC, 10-K, 1998-03-27

SPECTRA PHYSICS LASERS INC
10-K, 1998-03-27
SEMICONDUCTORS & RELATED DEVICES

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

FORM 10-K
(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

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

COMMISSION FILE NUMBER:
000-23461
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SPECTRA-PHYSICS LASERS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------

<TABLE>
<S> <C>
DELAWARE 77-0264342
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>

1335 TERRA BELLA AVENUE, MOUNTAIN VIEW, CALIFORNIA, 94043
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
650-961-2550

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

TITLE OF EACH CLASS:
NONE

NAME OF EACH EXCHANGE ON WHICH REGISTERED:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $0.01 PAR VALUE
(TITLE OF CLASS)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

As of February 28, 1998, 16,168,043 shares of common stock were
outstanding. The aggregate market value of the voting shares (based on the
closing price reported by the NASDAQ National Market System on February 27,
1998) of Spectra-Physics Lasers, Inc., held by nonaffiliates was $47,164,000.
For purpose of this disclosure, shares of common stock held by persons who own
5% or more of the outstanding common stock and shares of common stock held by
each officer and director have been excluded in that such persons may be deemed
to be 'affiliates' as that term is defined under the Rules and Regulations of
the Act. This determination of affiliate status is not necessarily conclusive.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be filed prior to April 30,
1998, pursuant to Regulation 14A of the Securities Exchange Act of 1934 are
incorporated by reference into Part III of this Form 10-K.
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PART I

ITEM I. BUSINESS

GENERAL

Spectra-Physics Lasers, Inc. (the "Company") is a leader in the design,
development, manufacture and distribution of lasers and laser systems for a
broad range of markets. The Company has been a pioneer in the laser industry and
has developed a proprietary and patented portfolio of laser, optic and related
manufacturing technologies. The Company offers two broad product lines: high
power semiconductor-based lasers and laser-based systems (high power
semiconductor lasers (HPSL) and semiconductor laser pumped solid state (SLPSS)
lasers) and conventional lasers and laser-related products. The Company's high
power semiconductor-based products range from semiconductor lasers, the basic
engine, through semiconductor laser pumped lasers to end user systems. Through
technological innovation, the Company is leading the transition to high power
semiconductor-based lasers from conventional lasers such as gas, liquid and lamp
pumped lasers. The Company has been at the forefront of high power
semiconductor-based laser technology for the last 14 years and is leveraging its
technical strengths to develop high power semiconductor-based lasers, which are
more efficient, reliable, cost-effective and compact than existing lasers. These
lasers are enabling many new applications and replacing conventional lasers in
existing applications in industrial, OEM and research and development markets.
According to Strategies Unlimited, a market research firm, the use of high power
semiconductor-based lasers is expected to increase approximately 30% to 40%
annually over the next several years.

The Company is also a leading supplier of conventional lasers and
laser-related products to industrial and research and development customers.
These lasers, while based upon older technology, have unique performance
characteristics that make them the only current solution for certain demanding
technical applications. According to Laser Focus World, the market for high
power conventional lasers is expected to grow from $1.2 billion in 1997 to $1.4
billion in 1998. The Company's conventional products include ultrafast systems,
amplifier systems, optical parametric oscillators, air and water-cooled ion
lasers, high energy flash lamp pumped YAG lasers, optics and optical systems.
The Company's strong market position and technology leadership in these
conventional laser applications enhances its opportunity to expand its high
growth semiconductor-based laser business by generating funds, capitalizing on
strong customer relationships and leveraging its technological expertise.

The Company works closely with its customers to develop its products and is
focused on providing innovative solutions to customer needs. To control critical
aspects of product quality, significantly improve time-to-market, reduce costs
and identify new applications, the Company has vertically integrated into
strategic technologies. The Company sells its products to a wide range of
customers for use in a variety of applications such as commercial printing,
materials processing, medical, research and development, optical data storage
and semiconductor manufacturing, inspection and repair. The Company's customers
include 3D Systems, Becton Dickinson, DaiNippon Screen, Electro-Scientific
Industries, Haemonetics, IBM, KLA/ Tencor, Komag, Presstek, Rofin-Sinar, Seagate
and Western Digital.

Spectra-Physics AB, a multinational corporation based in Sweden which is
listed for trading on the Stockholm Stock Exchange, indirectly owns 80.4% of the
Company's outstanding Common Stock.

Prior to the Reorganization described below, the Company, Opto Power
Corporation ("Opto Power") and Spectra-Physics Laser Data Systems, Inc. ("Laser
Data"), together with various foreign subsidiaries of Spectra-Physics AB that
conducted sales and technical support operations on their behalf, were operated
as a functional group called the Lasers and Optics Group (collectively, the
"Lasers and Optics Group"). In preparation for the Company's initial public
offering, the Lasers and Optics Group was reorganized (the "Reorganization") in
October 1997 so that the assets and liabilities (including contractual rights
and obligations) of the Lasers and Optics Group are now held directly or
indirectly by the Company. In connection with the Reorganization, the Company
entered into certain agreements with Spectra-Physics AB or its subsidiaries
relating to certain aspects of the ongoing relationships between them, such as
administrative support services and distribution, facilities leasing, trademark
and patent license arrangements. In Decem-

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ber 1997, the Company also entered into a registration rights agreement with
Spectra-Physics Holdings USA, Inc. ("Holdings"), a wholly-owned subsidiary of
Spectra-Physics AB.

In December 1997, the Company completed an initial public offering of
2,400,000 shares of common stock, at an offering price of $10.00 per share. An
additional 360,000 shares of common stock were sold in January 1998 in
accordance with an overallotment option granted to the underwriters. The net
proceeds from the sale of these shares was approximately $23.9 million.

STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT

Certain information in this Annual Report on Form 10-K, including but not
limited to the Management's Discussion and Analysis of Financial Condition and
Results of Operations, may constitute forward-looking statements as such term is
defined in Section 27A of the Securities Act of 1933 (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934. Certain forward-looking
statements can be identified by the use of forward-looking terminology such as,
"believes," "expects," "may," "will," "should," "seeks," approximately,"
"intends," "plans," "estimates," or "anticipates" or the negative thereof or
other comparable terminology, or by discussions of strategy, plans or
intentions. Forward-looking statements involve risks and uncertainties,
including those described in the Risk Factors section of Item 1 of this Annual
Report on Form 10-K, which could cause actual results to be materially different
than those in the forward-looking statements. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof. The Company assumes no obligation to update such information.

RISK FACTORS

Fluctuations In Quarterly Operating Results

The Company's operating results have fluctuated significantly in the past
and are expected to fluctuate in the future on a quarterly and annual basis as a
result of a number of factors, many of which are beyond the Company's control.
Results in any period could be affected by changes in market demand, competitive
market conditions, market acceptance of new or existing products, fluctuations
in foreign exchange rates, the cost and availability of components, the
Company's ability to manufacture and ship products, the mix of the Company's
customer base and sales channels, the mix of products sold, the Company's
ability to expand its sales and marketing organization effectively, the
Company's ability to attract and retain key technical and managerial employees
and general economic conditions. Due to the foregoing factors, the Company's
operating results in one or more future periods are expected to be subject to
significant fluctuations. In the event such fluctuations result in the Company's
financial performance being below the expectations of public market analysts and
investors, the price of the Company's Common Stock would likely decline, perhaps
substantially.

Sales to individual customers are often related to a customer's specific
requirements, the timing of which is subject to change. From time to time, the
Company has experienced accelerations and slowdowns in shipments to customers,
causing changes in the sales level of a given quarter relative to both the
preceding and subsequent quarters. A significant portion of the Company's sales
are to customers in the research and development market. Sales into this market
have historically varied from quarter-to-quarter due to seasonal fluctuations
and governmental spending patterns. In addition, announcements by the Company or
its competitors of new products or technologies could cause customers to defer
purchases of the Company's existing products. In the event that anticipated
orders from customers fail to materialize, or delivery schedules are deferred or
canceled as a result of the above factors or other unanticipated factors, the
Company's business, operating results and financial condition would be
materially adversely affected. As a result, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indicative of future performance.

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and in part from the Company's incentive compensation plan which compensates
employees based on annual results. The Company recognizes that the non-linear
pattern of its shipments leads to inefficiencies in asset and employee
utilization. The Company is taking steps to mitigate this sales trend, but this
pattern is likely to continue in the near term.

Despite the fluctuations in its quarterly sales patterns, the Company's
operating expenses are incurred on an approximately ratable basis. As a result,
if expected sales are deferred for any reason, the Company's business, operating
results and financial condition could be materially adversely affected.

The Company's gross margin is affected by a number of factors, including
product mix, product pricing, cost of components, the proportion of third party
products incorporated into the Company's systems, foreign exchange rates and
manufacturing costs. For example, since semiconductor-based lasers and laser
systems generally have higher gross margins than conventional lasers, absent
other factors, a shift in sales toward semiconductor-based lasers and systems
would lead to a gross margin improvement for the Company. On the other hand, if
market conditions in the highly competitive conventional laser market forced the
Company to lower unit prices, the Company would suffer a decline in gross margin
unless the Company were able to timely offset the price reduction by a reduction
in production costs or by sales of other products with higher gross margins.
Either of these events could have a material effect on the Company's business,
operating results and financial condition.

The Company's backlog on a given date consists of written purchase orders
or other commitments for products which are scheduled to be shipped within the
following twelve months. Orders in backlog are firm, but are generally subject
to cancellation or rescheduling without penalty. Decisions by customers to
reduce inventory levels could lead to reductions in purchases from the Company
and could have a material adverse effect on the Company's business, operating
results and financial condition.

Control by Principal Stockholder

Spectra-Physics AB beneficially owns 80.4% of the outstanding shares of
Common Stock of the Company. As a result, Spectra-Physics AB will be able to
control the outcome of matters requiring stockholder approval, including the
election of directors, and will have the ability to control the business and
affairs of the Company. So long as Spectra-Physics AB continues to beneficially
own a significant amount of the Company's outstanding Common Stock, only a
limited percentage of the Common Stock will be traded in the public market.

The Company has entered into certain agreements with Spectra-Physics AB or
its affiliates relating to certain aspects of the ongoing relationships between
them, such as tax sharing, administrative support service, office space rental
and trademark and patent license arrangements. Accordingly, the Company will
depend in part on its continuing relationship with Spectra-Physics AB.

Risks Associated with Sole Suppliers and Limited Sources

A number of components necessary for the manufacture and operation of many
of the Company's products such as crystals, ceramic components and Q switches
are obtained from sole suppliers or a limited group of suppliers. The Company
has experienced shortages of such supplies in the past. The Company does not
maintain any long-term supply agreements with any of its suppliers. The
Company's reliance on sole or a limited group of suppliers involves several
risks, including a potential inability to obtain an adequate supply of required
components and reduced control over pricing. The disruption or termination of
any of these sources could have a material adverse effect on the Company's
business, operating results and financial condition. Any inability to obtain
adequate deliveries or any other circumstance that would require the Company to
seek alternative sources of supply or to manufacture such components internally
could significantly delay the Company's ability to ship its products, which
could damage relationships with current and prospective customers and could have
a material adverse effect on the Company's business, operating results and
financial condition.

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Dependence on Key Personnel

The success of the Company depends to a significant degree on the efforts
of the Company's senior management team. The Company's operations may be
adversely affected if one or more members of senior management were to leave the
Company. The Company is also dependent upon its ability to attract and retain
qualified employees, particularly highly skilled design, process and test
engineers involved in the manufacture of existing products and the development
of new products and processes. The competition for such personnel is intense,
and the loss of key employees or the failure to attract qualified new employees
could have a material adverse effect on the Company's business, operating
results and financial condition.

Manufacturing Risks

The manufacture of certain of the laser and optic components, products and
systems sold by the Company is a highly complex and precise process. As a result
of the technical complexity of the Company's products, changes in the Company's
or its suppliers' manufacturing processes, or the inadvertent use of defective
or contaminated materials by the Company or its suppliers, could result in a
material adverse effect on the Company's ability to achieve acceptable
manufacturing yields and product reliability. To the extent the Company does not
achieve such yields or product reliability, its business, operating results,
financial condition and customer relationships would be adversely affected.

The Company relies exclusively on its own production capability to
manufacture certain strategic components, optics and optical systems,
semiconductor lasers, lasers and laser-based systems. Because the Company
manufactures, packages and tests these components, products and systems at its
own facilities, and such components, products and systems are not readily
available from other sources, any interruption in manufacturing resulting from
shortages of parts or equipment, fire, earthquake, natural disaster, equipment
failures or otherwise would have a material adverse effect on the Company's
business, operating results and financial condition.

Dependence on Key Markets and Successful Identification of New Markets

The Company's current products serve many applications in the commercial
printing, materials processing, medical, research and development, optical data
storage and semiconductor manufacturing, inspection and repair markets. No
assurances can be given that these markets will continue to generate significant
or consistent demand for the Company's products. Existing markets could be
significantly diminished by new technologies or products that replace or render
obsolete the Company's technologies and products. The Company is dependent on
successfully identifying new markets for its products. There can be no assurance
that the Company will be able to successfully identify new high-growth markets
in the future. Moreover, there can be no assurance that new markets will develop
for the Company's or its customers' products, or that the Company's technology
or pricing will enable such markets to develop.

Dependence on Key Customers

The Company's customers are generally not contractually obligated to
purchase any specified quantity of products in any particular period, and
product sales to major customers have varied widely from quarter to quarter and
year to year. There can be no assurance that the Company's current customers
will continue to place orders with the Company, that orders by existing
customers will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers. Loss of, or a material
reduction in orders by, one or more of the Company's major customers would have
a material adverse effect on the Company's business, operating results and
financial condition. Even if relationships with existing major customers
continue, such customers' requirements for the Company's products will depend on
the success of their product development, marketing, sales and other business
efforts. The Company's or its customer's products could be replaced or made
obsolete by other technologies or products, potentially leading to an adverse
impact on the Company's business, operating results and financial condition.

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Risks of Managing Future Growth

Any significant growth in the Company's sales or any significant expansion
in the scope of its operations would likely strain the Company's management,
financial, manufacturing and other resources and may require the Company to
implement and improve a variety of operating, financial and other systems,
procedures and controls. While the Company plans significant expansion of its
manufacturing, sales, accounting and other information systems to meet these
challenges, there can be no assurance that these efforts will succeed, or that
any existing or new systems, procedures or controls will be adequate to support
the Company's operations or that its systems, procedures and controls will be
designed, implemented or improved in a cost effective and timely manner. Any
failure to implement, improve and expand such systems, procedures and controls
in a timely and efficient manner could have a material adverse effect on the
Company's business, operating results and financial condition.

Rapid and Fundamental Technological Change

The laser and optics industry is characterized by extensive research and
development expenditures and rapid technological change. The development by
current or future competitors of new or improved products, processes or
technologies may make the Company's current or proposed products obsolete or
less competitive. Although the Company devotes significant resources to further
develop and enhance its existing products, including its semiconductor-based
lasers, there can be no assurance that new or alternative technologies will not
make the Company's products obsolete or less competitive. The Company's future
business, operating results and financial condition will depend on its ability
to enhance its existing products, develop new products that address the
particular needs of its customers and respond to technological advances and
emerging industry standards and practices.

Competition

The Company's various markets are highly competitive. The Company's overall
competitive position depends on a number of factors including the price, quality
and performance of its products, the level of customer service, the development
of new technology and the Company's ability to participate in emerging markets.
The Company faces competition from three primary sources: current direct
competitors, potential competitors and suppliers of new technologies. The
Company offers a range of components, subsystems, products and systems and has a
number of competitors worldwide in various segments of its markets. In its HPSL
markets, direct competitors include SDL, Inc., Siemens and Thompson-CSF. In its
SLPSS laser markets, major competitors include Coherent, Inc. and Lightwave
Electronics Inc. In the laser disk texturing market, the Company's major
competitor is IBM Corporation. In its other product markets, the Company's major
competitors include Coherent Inc., Continuum (a division of Hoya) and Uniphase
Corporation. None of the Company's competitors competes in all of the product
areas and industries currently served by the Company. However, as existing or
new markets continue to grow, the Company expects that new competitors will
emerge and present competitors will seek to increase their market share.

reduced margins or loss of market share, any of which could materially and
adversely affect the Company's business, operating results and financial
condition. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive pressures
faced by the Company will not have a material adverse effect on its business,
operating results and financial condition. The Company expects that both direct
and indirect competition will increase in the future. Additional competition
could adversely affect the Company's business, operating results and financial
condition through price reductions or loss of market share.

Dependence on Proprietary Technology; Risk of Patent Infringement Claims

The Company's future success and competitive position is dependent upon its
proprietary technology, and the Company relies on patent, trade secret,
trademark and copyright law to protect its intellectual property. There can be
no assurance that the patents owned or licensed by the Company will not be
invalidated, circumvented, challenged or licensed to others, that the rights
granted thereunder will provide competitive advantages to the Company or that
any of the Company's pending or future patent applications will be issued within
the scope of the claims sought by the Company, if at all. Furthermore, there can
be no assurance that others will not develop technologies that are similar or
superior to the Company's technology, duplicate the Company's technology or
design around the patents owned by the Company. In addition, effective
copyright, patent and trade secret protection may be unavailable, limited or not
applied for in certain foreign countries. Certain of the Company's technology is
licensed on a non-exclusive basis from third parties which may license such
technology to others, including competitors of the Company. There can be no
assurance that the steps taken by the Company to protect its technology will
prevent misappropriation of such technology.

From time to time the Company has received and expects in the future to
receive notices of claims of infringement of other parties' proprietary rights.
There can be no assurance that infringement claims (or claims for
indemnification resulting from infringement claims) will not be asserted against
the Company or will not result in an injunction against the sale of allegedly
infringing products or otherwise materially adversely affect the Company's
business, operating results and financial condition.

Risks Associated With International Sales

International sales accounted for approximately 45%, 52%, and 60%, of the
Company's net sales in 1997, 1996 and 1995, respectively. International sales
carry a number of inherent risks, including exposure to currency fluctuations,
potentially adverse tax consequences, reduced protection for intellectual
property rights in some countries, the impact of recessionary environments in
economies outside the United States, generally longer receivable collection
periods, changes in political and regulatory environments, tariffs and other
potential trade barriers. In addition, certain of the Company's international
sales are subject to export licensing and approvals by U.S. governmental
agencies. Although to date the Company has experienced no significant difficulty
in obtaining such licenses or approvals, the failure to obtain such licenses or
approvals or comply with such regulations in the future could have a material
adverse effect on the Company's business, operating results and financial
condition.

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Potential Adverse Impact of Environmental and Other Governmental Regulations

The Company's facilities and operations are subject to a wide variety of
foreign, federal, state and local environmental laws, regulations and
ordinances, including those related to air emissions, wastewater discharges and
chemical and hazardous waste management and disposal ("Environmental Laws"). The
Company's operations also are governed by laws relating to workplace safety and
worker health, primarily the Occupational Safety and Health Act ("Employee
Safety Laws"). Further, compliance with Environmental Laws also may require the
acquisition of permits or other authorizations for certain activities and
compliance with various standards or procedural requirements. Although the
Company believes that its operations are in compliance in all material respects
with current requirements under Environmental Laws and Employee Safety Laws, the
nature of the Company's operations exposes it to the risk of liabilities or
claims with respect to such matters.

Certain of these Environmental Laws, including the Comprehensive
Environmental Response, Compensation and Liability Act, as amended by the
Superfund Amendments and Reauthorization Act of 1986 ("CERCLA") and similar
state laws (collectively, "Superfund Laws"), hold owners or operators of land or
businesses liable for their own and for previous owners' or operators' releases
of hazardous or toxic substances, materials or wastes, pollutants or
contaminants, including petroleum and petroleum products ("Hazardous
Substances"). Such Superfund Laws also provide for responses to and liability
for releases of certain Hazardous Substances into the environment. The nature of
the Company's operations and the long history of industrial uses at some of its
current or former facilities expose the Company to risk of liabilities or claims
under Superfund Laws. The Company has received three notifications from state or
federal environmental regulatory agencies stating that the Company may be
potentially responsible under Superfund Laws for the release of Hazardous
Substances generated by its former operations at three locations. The Company
responded to the inquiries by asserting that it was not responsible for response
activities at any of these sites. Since the Company provided its responses, the
environmental regulatory agencies have not pursued the Company as a potentially
responsible party at two of the sites and the Company received a letter from the
environmental agency stating that it does not consider the Company as a
potentially responsible party at this time at the third site.

Since 1984, the Company's facilities in Mountain View, California
("Mountain View Site") have been undergoing investigation and remediation in
response to past releases of industrial solvents to the soil and groundwater. In
addition, the impacted groundwater has migrated to what is referred to as the
North Bayshore Area. As a result of these past releases, the Mountain View Site
and other neighboring sites are listed on the National Priorities List ("NPL" or
the "Superfund List") under CERCLA. The Company is subject to orders issued by
the California Regional Water Quality Control Board ("Orders") that require the
Company to perform remediation on- and off-site and investigate other
potentially responsible parties. Pursuant to the Orders and other orders issued
to other responsible parties, the Company and other responsible parties are
jointly performing and funding remediation which includes soil treatment and
on-site and off-site groundwater extraction, treatment and monitoring. All of
the required soil and groundwater remediation and monitoring systems currently
required by the Order are in place, and consequently the initial capital
expenses for such systems have been incurred. In October 1997, the Company was
served with a complaint that had been filed in the Superior Court of the State
of California seeking an unspecified amount of damages for personal injuries and
property damage incurred by residents of a single location alleged to have
resulted from the Company's and others' negligent and/or intentional handling of
toxic chemicals (Rosario Balcita et al. v. Teledyne Semiconductor,
Spectra-Physics Lasers, et al.). While the Company believes it has meritorious
defenses to the claims asserted in this lawsuit and intends to vigorously defend
itself in this case, the amount of loss, if any, that may result upon resolution
of this complaint is not currently estimable nor have any amounts been accrued
in the Company's financial statements. Accordingly, there can be no assurance
that the complaint will be resolved without adverse impact to the Company's
financial position or results of operations. There can be no assurances that
other parties will not come forward and claim personal injury or property
damage.

financial condition. However, future events, such as changes in existing laws
and regulations or their interpretation, or the discovery of heretofore unknown
contamination, may give rise to additional compliance costs or liabilities that
could have a material adverse effect on the Company's business, operating
results and financial condition. Compliance with more stringent laws or
regulations, as well as more vigorous enforcement policies of regulatory
agencies or stricter or different interpretations of existing laws, may require
additional expenditures by the Company that may be material.

Potential Sales of Stock by Holdings; Shares Eligible for Future Sale

Future sales by Holdings of the Company's Common Stock could adversely
affect the prevailing market price of the Common Stock. The Company and Holdings
have agreed not to offer, sell or otherwise dispose of any shares of Common
Stock except with respect to the Company's existing employee benefit plans,
without the prior written consent of NationsBanc Montgomery Securities, Inc.,
for a period of 180 days after December 11, 1997 (the "Lockup Period").
Following the Lockup Period, Holdings will be permitted to sell in the public
market specified amounts of Common Stock without registration pursuant to Rule
144 under the Securities Act of 1933, as amended (the "Securities Act"). In
addition, on December 8, 1997, the Company entered into a registration rights
agreement with Holdings that obligates the Company to register under the
Securities Act the shares of Common Stock owned by Holdings upon its demand.

No predictions can be made as to the effect, if any, that sales in the
public market of shares or the availability of additional shares for future sale
will have on the market price of the Common Stock. The market price of the
Common Stock could be adversely affected by future sales of Common Stock or the
perception that such sales may occur.

Certain Anti-Takeover Matters; Possible Issuance of Preferred Stock

Certain provisions of Delaware law, the Company's Certificate of
Incorporation and the Company's Bylaws could delay or make more difficult a
merger, tender offer or proxy contest involving the Company. The Company is
subject to Section 203 of the Delaware General Corporation Law ("DGCL") which,
subject to certain exceptions, prohibits a Delaware corporation from engaging in
any of a broad range of business combinations with any "interested stockholder"
for a period of three years following the date that such stockholder became an
interested stockholder. Under the Company's Certificate of Incorporation and
Bylaws, the directors may enlarge the size of the Board and fill any vacancies
on the Board. The Company's Bylaws provide that nominations for directors may
not be made by stockholders at any annual meeting unless the stockholder
intending to make a nomination notifies the Company of its intention a specified
period in advance and furnishes certain information, and require advance notice
of business to be brought by a stockholder before the annual meeting. The shares
of the Company's Preferred Stock may be issued in the future without further
stockholder approval and upon such terms and conditions, and having such rights,
privileges and preferences, as the Board of Directors may determine. The rights
of holders of Common Stock will be subject to, and may be adversely affected by,
the rights of any holders of Preferred Stock that may be issued in the future.
The issuance of Preferred Stock and the application of Section 203 of the DGCL
and certain other provisions of the Company's Certificate of Incorporation and
Bylaws could have the effect of discouraging, delaying or preventing a change of
control of the Company.

INDUSTRY BACKGROUND

A laser uses energy from a power source to stimulate a particular type of
material, which creates and emits photons (i.e., light). The light emitted by
lasers is more intense and has higher purity than the light emitted by
conventional light sources. These characteristics enable applications in several
broad markets such as telecommunications, medical and semiconductor
manufacturing. The principal factors that distinguish different types of lasers
and determine the particular laser suitable for a specific application are
wavelength (color) output power, repetition rate, cost and operating life.

During the early years of laser development in the 1960s and 1970s, lasers
were relatively expensive and large, and had low reliability and performance
characteristics. Consequently, lasers were used primarily for

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scientific research and limited industrial applications where there were few
alternatives to lasers. Since then, improvements in laser technology have
resulted in lower cost, smaller, more reliable and more efficient lasers. As a
result, the use of lasers for industrial and other commercial applications has
increased significantly. Today, lasers are used in a wide range of applications
and various markets including biotechnology, consumer electronics, industrial
process control, materials processing, measurement, medical, printing, research
and development, semiconductor manufacturing and telecommunications. According
to Laser Focus World, the worldwide market for lasers grew from approximately
$1.0 billion in 1993 to an estimated $3.2 billion in 1997, which represents a
compound annual growth rate of approximately 35%.

Lasers can be generally classified into four basic types: gas, liquid, lamp
pumped and semiconductor-based. A significant portion of the installed base of
lasers is comprised of gas, liquid and lamp pumped lasers. The principal markets
for these conventional lasers have been materials processing, medical and
scientific applications. According to Laser Focus World, the market for high
power conventional lasers was approximately $1.2 billion in 1997, and is
expected to increase to approximately $1.4 billion in 1998. Despite continuous
advances in technology, significant shortcomings still exist with most
conventional lasers. Most gas lasers are large, expensive, inefficient and
fragile, many liquid lasers use carcinogenic dyes and have limited performance
ranges, and lamp pumped lasers are limited by their dependence on inefficient
and unreliable incandescent lamps. These lasers, while based upon older
technology, have unique performance characteristics that make them the only
current solution for certain demanding technical applications.

Semiconductor-based lasers are a relatively new and innovative technology.
A semiconductor-based laser creates light from the flow of an electric current
through a specially designed semiconductor device. Semiconductor-based lasers
include both high and low powered devices as well as semiconductor laser pumped
solid state lasers.

The laser industry has been characterized by a high degree of technological
innovation. Today, the laser industry is undergoing a fundamental technology
transition to semiconductor-based lasers from conventional lasers. This
transition is being driven by a number of advantages of semiconductor-based
lasers including:

- Lower Operating Cost. The annual costs for power and water to operate a
10 W SLPSS laser is less than 5% of the cost to operate a gas laser. For
example, the annual cost in California for power and water to operate a
10 W SLPSS laser for 2,000 hours is $300, compared to more than $17,000
for a 10 W gas laser.

- Smaller Size. Semiconductor-based lasers are much smaller than
conventional lasers of comparable power. For example, a 10 W
semiconductor-based laser is one-tenth the size of a 10 W gas laser, and
semiconductor laser diodes can be as small as a grain of salt.

- Higher Reliability. Semiconductor pumped solid state lasers have
lifetimes exceeding 10,000 hours, compared to 500 hours for a lamp pumped
laser.

- Greater Efficiency. Semiconductor lasers convert electrical power to
light much more efficiently, converting greater than 40% of input power
compared to 0.02% for a gas laser.

As a result of the foregoing advantages, semiconductor-based lasers are
replacing conventional laser technologies in existing applications as well as
enabling many new applications. However, semiconductor-based lasers currently
cannot address applications that require very high power output and laser light
of certain wavelengths. Conventional lasers are the only solution for these
technically demanding applications due to their unique performance
characteristics.

The semiconductor-based laser market generally can be divided into two
categories: low power (less than 0.5 W), such as lasers used in CD players and
laser printers, and high power (0.5 W or greater). To date, the greatest
penetration of semiconductor-based lasers has been in applications that require
low power. As high power semiconductor-based laser technology continues to
advance, the use of high power semiconductor-based lasers is expected to
increase approximately 30% to 40% annually over the next several years according
to Strategies Unlimited, a market research firm.

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<PAGE> 11

Customers for high power semiconductor-based lasers are seeking improved
performance and reliability, reduced cost and a greater number of product
offerings. Faced with these challenges and increasing time-to-market pressures,
customers are increasingly relying upon third party technology providers for
further innovations in lasers, optics and other related technologies. Meeting
these requirements is extremely complex and requires significant expertise,
breadth of technology and engineering resources and a substantial financial
commitment.

STRATEGY

The Company has been a leading supplier of lasers and laser systems for
over 35 years and has been developing high power semiconductor-based lasers for
the last 14 years. The Company has a significant proprietary and patented
portfolio of lasers, optics and other related laser and manufacturing
technologies. As a result, the Company believes that it is uniquely positioned
to capitalize on the significant market opportunities for high power
semiconductor-based lasers and end-user systems. Key elements of the Company's
strategy include the following:

Capitalize on Leadership in Semiconductor-based Laser Technology. To
enhance its leadership position, the Company is continuing to focus substantial
resources on semiconductor-based laser technology, enabling the Company to
continue developing new products for existing and emerging markets. For example,
the Company recently commenced shipments of the world's highest power single
emitter semiconductor laser and the world's highest power commercially available
semiconductor laser bar. The Company also recently began shipping a 40 kHz, 355
nm UV laser for the stereolithography market.

Develop New Applications and Markets. The Company leverages its technology
and close working relationships with its key customers to develop innovative
solutions to complex customer requirements. In response to specific customer
needs, the Company has developed systems incorporating laser technology in
applications such as hard disk texturing and floptical disk manufacturing, and
is working with customers to develop systems incorporating laser technology in
enhanced magnetic resonance imaging, fiber laser pumping, diamond machining and
PC board drilling.

Introduce Systems Products. The Company's expertise in semiconductor-based
laser and optics technology has enabled it to successfully introduce and market
systems products in the disk drive industry. The Company's LZT-500 and LZT-1000
systems, which the Company commenced shipping in April 1997, use a
Spectra-Physics SLPSS laser and optical beam train together with custom hardware
and software to laser zone texture hard disks. Laser disk texturing systems
enable an increase in the storage capacity of a hard disk. The Company is
focused on developing other laser data storage systems based on its laser and
optics technology.

Continue Supporting Conventional Laser Technology. The Company intends to
maintain a leadership position in the supply of conventional laser systems
through continued targeted research and development investments. The Company
also intends to seek new applications for certain conventional technologies such
as the application of ultra-fast technology to inspect and test semiconductor
wafers.

Leverage Benefits of Strategic Vertical Integration. The Company has
vertically integrated into strategic laser technologies, components and
manufacturing processes such as optics and semiconductor wafers, and expects to
continue such strategic vertical integration in the future. This vertical
integration enables the Company to control the quality of strategic components,
significantly improve time-to-market for new products and technologies and more
easily identify new applications.

MARKETS

The Company produces a broad range of lasers, laser systems, optics,
optical systems and end user systems for the industrial, OEM and research and
development markets. The primary applications for the Company's products in
these markets are as follows:

- Printing/Graphics. Historically, the commercial printing market has used
silver halide-based film. In recent years, the commercial printing
industry has increasingly shifted to thermal-based materials
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<PAGE> 12

which require high power semiconductor-based lasers in the film exposure
process. The Company believes that the incremental use of thermal-based
materials for commercial printing will increase the demand for high power
semiconductor-based lasers. The Company's high power semiconductor-based
lasers are being used in conjunction with thermal-based film development
by a number of major film suppliers.

- Materials Processing. Materials processing encompasses a wide range of
industrial processes that require the delivery of precisely controlled
heat or light. Major segments of this market include:

Hard Disk Texturing. In hard disk drive manufacturing, disks must be
roughened or "textured" to prevent the head from fusing to the smooth
surface of the disk causing the hard drive to "crash." Traditional
texturing involves the mechanical application of a diamond paste to the
entire disk surface. Laser-based texturing -- in which a laser is used to
create tiny bumps on the disk surface -- is rapidly replacing mechanical
texturing. A laser produces faster, cleaner, less wasteful and more
consistent texturing over a smaller area of the disk, enabling more of the
disk to be used for storage and in most cases doubling the disk's storage
capacity.

Stereolithography. Stereolithography is the computer generation of
three-dimensional objects from CAD/CAM system input which typically is
used for producing models, manufacturing prototypes, masters and patterns.
Stereolithography involves exposing a proprietary photopolymer with
ultraviolet light which "cures" the polymer creating a solid model in
hours. Traditional hand crafting or machining methods can take weeks or
even months to achieve the same result. Because of the advantages of SLPSS
lasers, they have replaced conventional lasers in stereolithography
applications requiring high power. The Company recently commenced
shipments of a 40 kHz, 355 nm UV laser for the stereolithography market.

Semiconductor Manufacturing, Inspection and Repair. Lasers are used to
adjust the electrical characteristics of resistors, to inspect
semiconductor wafers for defects and to repair semiconductor devices such
as DRAMs and SRAMs. Because of their high reliability and ease of use,
SLPSS lasers are widely used in these applications.

Marking. Marking applications include plastics marking (e.g., marking
the keys on a computer keyboard) and the marking of finished electronic
components (e.g., marking very small semiconductor packages in final
stages of semiconductor manufacturing). SLPSS lasers are replacing
conventional flash lamp pumped YAG lasers in these and other direct-write
marking applications where the performance characteristics of SLPSS lasers
are required.

- Research and Development. Research and development has historically been
a major market for conventional laser technology, such as water cooled
gas lasers, high energy flash lamp pumped YAG lasers and ultrafast
systems with an installed base of tens of thousands of lasers. As new
SLPSS lasers that can replicate the performance of conventional lasers
are developed, they are rapidly replacing conventional lasers in this
market. For example, in 1996 the Company commenced shipments of a 5 W CW
green SLPSS laser called the Millennia to research and development
customers. To date, over 500 Millennia lasers have been sold, many of
which are being used by research and development customers to replace
their existing water cooled ion lasers. Current applications for SLPSS
lasers in the research and development market include pump lasers for
ultrafast systems, confocal microscopy systems and seed lasers in
amplifier systems.

- Medical. Semiconductor-based lasers are increasingly used in therapeutic,
surgical, dental and diagnostic medical applications. Therapeutic
applications include a variety of skin treatments, such as hair removal,
and thermal treatments using endoscopic delivery to internal organs such
as the prostate. Surgical applications are expanding rapidly and now
include general purpose endoscopic contact and non-contact surgical
tools. Several diagnostic techniques, including magnetic resonance
imaging, also employ semiconductor lasers. In this market, the Company
provides semiconductor-based lasers to medical device OEMs.

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<PAGE> 13

- Other. Part of the Company's strategy is to continue to identify
applications for its technology in other markets. For example, the
Company is working with Lucent Technologies to develop fiber lasers for
the telecommunications market. Recently, the two companies announced that
a fiber laser jointly developed by them achieved record output power
levels. The Company's SLPSS lasers are also used for PC board drilling
and flat-panel display repair. Additionally, the Company manufactures and
sells conventional lasers for use in light shows and other entertainment
market applications.

PRODUCTS

The Company produces a broad range of lasers, laser systems, optics,
optical systems and end user systems. The Company's semiconductor-based laser
products include HPSLs, SLPSS lasers and other SLPSS-based systems. Conventional
products include gas lasers, flash lamp pumped yttrium aluminum garnet (YAG)
lasers, optical parametric oscillators (OPOs), amplifiers, accessories, optics
and optical systems, and related services.

The following chart illustrates the Company's principal products and their
applications.

<TABLE>
<CAPTION>
PRODUCT
----------------------------------------
LASER APPLICATION HPSL SLPSS SYSTEMS CONVENTIONAL
----------------- ---- ----- ------- ------------
<S> <C> <C> <C> <C>
Printing/Graphics............................. M M M
Materials Processing
-- Hard Disk Texturing...................... M M
-- Stereolithography........................ M M
-- Semiconductor and Micromachining......... M M M
-- Marking.................................. M M M
Research and Development...................... M M M M
Medical....................................... M M M
Other
-- Telecommunications....................... M M
-- Entertainment............................ M M M
</TABLE>

High Power Semiconductor Lasers. HPSLs are extremely efficient converters
of electrical power to light and are also highly efficient in focusing generated
light into small spots. While many applications require small spots of very
intense heat, many others, such as pumping crystals and illumination, depend on
the semiconductor laser's ability to create large amounts of nearly
monochromatic photons. These lasers are compact, enabling more cost effective
solutions to a large number of problems. Because the light from
semiconductor-based lasers is emitted in a pattern very different from other
lasers (more like a fan of light rather than a "beam"), the Company has
developed technology to couple the light into an optical fiber to enhance the
"beam" quality or more conveniently deliver the light to the desired location.

The Company manufactures a range of HPSL products with wavelengths from 785
nm to 980 nm and output powers from less than one Watt to two dimensional arrays
which produce hundreds of Watts. These products are available in various forms,
from bare diodes on heat sinks, to fiber-coupled single emitters and bars, to
two dimensional arrays, to fully integrated modules and
microprocessor-controlled units containing power supplies and active coolers.

Semiconductor Laser Pumped Solid State Lasers. SLPSS lasers use
semiconductor lasers to pump a crystal to produce laser beams with special
characteristics in terms of mode quality, power stability, optical noise,
monochromaticity or energy storage. Like HPSLs, SLPSS lasers are smaller, more
efficient, more reliable and less costly to operate than the conventional laser
technologies they are replacing.

The Company produces SLPSS lasers to satisfy a broad range of customer
requirements. Depending on customer needs, an SLPSS laser can combine various
features including a modular power supply and laser head designs, various
crystals, fiber coupling, and different repetition rates, pulse widths and
wavelengths. The Company's SLPSS lasers contain several design features that
distinguish them from competing products.

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<PAGE> 14

Examples of such features include: air cooled laser heads that do not require a
separate water supply; semiconductor lasers in the power supply rather than in
the head which allow the lasers to be replaced in the field without disturbing
system alignment; and lasers designed with significant overhead which increases
reliability and product life. The Company has also developed a complete line of
intelligent power supplies to satisfy demanding customer requirements. All of
these power supplies support remote mounting of the fiber-coupled HPSL to
enhance field serviceability.

Laser Disk Texturing Products. The Company's laser disk texturing products
offer significant advantages over conventional mechanical processing. The
Company's LZT-1000 has two main components: a laser texturing component, in
which a semiconductor-based laser creates tiny bumps on the surface of the
disks, and a material handling component, in which a robot inserts and removes
the disks from the laser texturing fixture. The Company's LZT-500 includes only
the laser texturing component which enables the customer to integrate the laser
texturing system into its own proprietary material handling process. Both of the
Company's laser disk texturing systems can process up to 300 disks per hour.

Conventional Products. The Company is a leading supplier of high power
conventional lasers to industrial and research and development customers. These
lasers, while based upon older technology, have unique performance
characteristics that make them the only current solution for certain demanding
technical applications. According to Laser Focus World, the market for high
power conventional lasers is expected to grow from $1.2 billion to $1.4 billion
in 1997. The Company's strong market position and technology leadership in these
conventional laser applications enhances its opportunity to expand its high
growth semiconductor-based laser business by generating funds, capitalizing on
strong customer relationships and leveraging its technological expertise. The
Company manufactures and sells a broad range of conventional laser products
including:

- Air-cooled gas lasers ranging from 5 to 75 mW (10 models)

- Water-cooled gas lasers ranging from 4 to 30 W (7 models)

- Flash lamp pumped YAG lasers ranging from 500 mJ to 3 J as well as 4
harmonic wavelengths (12 models)

- Ultrafast lasers with pulse widths as low as 50 femtoseconds (6 models)

- OPOs covering wavelengths from 220 nm to 2600 nm (4 basic models with
numerous options)

- Amplifiers covering a wide range of powers, wavelengths, pulse widths and
repetition rates (2 basic models with numerous options)

- Optics and optical systems with super-smooth surfaces (1 angstrom or
less), damage thresholds of up to 1000 watts per square millimeter of
continuous power and very low scatter optics

TECHNOLOGY

General. The word "laser" is an acronym for "light amplification by
stimulated emission of radiation." A laser consists of (i) an active lasing
medium that gives off its own light (radiation) when excited; (ii) an optical
resonator with a partially reflective output mirror at one end and a fully
reflective rear mirror at the other that permits the light to bounce back and
forth between the mirrors through the lasing medium; and (iii) an external
energy source used to excite the lasing medium. The energy source can be light
from special lamps, light from another laser, an electric current or a chemical
reaction. The lasing medium can be a gas (such as helium and neon, argon or
carbon dioxide), a liquid (such as an organic dye), a semiconductor material
(such as aluminum gallium arsenide) or a crystal (such as ruby, YAG or titanium
sapphire). A laser works by causing the energy source to excite (pump) the
lasing medium, converting the energy from the source into an emission consisting
of particles of light (photons). These photons stimulate the release of more
photons as they are reflected back and forth between the two mirrors that make
up the laser's resonator. The resulting build-up in the number of photons is
emitted in the form of a laser beam through the output port or "window" created
by the partially reflective mirror. By changing the energy and the lasing
medium, different wavelengths and types of laser light can be produced. Heat
generated by the excitation of the lasing medium is
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<PAGE> 15

dissipated through a cooling mechanism, which varies according to the type of
laser technology; lasers can be cooled by water, air or, in the case of
semiconductor-based lasers, heat sinks attached to the semiconductor lasers.

Laser light has three fundamental properties that distinguish it from
conventional "spontaneous emission" light sources: monochromaticity,
directionality and coherence. Monochromaticity refers to the purity of color or
spectral bandwidth of emitted light; directionality describes the degree of
collimation or parallelism of the light rays; and coherence refers to the phase
relationship of the light waves as they are propagated. Laser light features
each of these properties to a high degree, and laser design revolves around
modulating and combining the three properties to serve the requirements of
specific applications. For example, monochromatic laser light can be used to
probe the structure of atoms, control complex chemical reactions or produce
realistic three dimensional holograms. Highly directional and coherent laser
light can be focused to much smaller spot sizes than any ordinary light source
which enables a wide range of applications including printing, marking and
inspection and measurement. Lasers can be continuous wave, pulsed or modelocked
with varying repetition rates; they can have different bandwidths (more or less
monochromatic) and different line widths; and they come in different powers from
microJoules to thousands of Watts. Different laser designs result in various
output characteristics in terms of power, pulse width, repetition rate and
wavelength depending on the needs of the application.

Spectra-Physics Technology. Formed in 1961 as the first commercial laser
company, the Company has a long history of introducing innovative technologies
and laser products. Some of the innovative laser products successfully
introduced by the Company include: commercial argon gas lasers (1964), high
power helium neon lasers (1976), sealed cavity air cooled gas lasers (1981),
HPSLs (1983), fiber-coupled SLPSS lasers (1986), titanium-sapphire ultrafast
lasers (1990), FC bar semiconductor technology (1992), high power CW SLPSS green
lasers (1996) and the highest power (40 W) commercially available HPSLs (1997).

Recent examples of the Company's technological leadership in
semiconductor-based lasers and systems include its discovery of QMAD, a patented
technique for shortening the fundamental output wavelength from an SLPSS laser
that enables the Company to produce green lasers with powers up to 12 W. The
high efficiency QMAD technique has also enabled the Company to produce green
SLPSS lasers with lower powers for price sensitive OEM markets. The Company also
recently developed and commercialized high power semiconductor bars that produce
over 40 W of power -- twice as much as was commercially available previously. In
addition, the Company recently developed and commercialized a 40 kHz, 355 nm UV
SLPSS laser producing more than 300 mW of power. These new SLPSS lasers are
displacing large frame gas lasers in the stereolithography market.

The Company is also a technology leader in laser disk texturing systems.
The Company's disk texturing systems incorporate diffraction limited optics
capable of producing bumps less than 4 mm in diameter, an autofocus servo for
maintaining long term consistency of 62 nm in bump height and have the highest
throughput per dollar of system cost and the lowest cost per square foot of
clean room space.

The Company also has state-of-the-art technology in its conventional
products. For example, the Company's Tsunami offers the highest power, broadest
tunability and widest pulse width coverage of any commercial ultrafast system.
The Company has also recently introduced a new series of flash lamp pumped YAG
lasers, the PRO, which has the highest beam pointing and energy stability of any
commercial YAG laser system.

SALES AND MARKETING

The Company's sales and service strategy is to have one primary channel to
the customer on a worldwide basis. This is accomplished through a separate
distribution organization responsible for selling and servicing products
directly in several countries and through over 30 independent distributors in
the rest of the world. The Company has direct sales units in North America,
Japan, Germany, France, the Netherlands and the United Kingdom. The Company
began establishing international direct sales offices in the mid-1970s.
Distributors are managed by the Company's export unit which is based in Mountain
View, California and has an office in Darmstadt, Germany.
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<PAGE> 16

As of January 31, 1998, the Company's direct sales units employ
approximately 169 people performing sales, service engineering, customer support
and administrative functions. They are responsible for the complete order
fulfillment cycle, from quotation through order placement to delivery. The sales
organization is also responsible for bringing the appropriate marketing and
technical resources to bear on a customer's requirements and ensuring the
customer receives high-quality support.

The Company's sales strategy also involves establishing long-term
relationships with its customers. For industrial and OEM customers, this
relationship starts at the early design-in of the Company's lasers and laser
systems into customer applications. The Company supports its customers with
on-site field service, technical service engineers and training programs and
telephone support from its direct sales units. Each sales unit maintains an
inventory of critical components and certain replacement systems and sub-systems
to help minimize customer downtime. The Company in general warrants its products
for twelve to twenty-four months depending on the product line. Certain
manufacturing intensive industries such as the hard disk manufacturing industry
require high levels of support to minimize costly downtime. The Company provides
direct service to its hard disk drive customers which are principally located in
California, Japan, Taiwan and Southeast Asia.

The Company's marketing activities include: analyzing and understanding
future product requirements of the Company's target markets and translating
those requirements into product specifications and cost targets by working
closely with customers and key technologists in industry and academia; providing
applications engineering support as part of the sales process to industrial and
OEM customers; and product promotion, which includes participating in trade
shows and conferences and advertising through trade journals, new product
announcements and direct mailings.

Backlog consists of written purchase orders or other commitments for
products which are scheduled to be shipped within the following twelve months.
As of December 31, 1997, the Company's backlog was approximately $50.3 million,
compared with approximately $43.4 million at December 31, 1996. Orders in
backlog are firm, but are subject to cancellation or rescheduling by the
customer without penalty. Because of the possible changes in product delivery
schedules and cancellation of product orders and because the Company's sales
will often not reflect orders shipped in the same quarter that they are booked,
the Company's backlog at any particular date is not necessarily indicative of
actual sales for any succeeding period.

CUSTOMERS

Through its global distribution and service network the Company provides a
range of laser solutions to its major markets. The Company has over 2000
customers, over 800 of which are OEM customers and over 1200 are research and
development customers. The Company's major customers include: 3D Systems, Becton
Dickinson, DaiNippon Screen, Electro-Scientific Industries, Haemonetics, IBM,
KLA/Tencor, Komag, Presstek, Rofin-Sinar, Seagate and Western Digital. During
1997 and 1996, 60% and 55% of the Company's sales were in North America and
export, 20% and 22% were in Europe and 20% and 23% were in Japan, respectively.
No single customer accounted for more than 10% of the Company's sales for 1997
or 1996.

RESEARCH AND DEVELOPMENT

The Company's research and development activities are divided into two main
areas: advanced research in selected fields such as optics fabrication and
coating, HPSLs and SLPSS lasers; and product engineering which focuses on
designing and developing products for known, quantified markets with clearly
defined performance goals and cost targets. The primary focus of these research
and development efforts is high power semiconductor-based lasers and laser
systems. The Company often develops new products at the customer's design-in
stage in order to maximize the functionality of the product for the customer.
The Company's products are designed for manufacturability and serviceability. In
addition, high parts commonality is a goal that has been achieved on a number of
product lines through the use of common power supplies and laser head platforms.

In 1997, 1996 and 1995, the Company expended approximately $14.4 million,
$12.0 million, and $7.9 million, respectively, on internally funded research and
development. In 1996 and 1997, such expendi-
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<PAGE> 17

tures included significant investments in the development of the Company's laser
disk texturing system. The Company expects to continue to spend substantial
amounts on research and development activities. The Company's ability to
successfully compete will be substantially dependent on its ability to design,
develop and introduce new products on a timely basis.

As of January 31, 1998, the Company had approximately 113 employees engaged
in advanced research and product development and engineering, of whom
approximately 76 are professional engineers or have master's or doctor's degrees
(including 19 Ph.D.s) The Company's research and development activities are
carried out in Mountain View, California for SLPSS lasers, optical coatings,
laser disk texturing and conventional products, in Oroville, California for
optical systems and optics fabrication and in Tucson, Arizona for HPSLs. The
Company maintains close working relationships with several leading industrial,
government and university research laboratories around the world. Such
relationships include funding of third party research, joint development
programs and licensing of patents developed by such organizations. The Company
also participates in certain U.S. government funded programs such as Technology
Reinvestment Program (TRP), when the programs' objectives are consistent with
the Company's technology road map.

MANUFACTURING OPERATIONS

The Company's manufacturing activities include semiconductor laser
manufacturing, plasma tube manufacturing, optics fabrication and coating, fine
mechanics manufacturing and assembly, integration and test. One of the Company's
core business philosophies is to concentrate its manufacturing efforts on
strategic activities and to outsource production of other components. This
philosophy forms the basis for the Company's vertical integration into
semiconductor wafer fabrication, semiconductor lasers, optics fabrication and
coating and very fine mechanical parts. The Company believes each of these
operations is essential to the rapid development of new products and to
maintaining a high level of product quality.

The Company focuses substantial efforts on maintaining and enhancing the
efficiency and quality of its manufacturing operations. The Company uses kanban,
just-in-time and product flow line techniques to reduce manufacturing cycle
times and inventory levels and to enable it to offer on-time delivery and high
quality products to its customers.

The Company has manufacturing operations in Mountain View and Oroville,
California and Tucson, Arizona. The Company's four manufacturing operations in
Mountain View include research optics manufacturing, plasma tube manufacturing,
laser manufacturing and laser disk texturing manufacturing. The Company's
manufacturing operations in Tucson include semiconductor laser manufacturing and
integrated unit assembly. The Company has manufacturing operations in Oroville
that include optics fabrication and coating, optical system manufacturing and
metal component fabrication. The Company's principal manufacturing operations
are:

- Semiconductor Laser Manufacturing. The Company's semiconductor laser
manufacturing operation is vertically integrated and has capabilities in
wafer fabrication, wafer processing, bar processing, device packaging,
test and burn-in and fiber-coupling. The Company has three large scale
epitaxial deposition units, two of which are capable of handling 30 two
inch diameter wafers and one of which handles 15 two inch diameter
wafers.

- Plasma Tube Manufacturing. The Company makes three types of plasma tubes:
glass, metal beryllium oxide and metal ceramic. These tubes are used as
the photon source for its gas lasers.

- Optics Fabrication and Coating. The Company fabricates and coats most of
the optics used in its lasers. These operations are conducted in a
state-of-the-art facility constructed to Class 10,000 clean room
standards with portions of the building maintained at either Class 1000
or Class 100 levels as required.

- Fine Mechanics Manufacturing. The fine mechanics operation primarily
produces aluminum and stainless steel components with relatively high
feature content and surface finish requirements for use in the Company's
laser and optical systems.

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<PAGE> 18

- Research Optics Manufacturing. The Company's film coating facility is
designed for the development of new coating technology and the production
of very large optics up to three feet in diameter.

- Assembly, Integration and Test. As part of the manufacturing process, the
Company assembles, integrates and tests its systems, including laser,
laser disk texturing, optical and power supply systems.

INTELLECTUAL PROPERTY

The Company has approximately 150 active patents and approximately 85
additional patent applications pending. The Company also has a royalty-free
license to all of SDL's patents applied for or issued prior to June 25, 1993.

The Company's future success and competitive position is dependent upon its
proprietary technology, and the Company relies on patent, trade secret,
trademark and copyright law to protect its intellectual property. There can be
no assurance that any of the patents owned or licensed by the Company will not
be invalidated, circumvented, challenged or licensed to others, that the rights
granted thereunder will provide competitive advantages to the Company or that
any of the Company's pending or future patent applications will be issued within
the scope of the claims sought by the Company, if at all. Furthermore, there can
be no assurance that others will not develop technologies that are similar or
superior to the Company's technology, duplicate the Company's technology or
design around the patents owned by the Company. In addition, effective
copyright, patent and trade secret protection may be unavailable, limited or not
applied for in certain foreign countries. Certain of the Company's technology is
licensed on a non-exclusive basis from third parties which may license such
technology to others, including competitors of the Company. There can be no
assurance that the steps taken by the Company to protect its technology will
prevent misappropriation of such technology.

The laser and optics industry is characterized by frequent litigation
regarding patent and other intellectual property rights. Litigation has been
necessary and may be necessary in the future to enforce the Company's patents
and other intellectual property rights, to protect the Company's trade secrets,
to determine the validity and scope of the proprietary rights of others or to
defend against claims of infringement or invalidity. Such litigation has in the
past resulted in substantial costs and diversion of resources and any future
actions could have a material adverse effect on the Company's business,
operating results and financial condition. From time to time the Company has
received and expects in the future to receive notices of claims of infringement
of other parties' proprietary rights. There can be no assurance that
infringement claims (or claims for indemnification resulting from infringement
claims) will not be asserted against the Company or will not result in an
injunction against the sale of allegedly infringing products or otherwise
materially adversely affect the Company's business, operating results and
financial condition. The Company actively seeks to patent its inventions. The
Company frequently reviews its inventions and attempts to determine which ones
will provide substantial differentiation between the Company's products and
those of competitors. In certain cases, the Company may also choose to keep an
invention or a process a trade secret. Trade secrets are routinely employed in
the Company's semiconductor laser, optics and plasma tube manufacturing
operations. The Company generally enters into non-disclosure agreements with its
employees and consultants to protect its proprietary technology.

COMPETITION

The Company's various markets are highly competitive. The Company's overall
competitive position depends on a number of factors including the price, quality
and performance of its products, the level of customer service, the development
of new technology and the Company's ability to participate in emerging markets.
The Company faces competition from three primary sources: current direct
competitors, potential competitors and suppliers of new technologies. The
Company offers a range of components, subsystems, products and systems and has a
number of competitors worldwide in various segments of its markets. In its HPSL
markets, direct competitors include SDL, Inc., Siemens and Thompson-CSF. In its
SLPSS laser markets, major competitors include Coherent, Inc. and Lightwave
Electronics Inc. In the laser disk texturing market, the Company's major
competitor is IBM Corporation. In its other product markets, the Company's major
competitors include Coherent, Inc., Continuum (a division of Hoya) and Uniphase
Corporation. None

18
<PAGE> 19

of the Company's competitors competes in all of the product areas and industries
currently served by the Company. However, as existing or new markets continue to
grow, the Company expects that new competitors will emerge and present
competitors will seek to increase their market share.

New technologies may emerge to compete with the Company's products. In most
of the Company's product lines, both the Company and its competitors are working
to develop new technologies, or improvements and modifications to existing
technologies, which will render present products obsolete. There can be no
assurance that the Company's development efforts will be successful. In
addition, there can be no assurance that markets will develop for any such
future products, or that any such products will be competitive with other
technologies or products that may be developed by others. Some of the Company's
competitors have significantly greater financial, technical, manufacturing,
marketing, sales and other resources than the Company. In addition, some of
these competitors may be able to respond more quickly to new or emerging
technologies, evolving industry trends and changes in customer requirements and
to devote greater resources to the development, promotion and sale of their
products than the Company. There can be no assurance that the Company's current
or potential competitors will not develop or acquire products comparable or
superior to those developed by the Company, combine or merge to form larger,
more significant competitors, or adapt more quickly than the Company to new
technologies, evolving industry trends and changing customer requirements.
Increased competition has resulted and is expected in the future to result in
price reductions, reduced margins or loss of market share, any of which could
materially and adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able to
compete successfully against current or future competitors or that competitive
pressures faced by the Company will not have a material adverse effect on its
business, operating results and financial condition. The Company expects that
both direct and indirect competition will increase in the future. Additional
competition could adversely affect the Company's business, operating results and
financial condition through price reductions or loss of market share.

EMPLOYEES

At January 31, 1998, the Company had 848 full time employees, including 113
in research, development and engineering, 169 in sales, service and marketing,
468 in operations and 98 in general management, administration and finance. The
Company intends to hire additional personnel in each of these areas. The Company
also had approximately 47 temporary workers and consultants at January 31, 1998.
The Company's future success will depend in part on its ability to attract,
train, retain and motivate highly qualified employees, who are in great demand.
There can be no assurance that the Company will be successful in attracting and
retaining such personnel. The Company's employees are not represented by any
collective bargaining organization, and the Company has never experienced a
general work stoppage, slowdown or strike. The Company considers its employee
relations to be good.

ITEM 2. PROPERTIES

The Company conducts its business from office and manufacturing facilities
at six locations in Mountain View, California, two facilities in Oroville,
California and one facility in Tucson, Arizona. In the aggregate, the Company
occupies approximately 46,100 square feet of owned space and 129,500 square feet
of leased space in Mountain View, 51,350 square feet of leased space in Oroville
and 29,300 square feet of owned space in Tucson. The Company's lease agreements
have expiration dates ranging from 1998 to 2006. The Company leases sales and
service offices in Tokyo and Osaka, Japan, Darmstadt, Germany, Z.A. de
Courtaboeuf, France, Eindhoven, the Netherlands and Hemel Hempstead, Great
Britain.

The Company is expanding its facilities in Oroville, which is scheduled for
completion in the first half of 1998. Additionally, a 48,000 square foot
addition to the Tucson facility is currently being planned and is scheduled for
completion by the end of 1998. The Company believes that its existing facilities
and these expansions will be adequate for the Company to meet its needs for the
next 12 months. The Company believes that suitable additional or alternative
space will be available, if necessary, in the future on commercially reasonable
terms.

19
<PAGE> 20

ITEM 3. LEGAL PROCEEDINGS

The Company's facilities and operations are subject to a wide variety of
Environmental Laws and Employee Safety Laws. Further, compliance with
Environmental Laws also may require the acquisition of permits or other
authorizations for certain activities and compliance with various standards or
procedural requirements. Although the Company believes that its operations are
in compliance in all material respects with current requirements under
Environmental Laws and Employee Safety Laws, the nature of the Company's
operations exposes it to the risk of liabilities or claims with respect to such
matters.

Certain of these Environmental Laws, including Superfund Laws, hold owners
or operators of land or businesses liable for their own and for previous owners'
or operators' releases of Hazardous Substances. Such Superfund Laws also provide
for responses to and liability for releases of certain Hazardous Substances into
the environment. The nature of the Company's operations and the long history of
industrial uses at some of its current or former facilities expose the Company
to risk of liabilities or claims under Superfund Laws. The Company has received
three notifications from state or federal environmental regulatory agencies
stating that the Company may be potentially responsible under Superfund Laws for
the release of Hazardous Substances generated by its former operations at three
locations. The Company responded to the inquiries by asserting that it was not
responsible for response activities at any of these sites. Since the Company
provided its responses, the environmental regulatory agencies have not pursued
the Company as a potentially responsible party at two of the sites and the
Company received a letter from the environmental agency stating that it does not
consider the Company as a potentially responsible party at this time at the
third site.

Since 1984, the Company's facilities in Mountain View, California
("Mountain View Site") have been undergoing investigation and remediation in
response to past releases of industrial solvents to the soil and groundwater. In
addition, the impacted groundwater has migrated to what is referred to as the
North Bayshore Area. As a result of these past releases, the Mountain View Site
and other neighboring sites are listed on the NPL or the Superfund List under
CERCLA. The Company is subject to Orders that require the Company to perform
remediation on- and off-site and investigate other potentially responsible
parties. Pursuant to the Orders and other orders issued to other responsible
parties, the Company and other responsible parties are jointly performing and
funding remediation which includes soil treatment and on-site and off-site
groundwater extraction, treatment and monitoring. All of the required soil and
groundwater remediation and monitoring systems currently required by the Order
are in place, and consequently the initial capital expenses for such systems
have been incurred. In October 1997, the Company was served with a complaint
that had been filed in the Superior Court of the State of California seeking an
unspecified amount of damages for personal injuries and property damage incurred
by residents of a single location alleged to have resulted from the Company's
and others' negligent and/or intentional handling of toxic chemicals (Rosario
Balcita et al. v. Teledyne Semiconductor, SpectraPhysics Lasers, et al.). While
the Company believes it has meritorious defenses to the claims asserted in this
lawsuit and intends to vigorously defend itself in this case, the amount of
loss, if any, that may result upon resolution of this complaint is not currently
estimable nor have any amounts been accrued in the financial statements.
Accordingly, there can be no assurance that the complaint will be resolved
without adverse impact to the Company's financial position or results of
operations. There can be no assurances that other parties will not come forward
and claim personal injury or property damage.

Based on the Company's experience to date, the Company believes that the
future cost of compliance with existing Environmental Laws (or liability for
known environmental liabilities or claims) and Employee Safety Laws should not
have a material adverse effect on the Company's business, operating results and
financial condition. However, future events, such as changes in existing laws
and regulations or their interpretation, or the discovery of heretofore unknown
contamination, may give rise to additional compliance costs or liabilities that
could have a material adverse effect on the Company's business, operating
results and financial condition. Compliance with more stringent laws or
regulations, as well as more vigorous enforcement policies of regulatory
agencies or stricter or different interpretations of existing laws, may require
additional expenditures by the Company that may be material.

20
<PAGE> 21

ITEM 4. SUBMISSION OF MATTERS TO A VOTE BY SECURITY HOLDERS

On December 10, 1997 and prior to the Company's initial public offering,
Holdings, which was the Company's sole shareholder at that time, approved a
130,000-for-one stock split of the Company's Common Stock, the Company's 1997
Stock Option Plan and the Company's Restricted Stock Plan.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Spectra-Physics Lasers, Inc.'s Common Stock began trading on the NASDAQ
National Market System under the symbol SPLI on December 12, 1997. The high and
low closing prices during the period of December 12, 1997 to December 31, 1997
as reported by the National Association of Security Dealers, Inc. were $13 5/8
and $12 1/8, respectively.

The number of stockholders of record as of February 28, 1998 was 25. No
cash dividends have been declared or paid and the Company has no present
intention to declare or pay cash dividends.

On December 18, 1997 the Company issued a total of 408,043 shares of Common
Stock to three employees of Opto Power Corporation, the Company's wholly owned
subsidiary, pursuant to the Spectra-Physics Restricted Stock Plan and in partial
exchange for such employees' agreement to cancel options to purchase, in the
aggregate, up to 20% of the outstanding common stock of Opto Power Corporation
on a fully diluted basis. The shares of Common Stock issued to such employees
were not registered under the Securities Act pursuant to the exemption from
registration provided by Section 4(2) of the Securities Act.

The subparagraph numbers listed below correspond to the applicable sections
on Item 701 (f) of Regulation S-K.

<TABLE>
<S> <C> <C>
(1) Effective date: December 11, 1997
Commission file number: 333-38329
(2) Offering date: December 11, 1997
(3) Not applicable.
(4) (i) The offering was terminated in January 1998 after
the sale of all securities registered.
(ii) Managing underwriters: NationsBanc Montgomery Securities, Inc.
Cowen & Company
(iii) Title of each class of securities registered: Common stock, par value: $0.01 pershare
(iv) Amount of securities registered: 2,760,000 shares
Aggregate price of the offering amount registered: $27,600,000
Amount of securities sold *: 2,400,000 shares
Aggregate offering price of the amount sold to $24,000,000
date *:
(v) Expenses incurred:
Underwriting discount and commissions $ 1,680,000
Other expenses 1,666,000
------------
Total expenses 3,346,000
------------
(vi) Net offering proceeds to issuer $20,654,000
============
(vii) Use of proceeds by issuer from December 11, 1997
to December 31, 1997: Short-term investments: $20,654,000
</TABLE>

- ---------------

* Does not include 360,000 shares sold for net proceeds of $3,248,000 on January
5, 1998 pursuant to the exercise by the underwriters of their overallotment
option.

None of the expenses incurred in the offering, nor the use of proceeds of
the offering, were paid to (i) directors, officers, general partners of the
issuer or their associates, (ii) persons owning 10% or more of any class of
securities of the issuer or (iii) affiliates of the issuer.

21
<PAGE> 22

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales................................ $159,174 $135,434 $112,527 $ 95,123 $ 88,997
Cost of products sold.................... 98,772 88,320 73,040 62,482 61,000
-------- -------- -------- -------- --------
Gross margin........................... 60,402 47,114 39,487 32,641 27,997
Operating expenses:
Research and development............... 14,365 12,005 7,933 7,788 9,646
Selling, general and administrative.... 32,539 28,966 27,848 24,812 27,906
Restructuring(1)....................... -- -- -- -- 1,142
Other(2)............................... 15,757 6,915 1,863 -- --
-------- -------- -------- -------- --------
Total operating expenses............. 62,661 47,886 37,644 32,600 38,694
-------- -------- -------- -------- --------
Operating income (loss).............. (2,259) (772) 1,843 41 (10,697)
Other income (expense):
Interest expense....................... (4,005) (5,374) (4,590) (3,492) (2,782)
Foreign currency gain (loss)........... 2,067 2,532 1,046 (1,439) (579)
Legal settlements(3)................... 17,010 -- -- -- 1,714
-------- -------- -------- -------- --------
Total other income (expense)......... 15,072 (2,842) (3,544) (4,931) (1,647)
-------- -------- -------- -------- --------
Income (loss) before income taxes.... 12,813 (3,614) (1,701) (4,890) (12,344)
Income tax expense (benefit)............. (21,048) 634 318 311 754
-------- -------- -------- -------- --------
Net income (loss).................... $ 33,861 $ (4,248) $ (2,019) $ (5,201) $(13,098)
======== ======== ======== ======== ========
OTHER DATA:
Operating income (loss) before infrequent
or unusual items(5).................... $ 13,498 $ 6,143 $ 3,706 $ 41 $ (9,555)
======== ======== ======== ======== ========
Pro forma net income (loss) per
share:
Basic............................. $ 2.57 $ (0.33)
======== ========
Diluted........................... $ 2.57 $ (0.33)
======== ========
Shares used in computing pro forma
net income (loss) per share (4):
Basic............................. 13,162 13,000
======== ========
Diluted........................... 13,191 13,000
======== ========
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.......................... $ 68,941 $ 27,531 $ 30,273 $ 26,452 $ 26,977
Total assets............................. 140,524 86,848 80,691 65,915 66,307
Long term obligations.................... 1,677 71,584 69,067 58,775 57,852
Stockholders' equity (deficit)........... 96,324 (21,223) (16,480) (14,348) (10,823)
</TABLE>

- ---------------

(1) In 1993, the Company recorded $1,142,000 of restructuring expenses
associated with a reduction in force and costs to exit certain excess
facilities, including the write-off of related property, plant and
equipment.

(2) Includes $1,657,000 in 1997, $1,915,000 in 1996, and $863,000 in 1995 of
legal expenses associated with a lawsuit which was settled in the second
quarter of fiscal 1997; and $14,100,000 in 1997, $5,000,000 in 1996 and
$1,000,000 in 1995 of compensation expense associated with certain stock
options.

(3) In May 1997, the Company received net proceeds of $17,010,000 in settlement
of a lawsuit. In 1993, the Company received net proceeds of $1,714,000 from
its insurance company for claims regarding certain environmental matters.

(4) See Note 2 of the Notes to the Consolidated Financial Statements for an
explanation of shares used in computing pro forma net income (loss) per
share.

(5) Other data is presented as supplemental information and should not be
construed as a substitute, or better, indicator of, results of operations
than operating income (loss) or net income (loss) determined in accordance
with generally accepted accounting principles. This data represents actual
operating income (loss) adjusted for the following: (a) restructuring
expenses of $1,142,000 in 1993; (b) legal expenses associated with a lawsuit
of $1,657,000 in 1997, $1,915,000 in 1996 and $863,000 in 1995; and (c)
compensation expense associated with stock options of $14,100,000 in 1997,
$5,000,000 in 1996 and $1,000,000 in 1995. While such items are not expected
to be incurred in the future, there can be no assurances that similar items
might not occur.

22
<PAGE> 23

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

The Company is a leader in the design, development, manufacture and
distribution of lasers and laser systems for a broad range of markets. Prior to
the Reorganization in October 1997, the Company, Opto Power and Laser Data,
together with various foreign subsidiaries of Spectra-Physics AB that conducted
sales and technical support operations on their behalf, were operated as a
functional group called the Lasers and Optics Group. As a result of the
Reorganization, the assets and liabilities (including contractual rights and
obligations) of the aforementioned entities are now held directly or indirectly
by the Company. The consolidated financial statements presented reflect the
financial position, results of operations and cash flows of the Company as if it
were a separate entity for each period presented. The Company's historical
results have varied significantly from period to period due to the inclusion of
charges related to legal expenses associated with a lawsuit and compensation
expenses associated with certain stock options. The Company also incurred
interest expense on loans and advances from Spectra-Physics AB and foreign
currency gains and losses resulting from the Company's participation in
Spectra-Physics AB's foreign currency hedging program. These charges and credits
are not expected to be incurred in the future. However, there can be no
assurance that similar items might not occur.

The Company derives its revenue primarily from the sale of
semiconductor-based and conventional lasers and laser systems. Conventional
lasers are primarily sold into the research and development market. This market
is typically characterized by the sale of single units and systems with prices
that range from approximately $3,000 to $500,000. Sales in this market have
historically varied from quarter to quarter due to seasonal fluctuations and
governmental spending patterns. Semiconductor-based lasers and laser systems are
sold into the research and development market and the OEM/industrial market. The
OEM/industrial market is characterized by unit sales, with varying prices, in
volumes of as much as several thousand units. Over the last three years, a
growing proportion of the Company's total net sales and most of its sales growth
have been from semiconductor-based lasers. Net sales for products are recognized
upon shipment.

The Company has experienced a trend in its sales whereby its fiscal fourth
quarter net sales represent a disproportionate share of the Company's annual net
sales and whereby the Company's first quarter net sales decline significantly
compared to the fourth quarter of the prior fiscal year. The Company believes
these sales patterns result in part because of Spectra-Physics AB's emphasis on
annual (as opposed to quarterly) results and in part from the Company's
incentive compensation plan which compensates employees based on annual results.
The Company recognizes that the non-linear pattern of its shipments leads to
inefficiencies in asset and employee utilization. The Company is taking steps to
mitigate this sales trend, but this pattern is likely to continue in the near
term.

The Company's gross margin is affected by a number of factors, including
product mix, product pricing, cost of components, the proportion of third party
products incorporated into the Company's systems, foreign currency exchange
rates and manufacturing costs. For example, since semiconductor-based lasers and
laser systems generally have higher gross margins than conventional lasers,
absent other factors, a shift in sales toward semiconductor-based lasers and
systems would lead to a gross margin improvement for the Company. On the other
hand, if market conditions in the highly competitive conventional laser market
forced the Company to lower unit prices, the Company would suffer a decline in
gross margin unless the Company were able to timely offset the price reduction
by a reduction in production costs or by sales of other products with higher
gross margins. Either of these events could have a material effect on the
Company's business, operating results and financial condition.

The Company spends a significant amount of resources on research and
development. In recent years, the Company has focused much of these resources on
semiconductor-based lasers and laser systems. The Company expects to continue to
spend substantial resources in developing products for semiconductor-based
lasers and laser systems while making focused research and development
expenditures to maintain its leadership position in conventional lasers.

23
<PAGE> 24

A significant proportion of the Company's sales are to international
customers and are denominated in currencies other than the U.S. dollar. The
Company also has sales and support operations located in certain European
countries and in Japan which operate in local currencies. As a result, while the
Company attempts to hedge its economic risk of foreign currency fluctuations,
the Company is exposed to fluctuations in foreign currency exchange rates that
have had in the past, and may have in the future, a significant impact on the
Company's results of operations.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the Company's
results of operations as a percentage of net sales:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Net sales............................................... 100.0% 100.0% 100.0%
Cost of products sold................................... 62.1 65.2 64.9
----- ----- -----
Gross margin.......................................... 37.9 34.8 35.1
----- ----- -----
Operating expenses:
Research and development.............................. 9.0 8.9 7.0
Selling, general and administrative................... 20.4 21.4 24.7
Other................................................. 9.9 5.1 1.7
----- ----- -----
Total operating expenses...................... 39.3 35.4 33.4
----- ----- -----
Operating income (loss)....................... (1.4) (0.6) 1.7
Other income (expense):
Interest expense...................................... (2.5) (4.0) (4.1)
Foreign currency gain (loss).......................... 1.3 1.9 0.9
Legal settlement...................................... 10.7 -- --
----- ----- -----
Total other income (expense).................. 9.5 (2.1) (3.2)
----- ----- -----
Income (loss) before income taxes............. 8.1 (2.7) (1.5)
Income tax expense (benefit) ........................... (13.2) 0.5 0.3
----- ----- -----
Net income (loss)............................. 21.3% (3.2)% (1.8)%
===== ===== =====
Other Data:
Operating income (loss) before infrequent or unusual
items*............................................. 8.5% 4.5% 3.4%
===== ===== =====
</TABLE>

- ---------------
* See footnote (5) of Item 6. Selected Financial Data.

YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

Net sales

Net sales were $159.2 million in 1997, $135.4 million in 1996, and $112.5
million in 1995, representing an increase of 17.5% from 1996 to 1997 and 20.4%
from 1995 to 1996. Net sales for 1997, calculated using foreign currency
exchange rates for 1996, and for 1996, calculated using foreign currency
exchange rates for 1995, increased 23.2% from 1996 to 1997, and 25.6% from 1995
to 1996. The growth in sales in actual terms was principally due to increased
volumes of high-power semiconductor-based lasers and laser systems, particularly
the Millennia, a product introduced in the first quarter of 1996, as the market
for these products expanded due to customers' acceptance of these products. Net
sales were in the following geographic markets (based on the location of the
Company's sales subsidiary):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Europe..................................... $ 31,535 $ 30,449 $ 28,223
Japan...................................... 31,334 30,517 30,479
United States and export................... 96,305 74,468 53,825
-------- -------- --------
$159,174 $135,434 $112,527
======== ======== ========
</TABLE>

24
<PAGE> 25

Net sales at actual currency exchange rates increased: 3.6% from 1996 to
1997 and 7.9% from 1995 to 1996 for Europe; and 29.3% from 1996 to 1997 and
38.4% from 1995 to 1996 for the U.S. Net sales at actual currency exchange rates
for Japan were flat from 1996 to 1997 and from 1995 to 1996. Net sales for 1997,
calculated using foreign currency exchange rates for 1996, and for 1996,
calculated using foreign currency exchange rates for 1995, increased: 15.1% from
1996 to 1997 and 11.8% from 1995 to 1996 for Europe; 14.6% from 1996 to 1997 and
15.7% from 1995 to 1996 for Japan; and 29.3% from 1996 to 1997 and 38.4% from
1995 to 1996 for the U.S. The significant increases in net sales in the U.S. for
these periods reflect the early adoption of semiconductor-based lasers and laser
systems in the U.S. compared to Europe and Japan.

Cost of products sold and gross margin

Cost of products sold includes all manufacturing materials and labor and a
proportionate share of manufacturing overhead costs, as well as costs of
shipping, tooling, royalties, third party products incorporated in the Company's
products and provisions for excess and obsolete inventories and warranty. Cost
of products sold varies by product mix, product pricing, cost of components, the
proportion of third party products incorporated in systems manufactured by the
Company, and manufacturing costs.

Gross margin was $60.4 million in 1997, $47.1 million in 1996, and $39.5
million in 1995, representing an increase of 28.2% from 1996 to 1997 and 19.3%
from 1995 to 1996. As a percentage of net sales, gross margin was 37.9%, 34.8%,
and 35.1% in 1997, 1996 and 1995, respectively. The principal reasons for the
improvement in gross margin as a percentage of net sales in 1997 compared to
1996 was the higher proportion of high powered semiconductor-based lasers and
laser systems which generally have higher gross margins than conventional
products and the increase in sales that allowed the absorption of fixed
manufacturing overhead expenses over a larger unit base. The slight decline in
gross margin as a percentage of net sales in 1996 compared to 1995 was due
principally to a higher proportion in 1996 of sales of third party products
which are incorporated in the Company's systems and on which the Company
typically earns lower margins. Also, there was a negative effect on gross
margins from the strengthening of the U.S. dollar compared to non-U.S. dollar
currencies, particularly the Japanese Yen.

Operating expenses

Operating expenses totaled $62.7 million in 1997, $47.9 million in 1996 and
$37.6 million in 1995, representing an increase of 30.9% from 1996 to 1997 and
27.2% from 1995 to 1996. As a percentage of net sales, operating expenses were
39.3%, 35.4%, and 33.4% in 1997, 1996, and 1995, respectively. Included in other
operating expenses were legal expenses associated with a lawsuit which was
settled in the second quarter of 1997 of $1.7 million in 1997, $1.9 million in
1996 and $0.9 million in 1995, and compensation expense associated with certain
stock options of two subsidiaries of $14.1 million in 1997, $5.0 million in 1996
and $1.0 million in 1995. The stock options for one subsidiary were modified so
as to establish the measurement date and the amount of compensation expense the
Company is required to record and, for the other subsidiary, were cancelled for
a combination of cash and common stock of the Company. Accordingly, the Company
does not expect to incur additional compensation expense relating to these stock
options in the future. Excluding such legal and compensation expenses, operating
expenses increased 14.5% from 1996 to 1997 and 14.5% from 1995 to 1996 and were
29.4%, 30.3% and 31.7% of net sales in 1997, 1996 and 1995, respectively.

Research and development expenses represent expenses associated with
Company funded research and new product development, and efforts designed to
improve the performance of existing products and manufacturing processes.
Customer funded product development engineering for certain OEM customers and
the U.S. government, which to date has been minimal, is recorded as a reduction
of research and development expenses. Research and development expenses are
charged to operations as incurred.

Research and development expenses totaled $14.4 million in 1997, $12.0
million in 1996 and $7.9 million in 1995, representing an increase of 19.7% from
1996 to 1997 and 51.3% from 1995 to 1996. As a percentage of net sales, research
and development expenses were 9.0%, 8.9% and 7.0% in 1997, 1996 and 1995,
respectively. The increase in research and development expenses was principally
focused on semiconductor-based lasers and laser systems and laser disk texturing
systems.

25
<PAGE> 26

Selling, general and administrative expenses include the expenses of the
Company's sales and support subsidiaries in the United Kingdom, France, Germany,
the Netherlands and Japan as well as the Company's North American sales and
support organization, and other administrative expenses such as legal,
accounting, corporate offices and an allocation of expenses from Spectra-Physics
AB and affiliates for services provided to the Company.

Selling, general and administrative expenses totaled $32.5 million in 1997,
$29.0 million in 1996 and $27.8 million in 1995, representing an increase of
12.3% from 1996 to 1997 and 4.0% from 1995 to 1996. As a percentage of net
sales, selling, general and administrative expenses were 20.4%, 21.4%, and 24.7%
in 1997, 1996 and 1995, respectively. The principal reasons for the increase in
selling, general and administrative expenses in dollar terms in 1997 compared to
1996 were increased salaries and benefits, including performance and incentive
bonuses, and increased sales and marketing efforts aimed at the high powered
semi-conductor based lasers and laser systems markets offset in part by the
impact of the strengthening U.S. dollar compared to non-U.S. dollar currencies.
The principal reasons for the increase in selling, general and administrative
expenses in dollar terms in 1996 compared to 1995 were increased salaries and
benefits and increased sales and marketing efforts associated with the Company's
laser disk texturing systems offset, in part, by the strengthening of the U.S.
dollar compared to the Japanese Yen.

Interest expense

Interest expense totaled $4.0 million in 1997, $5.4 million in 1996 and
$4.6 million in 1995, representing a decrease of 25.5% from 1996 to 1997 and an
increase of 17.1% from 1995 to 1996. Interest expense was incurred on loans and
advances from Spectra-Physics AB and affiliates. Interest expense was also
imputed on the certain non-interest bearing advances from Spectra-Physics AB and
affiliates. The amount of such imputed interest was $0.6 million in 1997, $1.0
million in 1996, $1.1 million in 1995. In connection with the Reorganization,
Spectra-Physics AB and affiliates converted all loans and advances to the
Company to equity. Accordingly, beginning October 1, 1997, the Company no longer
incurred interest expense on such loans and advances.

Foreign currency gain (loss)

All of the Company's manufacturing is performed in the United States.
However, the Company has significant sales outside the United States denominated
in currencies other than the U.S. dollar. Also, the Company's sales and support
subsidiaries pay local operating expenses in local currencies. As a result, the
Company's operations are exposed to fluctuations in foreign currency exchange
rates and these fluctuations have been, and may in the future be, material.

From late 1995 to September 1997, the Company had a hedging program with
Spectra-Physics AB whereby it hedged a portion of its anticipated non-U.S.
dollar denominated cash flows on a twelve-month rolling basis. Accordingly, at
the end of each period, there was approximately twelve months of foreign
exchange contracts open to deliver a specified amount of foreign currency at a
specified rate. As allowed under generally accepted accounting principles
("GAAP") in Sweden, the Company had deferred the unrealized gain or loss
resulting from the impact of currency exchange rate movements on open contracts
until the underlying transaction was completed. However, since these contracts
were not, as required under U.S. GAAP, designated as hedges of firm,
identifiable foreign currency commitments, the proper U.S. accounting treatment
for these contracts was to recognize unrealized gain or loss resulting from the
impact of currency exchange rate movements on open contracts in each period
reported. Accordingly in the accompanying financial statements such gains and
losses were recorded as other income or expense. Also included in other income
and expense were realized gains and losses on the settlement of foreign exchange
contracts and realized and unrealized gains and losses on transactions
denominated in currencies other than the U.S. dollar for U.S. based operations.

In October 1997, the Company changed the way it hedges its foreign currency
exposures. It closed all of its 1998 outstanding foreign exchange contracts with
Spectra-Physics AB by buying offsetting currency contracts. Settlement costs for
closing these contracts early were approximately $0.4 million. The Company

26
<PAGE> 27

now hedges its foreign exchange exposure by entering into transactions with
independent financial institutions. The Company's policy is to not hold or issue
financial instruments for trading purposes nor will it hold or issue leveraged
derivative financial instruments. The objective of the Company's foreign
exchange risk management policy is to preserve the U.S. dollar value of its
non-U.S. dollar cash flows. These cash flows arise primarily from the sale of
the Company's products in currencies other than U.S. dollar, most of which are
made through the Company's subsidiaries in Japan and Europe. The Company will
use forward exchange contracts and simple purchased foreign currency option
contracts to hedge, respectively, firm commitments and probable anticipated
transactions that expose the Company to enterprise risk. Gains and losses on
forward exchange contracts that are designated as hedges of a firm order from a
customer outside the United States will be deferred and included in the
measurement of the underlying transaction. Gains on purchased foreign currency
options with little or no intrinsic value designated as hedges of probable
anticipated foreign sales transactions expected to occur within the next three
to six months whose significant characteristics and terms are known will also be
deferred and recognized at the time of the closing of the anticipated
transactions.

Foreign currency gain (loss) were net gains of $2.1 million in 1997, $2.5
million in 1996 and $1.0 million in 1995.

Income tax expense (benefit)

Income taxes have been provided in the financial statements as if the
Company were a separate taxable entity. For periods prior to the three months
ended September 30, 1997, income tax expense reflected foreign taxes only due to
the expectation by the Company at that time of continuing losses in the U.S.
Deferred tax assets were established relating to: (i) net operating loss
carryforwards, which included interest expense from Spectra-Physics AB and
affiliates; (ii) accrued compensation associated with employee stock options;
(iii) inventory valuation reserves; and (iv) other accruals. These deferred tax
assets were offset in total by a valuation allowance due to the expectation of
continued losses in the U.S.

During the quarter ended September 30, 1997, the Company decreased the tax
valuation allowance and recognized a tax benefit relating to the above items
(net of foreign taxes) totaling $23.3 million. The decrease of the valuation
allowance and the recognition of the tax benefit in the quarter was based on
management's expectations regarding future taxable income for the Company.
Management's expectations included the consideration of the conversion of loans
and advances from Spectra-Physics AB and affiliates to equity in October 1997
which eliminated related interest charges in the future.

For income tax return purposes, the Company was part of a U.S. consolidated
group pursuant to a tax sharing agreement among Spectra-Physics AB affiliated
companies through September 30, 1997. Under this tax sharing agreement, the
Company's net operating loss carryovers referred to above were used to offset
the taxable income of other members of the tax filing group with no benefit to
the Company. Accordingly, the deferred tax asset arising from the net operating
loss carryforwards (amounting to $10.2 million) was recorded as a dividend to
Spectra-Physics AB. Effective October 1997, the Company and affiliates of
Spectra-Physics AB have entered into a tax sharing arrangement which generally
requires the Company to determine its U.S. tax liability as a separate
consolidated group.

Income tax expense was a net benefit of $21.0 million in 1997, and net
expense of $0.6 million in 1996 and $0.3 million in 1995. The income tax expense
in 1996 and 1995 represented foreign taxes currently payable at each of the
applicable country's statutory rate.

The Company expects its future effective tax rate to approximate statutory
rates.

LIQUIDITY AND CAPITAL RESOURCES

Through the third quarter of 1997, the Company had satisfied its liquidity
requirements through cash provided by SpectraPhysics AB and affiliates in the
form of loans and advances. As of October 1, 1997, all outstanding loans and
advances from Spectra-Physics AB and affiliates were converted to equity. At
December 31, 1997, the Company had working capital of $68.9 million, including
cash and cash equivalents of

27
<PAGE> 28

$33.5 million, compared to working capital at December 31, 1996 of $27.5
million, including cash and cash equivalents of $2.5 million.

Cash provided by operating activities was $26.6 million and $4.3 million in
the years ended December 31, 1997 and 1996, respectively. Cash used in operating
activities was $2.6 million in the year ended December 31, 1995. Substantially
all the net cash used in or provided by operating activities represented the net
income (loss) for the year adjusted for depreciation and amortization, and
increases in accrued and other liabilities, offset by increases in accounts
receivable and, in the year ended December 31, 1997, inventories and the benefit
of deferred taxes.

Cash used in investing activities, mostly purchases of property, plant and
equipment, was $9.4 million, $5.0 million and $8.1 million in the years ended
December 31, 1997, 1996 and 1995, respectively.

Cash provided by financing activities was $13.7 million, $2.1 million, and
$11.0 million in the years ended December 31, 1997, 1996 and 1995, respectively.
During the year ended December 31, 1997, net transfers to Spectra-Physics AB and
affiliates and changes in loans and advances from Spectra-Physics AB amounted to
a net decrease in cash of $25.7 million, principally relating to the utilization
by affiliates of Spectra-Physics AB of the Company's net operating loss
carryfoward for tax purposes and the remittance to Spectra-Physics AB of cash
received by the Company on the settlement of litigation. This amount was offset
by the net proceeds from the Company's initial public offering of its common
stock of $20.7 million, by $17.2 million of cash provided by Spectra-Physics AB
to settle certain stock options and other liabilities, and by $1.5 million of
net borrowings under the Company's credit facility in Japan. All of the cash
provided by financing activities during the years ended December 31, 1996 and
1995 represented changes in loans and advances from Spectra-Physics AB and
affiliates.

The above activities resulted in an increase in cash and cash equivalents
of $31.0 million, $1.5 million and $0.3 million in the years ended December 31,
1997, 1996 and 1995, respectively.

In October 1997, the Company entered into certain agreements with employees
of its Opto Power subsidiary who held stock options to purchase common stock of
the subsidiary. Under the agreements, the option holders agreed to terminate the
options in exchange for a combination of cash payment and the Company's common
stock. Such cash payments totalled approximately $14.7 million and were funded
by a capital contribution by Spectra-Physics AB and affiliates.

As part of the Reorganization, the Company assumed a short-term credit
facility in Japan. The credit facility is with two banks, is unsecured but is
guaranteed by Spectra-Physics AB through November 1998, allows aggregate
borrowings of 1.2 billion Yen ($9.2 million) and bears interest at 1.625% per
annum. At December 31, 1997 there were $7.3 million of borrowings outstanding
under this facility. In October 1997, the Company obtained a $20.0 million
uncommitted, unsecured credit facility with a bank. At December 31, 1997, there
were no borrowings under this facility.

The Company has reviewed its short- and long-term liquidity needs. The
Company has determined that funding from SpectraPhysics AB will not be necessary
in the future. The Company's liquidity needs for at least the next twelve months
will be met by cash flows from operations, existing cash balances and borrowings
available under its credit facilities.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," which was adopted by the Company in 1997, and in March 1997, issued SFAS
No. 129, "Disclosures of Information About Capital Structure," which is required
to be adopted by the Company in 1998. These statements specify the computation,
presentation and disclosure requirements for earnings per share and the capital
structure of a company.

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information." Both of these statements are effective for the Company in
1998. SFAS No. 130 establishes the requirements for disclosure of comprehen-

28
<PAGE> 29

sive income. Comprehensive income generally represents all changes in
stockholders' equity except those resulting from investments or contributions
from stockholders. SFAS No. 131 requires publicly-held companies to report
financial and other information about key sales-producing segments of the entity
for which such information is available and utilized by the chief operating
decision maker. Specific information to be reported for individual segments
includes profit and loss, certain sales and expense items and total assets. A
reconciliation of segment financial information to amounts reported in the
financial statements would be provided.

The Company has determined that the impact of adopting each of the recently
issued accounting standards will not be material to its financial position or
results of operations.

YEAR 2000 COMPLIANCE

The "Year 2000" issue is the result of computer programs being written
using two digits rather than four to define the applicable year. As such,
computer programs that have date sensitive software might recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in program
failure or miscalculation causing disruptions of operations including, among
other things, a temporary inability to process transactions, send invoices,
operate equipment or engage in similar normal business activities.

The Company has reviewed both its internal computer systems and its
products that could be affected by the "Year 2000" issue and has identified some
systems and a few products that will be affected. The Company presently
believes, with modification to existing software and converting to new software,
the "Year 2000" issues relating to internal computer systems and products will
not cause significant operational problems or customer problems. Furthermore,
the cost of implementing these solutions is not anticipated to be material to
its financial position or results of operations. However, if such modifications
and conversions are not made, or not completed timely, the "Year 2000" issue
could have a material impact on the operations of the Company. Furthermore, the
costs of such conversions and updates are based on management's best estimates,
which are derived utilizing numerous assumptions of future events including such
things as, but not limited to, the availability and cost of personnel trained in
this area, the ability to locate and correct all relevant computer codes and
similar uncertainties.

The Company will initiate formal communications with all of its significant
suppliers and large customers in 1998 to determine the extent to which the
Company is vulnerable to those third parties failure to remediate their own
"Year 2000" Issues. There can be no guarantee that the systems of other
companies on which other companies rely will be timely converted, or a failure
to convert by another company, or a conversion that is incompatible with the
Company's systems will not have a material adverse impact on the Company.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 14(a) for an index to the consolidated financial statements and
supplementary information which are attached hereto.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

29
<PAGE> 30

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding Registrant's officers and directors will be set forth
under the captions "Management" and "Election of Directors" in the Registrant's
proxy statement for use in connection with the Annual Meeting of Stockholders to
be held in May 1998 (the "1998 Proxy Statement"), and is incorporated herein by
reference. The 1998 Proxy Statement will be filed with the Securities and
Exchange Commission within 120 days after the end of the Registrant's fiscal
year end.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning compensation of the Registrant's directors and
executive officers will be set forth under the captions "Election of
Directors -- Compensation of Directors" and "Management -- Summary Compensation
of Named Executive Officers" in the Registrant's 1998 Proxy Statement and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners and
management will be set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Registrant's 1998 Proxy Statement and
is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions will
be set forth under the caption "Certain Relationships and Related Transactions"
in the Registrant's 1998 Proxy Statement and is incorporated herein by
reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND FORM 8-K REPORTS

(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

The following consolidated financial statements of Spectra-Physics Lasers,
Inc. are filed as part of this report on Form 10-K:

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Accountants' Report............................. 34
Consolidated Balance Sheet -- December 31, 1997 and 1996.... 35
Consolidated Statement of Operations -- Years ended December
31, 1997, 1996 and 1995................................... 36
Consolidated Statement of Cash Flows -- Years Ended December
31, 1997, 1996 and 1995................................... 37
Consolidated Statement of Stockholders' Equity
(Deficit) -- Years Ended December 31, 1997, 1996, and
1995...................................................... 38
Notes to Consolidated Financial Statements.................. 39
</TABLE>

2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES

<TABLE>
<S> <C>
Schedule II -- Valuation and Qualifying Accounts............ 53
</TABLE>

Schedules not listed above have been omitted because the matter or
conditions are not present or the information required to be set forth
therein is included in the Consolidated Financial Statements hereto.

30
<PAGE> 31

(b) REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the three-months ended December
31, 1997.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 Plan of Reorganization of the Company (Incorporated by
reference to exhibit 2.1 of the Company's Registration
Statement on Form S-1 (No. 333-38329))
3.1 Certificate of Incorporation of the Company, as amended
(Incorporated by reference to exhibit 3.1 of the Company's
Registration Statement on Form S-1 (No. 333-38329))
3.2 Bylaws of the Company (Incorporated by reference to exhibit
3.2 of the Company's Registration Statement on Form S-1 (No.
333-38329))
4.1 Specimen of Common Stock Certificate (Incorporated by
reference to exhibit 4.1 of Amendment No. 1 of the Company's
Registration Statement on Form S-1 (No. 333-38329))
10.1 Agreement by and between Spectra-Physics USA and the
Company, dated as of August 29, 1997 (Incorporated by
reference to exhibit 10.1 of the Company's Registration
Statement on Form S-1 (No. 333-38329))
10.2 Registration Rights Agreement between Spectra-Physics USA
and the Company (Incorporated by reference to exhibit 10.2
of Amendment No. 2 of the Company's Registration Statement
on Form S-1 (No. 333-38329))
10.3 Form of Executive Employment Agreement with certain officers
of the Company (Incorporated by reference to exhibit 10.3 of
Amendment No. 2 of the Company's Registration Statement on
Form S-1 (No. 333-38329))
10.4 Employment Agreement dated May 19, 1995 between the Company
and Mark S. Sobey (Incorporated by reference to exhibit 10.4
of Amendment No. 1 of the Company's Registration Statement
on Form S-1 (No. 333-38329))
10.5 Form of Executive Incentive Plan (Incorporated by reference
to exhibit 10.5 of Amendment No. 1 of the Company's
Registration Statement on Form S-1 (No. 333-38329))
10.6 1997 Spectra-Physics Lasers, Inc. Stock Option Plan
(Incorporated by reference to exhibit 10.6 of Amendment No.
1 of the Company's Registration Statement on Form S-1 (No.
333-38329))
10.7 Patent License Agreement dated as of October 4, 1997 by and
between the Company, as licensor, and Spectra Precision,
Inc., as licensee (Incorporated by reference to exhibit 10.7
of Amendment No. 1 of the Company's Registration Statement
on Form S-1 (No. 333-38329))
10.8 Patent License Agreement dated as of October 4, 1997 by and
between Spectra Precision, Inc., as licensor, and the
Company, as licensee (Incorporated by reference to exhibit
10.8 of Amendment No. 1 of the Company's Registration
Statement on Form S-1 (No. 333-38329))
10.9 Tradename and Trademark License Agreement dated as of August
29, 1997 by and between the Company, Spectra-Physics AB and
certain Spectra-Physics AB subsidiaries (Incorporated by
reference to exhibit 10.9 of Amendment No. 1 of the
Company's Registration Statement on Form S-1 (No.
333-38329))
10.10 Form of Restricted Stock Plan Agreement among the Company,
Opto Power and certain Opto Power employees (Incorporated by
reference to exhibit 10.10 of Amendment No. 1 of the
Company's Registration Statement on Form S-1 (No.
333-38329))
</TABLE>

31
<PAGE> 32

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
21.1 List of Subsidiaries (Incorporated by reference to exhibit
21.1 of the Company's Registration Statement on Form S-1
(No. 333-38329))
23.2 Report of Coopers & Lybrand L.L.P. (included on page 53)
24.1 Powers of Attorney (included on signature page)
27.1 Financial Data Schedule
</TABLE>

32
<PAGE> 33

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 23, 1998.

SPECTRA-PHYSICS LASERS, INC.

/s/ PATRICK L. EDSELL
--------------------------------------
By: Patrick L. Edsell
Chairman, President and Chief
Executive Officer

POWER OF ATTORNEY

Know all men by these presents, that each person whose signature appears
below constitutes and appoints Patrick L. Edsell and Thomas J. Scannell, jointly
and severally, his attorneys-in-fact, each with the power of substitution for
him in any and all capacities, to sign any amendments to this report, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereor.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>

/s/ PATRICK L. EDSELL (Director, Chairman, President March 23, 1998
- --------------------------------------------------- and Chief Executive Officer)
Patrick L. Edsell

/s/ THOMAS J. SCANNELL (Vice President -- Finance) March 18, 1998
- --------------------------------------------------- (Principal Financial and
Thomas J. Scanell Accounting Officer)

/s/ LAWRENCE C. KARLSON (Director) March 23, 1998
- ---------------------------------------------------
Lawrence C. Karlson

/s/ LENNART F. RAPPE (Director) March 26, 1998
- ---------------------------------------------------
Lennart F. Rappe

/s/ LARS SPONGBERG (Director) March 23, 1998
- ---------------------------------------------------
Lars Spongberg

/s/ THOMAS T. VAN OVERBEEK (Director) March 24, 1998
- ---------------------------------------------------
Thomas T. van Overbeek
</TABLE>

33
<PAGE> 34

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
Spectra-Physics Lasers, Inc.

We have audited the accompanying consolidated balance sheet of
Spectra-Physics Lasers, Inc. as of December 31, 1997 and 1996, and the related
consolidated statements of operations, cash flows, and stockholders' equity
(deficit) for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Spectra-Physics
Lasers, Inc. as of December 31, 1997 and 1996, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.

COOPERS & LYBRAND L.L.P.

San Jose, California
January 16, 1998

34
<PAGE> 35

SPECTRA-PHYSICS LASERS, INC.

CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

ASSETS

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 33,487 $ 2,531
Accounts receivable, including $86 and $366, respectively,
due from affiliated companies, less allowance for
doubtful accounts of $540 and $361, respectively....... 39,511 37,952
Inventories............................................... 25,857 21,809
Deferred tax assets....................................... 8,200 --
Prepaid expenses and other current assets................. 4,409 1,726
-------- --------
Total current assets.............................. 111,464 64,018
Property, plant and equipment, net.......................... 25,480 20,651
Intangible assets, net of accumulated amortization of $1,995
and $1,772, respectively.................................. 1,637 1,110
Other assets................................................ 1,943 1,069
-------- --------
Total assets...................................... $140,524 $ 86,848
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 10,453 $ 8,128
Borrowings under credit facility.......................... 7,321 --
Taxes payable............................................. -- 573
Interest due SPAB......................................... -- 4,062
Accrued and other current liabilities..................... 24,749 23,724
-------- --------
Total current liabilities......................... 42,523 36,487
Long term liabilities:
Loans and advances from SPAB.............................. -- 69,698
Other long term liabilities............................... 1,677 1,886
-------- --------
Total long term liabilities....................... 1,677 71,584
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, par value $0.01:
Authorized -- 60,000,000 shares
Outstanding -- 15,808,043 in 1997...................... 158 --
Additional paid-in capital................................ 93,991 --
Retained earnings......................................... 3,629 --
Cumulated translation adjustment.......................... (1,454) (40)
Parent equity (deficit)................................... -- (21,183)
-------- --------
Total stockholders' equity (deficit)........................ 96,324 (21,223)
-------- --------
Total liabilities and stockholders' equity
(deficit)....................................... $140,524 $ 86,848
======== ========
</TABLE>

See Notes to Consolidated Financial Statements.
35
<PAGE> 36

SPECTRA-PHYSICS LASERS, INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net sales.................................................. $159,174 $135,434 $112,527
Cost of products sold...................................... 98,772 88,320 73,040
-------- -------- --------
Gross margin............................................. 60,402 47,114 39,487

Operating expenses:
Research and development................................. 14,365 12,005 7,933
Selling, general and administrative...................... 32,539 28,966 27,848
Other.................................................... 15,757 6,915 1,863
-------- -------- --------
Total operating expenses......................... 62,661 47,886 37,644
-------- -------- --------
Operating income (loss).......................... (2,259) (772) 1,843

Other income (expense):
Interest expense......................................... (4,005) (5,374) (4,590)
Foreign currency gain (loss)............................. 2,067 2,532 1,046
Legal settlement......................................... 17,010 -- --
-------- -------- --------
Total other income (expense)..................... 15,072 (2,842) (3,544)
-------- -------- --------
Income (loss) before income taxes................ 12,813 (3,614) (1,701)
Income tax expense (benefit)............................... (21,048) 634 318
-------- -------- --------
Net income (loss)................................ $ 33,861 $ (4,248) $ (2,019)
======== ======== ========

Pro forma net income (loss) per share:
Basic.................................................... $ 2.57 $ (0.33)
======== ========
Diluted.................................................. $ 2.57 $ (0.33)
======== ========
Shares used in computing pro forma net income (loss) per
share:
Basic.................................................... 13,162 13,000
======== ========
Diluted.................................................. 13,191 13,000
======== ========
</TABLE>

See Notes to Consolidated Financial Statements.
36
<PAGE> 37

SPECTRA-PHYSICS LASERS, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)........................................... $ 33,861 $(4,248) $(2,019)
Adjustments to reconcile net income (loss) to cash provided
by (used in) operating activities:
Depreciation and amortization............................. 4,839 4,420 3,729
Deferred tax assets....................................... (8,200) -- --
Changes in operating assets and liabilities:
Accounts receivable.................................... (1,559) (4,285) (7,034)
Inventories............................................ (4,048) 896 (3,632)
Prepaid expenses and other current assets.............. (2,279) (763) 493
Accounts payable....................................... 2,325 (79) 2,058
Accrued and other liabilities.......................... 1,683 8,359 3,772
-------- ------- -------
Total cash provided by (used in) operating
activities...................................... 26,622 4,300 (2,633)
-------- ------- -------
INVESTING ACTIVITIES
Purchases of property, plant and equipment.................. (8,672) (5,055) (8,093)
Other....................................................... (720) 103 4
-------- ------- -------
Total cash provided by (used in) investing
activities...................................... (9,392) (4,952) (8,089)
-------- ------- -------
FINANCING ACTIVITIES
Net transfers (to) from SPAB................................ (27,743) (479) (92)
Contribution of cash by SPAB to settle certain stock options
and other liabilities..................................... 17,249 -- --
Net borrowings under credit facility........................ 1,508 -- --
Changes in loans and advances from SPAB..................... 2,058 2,620 11,078
Net proceeds from initial public offering of common stock... 20,654 -- --
-------- ------- -------
Total cash provided by (used in) financing
activities...................................... 13,726 2,141 10,986
-------- ------- -------
Increase (decrease) in cash....................... 30,956 1,489 264
Cash and cash equivalents at beginning of year.............. 2,531 1,042 778
-------- ------- -------
Cash and cash equivalents at end of year.................... $ 33,487 $ 2,531 $ 1,042
======== ======= =======
Non-cash financing activity:
Reorganization:
Conversion of debt and accrued interest to equity......... $ 73,758
Transfer of assets, net of cash........................... 2,299
Assumption of liabilities................................. (2,968)
--------
$ 73,089
========
</TABLE>

See Notes to Consolidated Financial Statements.
37
<PAGE> 38

SPECTRA-PHYSICS LASERS, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE PARENT
------------------- PAID-IN RETAINED TRANSLATION EQUITY
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENTS (DEFICIT) TOTAL
---------- ------ ---------- -------- ----------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE-DECEMBER 31, 1994......... 13,000,000 $ -- $ -- $ -- $ (3) $(14,345) $(14,348)
Net transfers (to) from SPAB.... (92) (92)
Foreign currency translation.... (21) (21)
Net loss........................ (2,019) (2,019)
---------- ---- ------- ------ ------- -------- --------
BALANCE-DECEMBER 31, 1995......... 13,000,000 (24) (16,456) (16,480)
---------- ---- ------- ------ ------- -------- --------
Net transfers (to) from SPAB.... (479) (479)
Foreign currency translation.... (16) (16)
Net loss........................ (4,248) (4,248)
---------- ---- ------- ------ ------- -------- --------
BALANCE-DECEMBER 31, 1996......... 13,000,000 (40) (21,183) (21,223)
---------- ---- ------- ------ ------- -------- --------
Net transfers (to) from SPAB.... (27,743) (27,743)
Net income prior to the
Reorganization................ 30,232 30,232
Reorganization.................. 130 54,265 18,694 73,089
Initial public offering of
common stock.................. 2,400,000 24 20,630 20,654
Contribution of cash by SPAB and
issuance of common stock by
the Company to settle certain
stock options of a
subsidiary.................... 408,043 4 19,096 19,100
Foreign currency translation.... (1,414) (1,414)
Net income subsequent to the
Reorganization................ 3,629 3,629
---------- ---- ------- ------ ------- -------- --------
BALANCE-DECEMBER 31, 1997......... 15,808,043 $158 $93,991 $3,629 $(1,454) $ -- $ 96,324
========== ==== ======= ====== ======= ======== ========
</TABLE>

See Notes to Consolidated Financial Statements.
38
<PAGE> 39

SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND BASIS OF PRESENTATION

Spectra-Physics Lasers, Inc. designs, develops, manufactures and
distributes lasers and laser systems for the industrial, original equipment
manufacturer (OEM), and research and development markets.

Prior to the Reorganization referred to below, Spectra-Physics Lasers, Opto
Power Corporation, and Spectra-Physics Laser Data Systems, Inc., together with
various foreign subsidiaries of Spectra-Physics AB that conducted sales and
technical support operations on their behalf (collectively the "Company"), were
operated as a functional group called the Lasers and Optics Group. In
preparation for its initial public offering the Company was reorganized in
October 1997 so that the assets and liabilities (including contractual rights
and obligations) of the Lasers and Optics Group were held directly or indirectly
by the Company. Accordingly, pursuant to various agreements (i) the assets and
liabilities of the Lasers and Optics Group not held by the Company were
transferred to the Company and (ii) the assets and liabilities of the Company
not part of the Lasers and Optics Group were transferred to SPAB's subsidiaries
(other than the Company and its subsidiaries.) In connection with the
Reorganization, intercompany receivables and payables were eliminated. Unless
specified otherwise, SPAB refers to Spectra-Physics AB and/or affiliates of
Spectra-Physics AB (other than the Company and its subsidiaries). All entities
involved in the reorganization were direct or indirect wholly-owned subsidiaries
of SPAB.

The accompanying consolidated financial statements includes the accounts of
the Company and reflects the financial position, results of operations, and cash
flows of the Company as if it were a separate entity for each period presented.
The accompanying financial statements do not include assets and liabilities not
part of the Laser and Optics Group. These assets were transferred to SPAB. The
Reorganization described above has been accounted for as a transfer between
entities under common control in a manner similar to a pooling of interests.

The accompanying consolidated financial statements also include allocations
of certain SPAB corporate and group expenses (including cash management and
treasury, legal, employee benefits, insurance, income taxes and corporate
overhead services) relating to the Company's businesses. Management believes
these allocations are reasonable. However, the financial information included
herein may not necessarily reflect the consolidated financial position, results
of operations, and cash flows of the Company in the future or what they would
have been had the Company been a separate entity during the periods presented.

In connection with the Reorganization, the Company entered into several
agreements with SPAB that provide for (1) certain tax sharing matters, (2)
registration rights in favor of SPAB, (3) the use of the Spectra-Physics name
and trademark, (4) cross licensing of certain patents, (5) certain distribution
arrangements, and (6) various indemnification arrangements. In addition, certain
subsidiaries of the Company and certain subsidiaries of SPAB entered into
agreements providing for the continuation of certain ongoing service and
facilities leasing arrangements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation:

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.

Use of Estimates:

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Such estimates relate to the useful lives of property, plant
and equipment, allowances for doubtful accounts and customer returns, inventory
realizability, potential accruals

39
<PAGE> 40
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

relating to litigation matters, warranty and other accruals, and contingent
assets and liabilities. Actual results could differ from those estimates, and
such differences may be material to the financial statements.

Cash Equivalents:

The Company considers all highly liquid investments with a maturity of 90
days or less when purchased to be cash equivalents. Cash equivalents (which are
classified as available for sale) are stated at cost, which approximates fair
value, and consist of bankers' acceptances, repurchase agreements, commercial
paper, and money market funds of major banks and other institutions.

Inventories:

Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market.

Property, Plant and Equipment:

Property, plant and equipment are stated at cost and are depreciated on a
straight-line basis over the estimated useful lives of the related assets of 3
to 25 years.

The Company adopted Statement of Financial Accounting Standards (SFAS) No.
121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of" effective as of the beginning of fiscal 1997. The adoption of
this statement had no material affect on the Company's financial statements.

Intangible Assets:

Intangible assets, principally patent rights, are stated at cost and
amortized on a straight-line basis over their estimated useful lives of
generally 7 to 17 years.

Foreign Currency Translation:

The local currency of the Company's subsidiaries in the United Kingdom,
Germany, the Netherlands, France and Japan are the functional currencies for
each entity. The assets and liabilities and sales and expense accounts of these
foreign subsidiaries have been translated using the exchange rate at the balance
sheet date and the weighted average exchange rate for the period, respectively.

The net effect of the translation of the accounts of the Company's
subsidiaries has been included in stockholders' equity as cumulative translation
adjustments. The net effect of adjustments that arise from exchange rate changes
on transactions denominated in a currency other than the local currency are
included in other income (expense) as incurred.

Environmental Matters:

Accruals for remediation costs are recognized when management determines
that it is probable that a liability has been incurred and such costs can be
reasonably estimated. Such accruals are recorded at undiscounted amounts and are
recorded even if significant uncertainties exist over the ultimate cost of the
remediation. Ongoing environmental compliance costs, including maintenance and
monitoring costs, are charged against the accrual.

Parent Equity (Deficit):

Parent equity (deficit) includes historical investments and advances from
SPAB, including net transfers to/from SPAB, income taxes and other liabilities
paid by (owed by) SPAB for the benefit of the Company, and amounts due to/from
SPAB for services and other charges, as well as current period net income (loss)
through the date of the Reorganization.
40
<PAGE> 41
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Sales Recognition:

Net sales and related cost of sales for products are recognized upon
shipment.

Concentrations:

Cash is invested in deposits with banks in the United States and in
countries where subsidiaries operate. Deposits in these banks may exceed the
amount of insurance provided on such deposits; however, the Company is exposed
to loss only to the extent of the amount of cash reflected on its balance sheet.
The Company has not experienced any losses on its deposits of cash.

The Company markets its products on both a direct and an OEM basis
principally in North America, Europe and Japan to companies for use in printing,
micro-machining, marking, materials processing, medical, semiconductor
manufacturing, inspection and repair applications, as well as universities and
other entities involved in research. No individual customer accounts for more
than 10% of net sales. The Company has adopted credit policies and standards to
accommodate growth into these markets. The Company performs continuing credit
evaluations of its customers' financial condition and although the Company
generally does not require collateral, letters of credit may be required from
its customers in certain circumstances. Bad debt losses to date have been
insignificant.

A number of components necessary for the manufacture and operation of many
of the Company's products are obtained from a sole supplier or a limited group
of suppliers. The disruption or termination of any of these sources could have a
material adverse effect on the Company's business, operating results and
financial condition.

Warranty Costs:

Upon shipment of product, the Company accrues the estimated cost of
warranty. The Company in general warrants its products for twelve to twenty-four
months depending on the product line.

Advertising and Promotion Costs:

The Company's policy is to expense advertising and promotion costs as they
are incurred. The Company's advertising and promotion expenses were
approximately $1.9 million, $1.3 million, and $1.2 million in the years ended
December 31, 1997, 1996, and 1995, respectively.

Income Taxes:

The accompanying financial statements reflect the provisions of SFAS No.
109, "Accounting for Income Taxes." Accordingly, the Company uses the liability
method to calculate deferred taxes. The realization of deferred tax assets is
based on historical tax positions and expectations about future taxable income.
Deferred income tax assets and liabilities are computed for differences between
the financial statement and tax basis of assets and liabilities based on enacted
tax laws and rates applicable to the period in which differences are expected to
affect taxable income. Valuation allowances are established, when necessary, to
reduce deferred tax assets to amounts that are more likely than not to be
realized.

Prior to the Reorganization, income taxes were provided as if the Company
were a separate taxable entity. Under the Company's tax sharing agreement with
SPAB prior to the Reorganization, however, the consolidated tax liability for a
given year was allocated only to companies in the group which had separate
taxable income for that year. The tax liability was allocated pro-rata based on
each company's relative separate taxable income. Companies with losses were not
allocated any of the tax liability and were not given any benefit for their
losses. Any differences between the Company's method for providing income tax
expense (benefit) in the historical financial statements and the tax sharing
arrangement it had with SPAB were

41
<PAGE> 42
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

reflected in Parent equity (deficit) as contributions or dividends. Effective
October 1997, the Company and SPAB entered into a new tax sharing arrangement
that generally requires the Company to determine its U.S. tax liability as a
separate consolidated group.

Financial Instruments With Off-Balance-Sheet Risk:

From 1991 to October 1997, the Company entered into forward foreign
exchange contracts with SPAB to offset certain operational exposures from
changes in foreign currency exchange rates. Such exposures resulted from
portions of the Company's operations being denominated in currencies other than
the U.S. dollar, primarily the Japanese yen and European currencies. These
foreign exchange contracts were entered into in anticipation of product sales
made in the normal course of business, and accordingly, were speculative in
nature.

Since the forward foreign exchange contracts were not designated as hedges
of firm, identifiable foreign currency commitments, the unrealized gains and
losses resulting from the impact of currency exchange rate movements on these
contracts were recognized in the periods in which the exchange rates changed.
Such gains and losses were recorded as other income or expense. Also, included
in other income and expense were realized gains and losses on the settlement of
foreign exchange contracts and realized and unrealized gains and losses on the
transactions denominated in currencies other than the U.S. dollar for U.S. based
operations.

In October 1997, the Company changed the way it hedges its foreign currency
exposures. It closed all of its 1998 outstanding foreign exchange contracts with
SPAB by buying offsetting currency contracts. The Company now hedges its foreign
exchange exposure by entering into transactions with credit-worthy independent
financial institutions. The Company's policy is to not hold or issue financial
instruments for trading purposes nor will it hold or issue leveraged derivative
financial instruments. The objective of the Company's foreign exchange risk
management policy is to preserve the U.S. dollar value of its non-U.S. dollar
cash flows. These cash flows arise primarily from the sale of the Company's
products in currencies other than the U.S. dollar, most of which are made
through the Company's subsidiaries in Japan and Europe. The Company's policy is
to use forward exchange contracts and simple purchased foreign currency option
contracts to hedge, respectively, firm commitments and probable anticipated
transactions that expose the Company to enterprise risk.

Gains and losses on forward exchange contracts that are designated as
hedges of a firm order from a customer outside the United States are deferred in
other current assets or liabilities ($0.2 million in other current liabilities
at December 31, 1997) and included in the measurement of the underlying
transaction. Gains on purchased foreign currency options with little or no
intrinsic value designated as hedges of probable anticipated foreign sales
transactions expected to occur within the next three to six months whose
significant characteristics and terms are known will also be deferred in other
current assets or liabilities and recognized at the time of the closing of the
anticipated transactions. Hedge accounting will be applied only if the
derivative reduces the risk of the underlying hedged item and is designated at
inception as a hedge. Additionally, the derivative must result in payoffs that
are expected to be highly inversely correlated to those of the hedged item.
Derivatives are measured for effectiveness both at inception and on an ongoing
basis. If a derivative instrument ceases to meet the criteria for deferral, any
subsequent gains or losses will be recognized in operations as incurred. If a
firm commitment does not occur, the foreign exchange contract will be terminated
and any gain or loss will be recognized in operations. If a hedging instrument
is sold or terminated prior to maturity, gains or losses will continue to be
deferred until the hedged item is recognized.

The Company's forward exchange contracts contain credit risk in that its
banking counterparties may be unable to meet the terms of the agreements. The
Company minimizes such risk by limiting its counterparties to major financial
institutions. In addition, the potential risk of loss with any one party
resulting from this type of credit risk is monitored. Management does not expect
any loss as a result of default by other parties.

42
<PAGE> 43
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The contract amounts and fair value of forward foreign exchange contracts
outstanding was $14.5 million and $15.0 million, respectively, at December 31,
1997.

Pro Forma Net Income (Loss) Per Share:

The Company has adopted SFAS No. 128, "Earnings per share" effective
December 31, 1997. SFAS No. 128 requires the presentation of basic and diluted
net income (loss) per share. Basic net income (loss) per share is computed by
dividing net income (loss) by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is computed
giving effect to all diluted potential common shares that were outstanding
during the period. Dilutive potential common shares consist of the incremental
common shares issuable upon the exercise of stock options. In 1997 and 1996,
weighted average shares were 13,162,000 and 13,000,00, respectively, and in 1997
the shares used in the diluted calculation included 29,000 shares due to grants
of options to purchase 2,087,145 shares of common stock. Stock options granted
by subsidiaries of the Company were not included in the calculation of net
income (loss) per share as they were anti-dilutive. Pro forma basic and diluted
net loss per share for 1996 gives effect to the Reorganization.

Stock Based Compensation:

In 1995, the Financial Accounting Standards Board ("FASB") issued SFAS No.
123, "Accounting for Stock-Based Compensation," which establishes a fair value
based method of accounting for stock-based compensation plans and is effective
for fiscal years beginning after December 15, 1995. SFAS No. 123 allows a
company to continue to follow the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and disclose the pro
forma impact of SFAS No. 123 on results of operations and earnings per share.
The Company has elected to continue to account for its stock-based compensation
plans in accordance with the provisions of APB 25. As the terms of certain
stock-based compensation plans obligated the Company to settle the options in
cash in certain instances, the Company has reflected compensation expense
relating to these stock-based compensation plans in the statement of operations.

Impact of Recently Issued Accounting Standards:

In February 1997, the FASB issued SFAS No. 128, "Earnings per Share," which
was adopted by the Company in 1997, and in March 1997, issued SFAS No. 129
"Disclosures of Information About Capital Structure," which is required to be
adopted by the Company in 1998. These statements specify the computation,
presentation and disclosure requirements for earnings per share and the capital
structure of a company.

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income" and SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information." Both statements are effective for the Company in fiscal
1998. SFAS No. 130 establishes the requirements for disclosure of comprehensive
income. Comprehensive income generally represents all changes in stockholders'
equity except those resulting from investments or contributions from
stockholders. SFAS No. 131 requires publicly-held companies to report financial
and other information about key sales-producing segments of the entity for which
such information is available and utilized by the chief operating decision
maker. Specific information to be reported for individual segments includes
profit and loss, certain sales and expense items and total assets. A
reconciliation of segment financial information to amounts reported in the
financial statements would be provided.

The Company has determined that the impact of adopting each of the recently
issued accounting standards will not be material to its financial position or
results of operations.

43
<PAGE> 44
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Reclassifications:

Certain 1996 and 1995 amounts have been reclassified to conform to the 1997
presentation.

3. TRANSACTIONS WITH SPAB

SPAB allocated certain expenses relating to cash management and treasury,
legal, employee benefits, insurance, income taxes and corporate overhead
services. Charges were allocated to the Company based on actual amounts incurred
on behalf of the Company or agreed upon amounts or percentages based on the
Company's headcount and sales that management of the Company believes were
reasonable. Amounts charged to operations were $0.3 million in each of the years
ended December 31, 1997, 1996, and 1995, respectively.

SPAB used a centralized cash management program to finance its operations.
Cash deposits from the Company's operations were transferred to SPAB on a
periodic basis and SPAB funded the Company's disbursement bank account as
required. Prior to the Reorganization, the Company and SPAB had an agreement
whereby SPAB charged the Company interest based on certain of the Company's net
balance payable to SPAB calculated using SPAB cost of related borrowed funds.
Certain borrowings from SPAB were not subject to interest charges; however,
interest expense has been imputed in the accompanying statement of operations at
rates consistent with actual rates charged to the Company. Beginning in October
1997, the Company no longer participates in SPAB's centralized cash management
program.

The activity in the net transfers (to) from SPAB account, is summarized
below (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
SPAB service and other charges....................... $ 249 $ 328 $ 328
Income taxes paid by (owed by) SPAB, net............. (10,863) (1,365) 112
Liabilities paid by SPAB for the benefit of the
Company............................................ -- 1,775 862
Cash transfers (to) SPAB............................. (17,702) (2,202) (2,464)
Interest expense imputed on non-interest bearing
loans.............................................. 573 985 1,070
-------- ------- -------
Net transfers (to) from SPAB....................... $(27,743) $ (479) $ (92)
======== ======= =======
</TABLE>

Loans and advances from SPAB represented a short-term interest bearing
$30,000,000 loan and various interest bearing short-term cash advances as well
as long-term interest bearing and non-interest bearing loans to the Company and
its foreign sales subsidiaries. The interest bearing loans and advances accrued
interest at a rate determined by SPAB. Interest has been imputed on the
non-interest bearing obligations at a rate consistent with the interest bearing
obligations.

In October 1997, in connection with the Reorganization, SPAB converted all
loans, advances, and interest accrued on such amounts outstanding to equity of
the Company.

44
<PAGE> 45
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

4. BALANCE SHEET ACCOUNTS

Inventories, property, plant and equipment, and accrued and other current
liabilities consisted of the following (in thousands):

<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
INVENTORIES:
Raw material........................................... $10,250 $10,484
Work in process........................................ 8,077 6,092
Finished goods......................................... 7,530 5,233
------- -------
$25,857 $21,809
======= =======
PROPERTY, PLANT AND EQUIPMENT:
Land, buildings and leasehold improvements............. $21,021 $19,506
Machinery and office equipment......................... 48,821 41,579
------- -------
69,842 61,085
Less accumulated depreciation and amortization......... 44,362 40,434
------- -------
$25,480 $20,651
======= =======
ACCRUED AND OTHER CURRENT LIABILITIES:
Salaries and wages..................................... $ 3,917 $ 2,914
Benefits, bonus and commissions........................ 5,730 4,387
Accrued compensation for stock options................. 1,000 6,000
Warranty............................................... 2,802 2,433
Advance payments from customers........................ 5,676 5,501
Other.................................................. 5,624 2,489
------- -------
$24,749 $23,724
======= =======
</TABLE>

5. STOCKHOLDERS' EQUITY

Preferred Stock:

After the Reorganization, the Company's authorized preferred stock was
10,000,000 shares with a par value of $0.01 per share. The Board of Directors
may, at its discretion, designate one or more series of preferred stock and
establish the voting, dividend, liquidation, and other rights and preferences of
the shares of each series, and provide for the issuance of shares of any series.

Stock Options:

Spectra-Physics Lasers, Inc. The Company has adopted the 1997
Spectra-Physics Lasers, Inc. Stock Option Plan which provides for the granting
of non-qualified stock options ("options") to certain officers, key employees
and non-employee directors of the Company. The aggregate maximum number of
shares of common stock available for awards under the 1997 Plan is 2,309,721
shares, subject to adjustment to reflect changes in the Company's
capitalization. No awards can be made under the 1997 Plan more than 10 years

45
<PAGE> 46
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

after the date the plan was adopted. The exercise price of the options will be
determined by the Board of Directors, provided that the exercise price must be
at least 100% of the fair market value of a share of common stock on the date
the option is granted. An option's term shall not exceed ten years from the date
of grant. No option may be exercised sooner than six months from the date of
grant.

During 1997, the Company granted options to purchase 2,087,145 shares of
common stock exercisable at $10.00 per share. These options vest 25% upon the
first anniversary of the grant date and 6.25% at the end of each three-month
period thereafter. Subject to the terms of the 1997 Plan, these options will be
exercisable to the extent vested beginning two years after the grant date. These
options may not be exercised following termination of the grantee's employment
with the Company, except that in the event that a grantee's employment
terminates due to death, disability or retirement, options held by such grantee
or his estate shall be exercisable, to the extent vested at the time of
termination of employment, for a period of three (3) months after termination of
employment or, if later, the end of the foregoing two-year period. The weighted
average fair value of options granted was $4.33 per share. No option granted
under the 1997 plan was canceled, exercised or exercisable. At December 31,
1997, options granted under the 1997 plan had a contractual life of 10 years.

As permitted under SFAS 123, the Company has elected to follow APB No. 25,
in accounting for stock awards to employees. Under APB No. 25, the Company
generally recognizes no compensation expense with respect to such awards under
fixed plans. Pro forma information regarding net income (loss) and earnings
(loss) per share is required by SFAS 123 which also requires that the
information be determined as if the Company has accounted for its employee stock
options under the fair value method of SFAS 123. The fair value for these
options was estimated at the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:

<TABLE>
<S> <C>
Risk-free interest rate..................................... 5.7%
Dividend yield.............................................. 0.0%
Volatility.................................................. 47%
Average life................................................ 4 years
</TABLE>

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
these subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not provide a reliable
single measure of the fair value of its employee stock options.

The effect of applying SFAS No. 123 resulted in pro forma net income of
$33,823,000 and earnings per share basic and diluted of $2.56 for the year ended
December 31, 1997.

Spectra-Physics Laser Data Systems, Inc. Spectra-Physics Laser Data
Systems, Inc. ("Laser Data"), a subsidiary of the Company, granted certain of
its employees options to purchase up to 20% of total common stock outstanding.
One-half of the options vested annually beginning in 1996 and ending in 1999 and
one-half were performance-based options. At December 31, 1996, all the options
remained outstanding and 40 shares under option were vested. The options were
exercisable from the effective date of an initial public offering of Laser
Data's common stock until the earlier of the first anniversary of such initial
public offering or May 1, 2000. If a sale of control of the subsidiary occurred
before May 1, 2000, the subsidiary was to redeem the options, to the extent
vested, by paying the holders the difference between the exercise price and the
per share value received in the sale of control (unless the acquirer in the sale
of control did not wish such options to be cancelled, in which case they were
not to be redeemed). Subject to certain qualifications, if neither an initial
public offering nor a sale of control occurred before May 1, 2000, the
subsidiary was to redeem the options by

46
<PAGE> 47
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

paying its option holders the difference, on a per-share basis, between the
exercise price and the fair value of the subsidiary's common stock as determined
by the board of directors, provided that the holders of a majority of the
options were allowed to request an independent appraisal of the board's
valuation. In 1997, prior to the modifications described below, the Company
recorded a charge to operations of $0.2 million in connection with the Laser
Data options.

In December 1997, these options were modified so that all of the options
became exercisable (a) during the period (i) beginning on the effective date of
a Laser Data initial public offering, if any, and (ii) ending on the earlier to
occur of the first anniversary following any such initial public offering and
February 28, 2000 (after which time the right to exercise vested options is
terminated) or (b) during the period commencing on February 28, 2000 and ending
on December 31, 2002. The options were also modified such that 31% of the
options were vested with the remaining options vesting at varying rates through
December 31, 1999, and Laser Data's requirement to redeem the options was
eliminated. These modifications resulted in (1) a new measurement date for the
options, for which the Company recorded a charge of $1.0 million, based on the
difference between the exercise price of the options and the estimated fair
value of Laser Data on the date the options were modified, and (2) the
establishment of the amount of compensation expense related to these options. At
December 31, 1997 options to purchase 174 shares were outstanding at a weighted
average price of $0.05 per share, none were exercisable, and 54 shares under
option were vested.

6. BENEFIT AND INCENTIVE PLANS

The Company sponsors a defined contribution plan covering substantially all
U.S. employees. The plan provides for limited Company matching of participants'
contributions. Contributions to the plan by the Company and charged to
operations were $0.6 million, $0.5 million and $0.4 million in the years ended
December 31, 1997, 1996 and 1995, respectively.

The Company's Executive Incentive Plan and Employee Bonus Plan provides
certain officers and employees of the Company with annual incentive cash bonus
awards based on the achievement of certain pre-established quantitative and
qualitative goals, including overall Company profitability. The Company charged
to operations $2.4 million, $1.9 million and $1.3 million in the years ended
December 31, 1997, 1996 and 1995, respectively, under these plans.

SPAB adopted the 1994 Phantom Stock Option Plan pursuant to which certain
of the then executive officers and employees of the Company were granted in 1994
an aggregate of 35,000 phantom stock options (the "Phantom Stock Options") at an
exercise price of 117 SEK (Swedish krona) per option. The terms of the options
expire after four years. Each Phantom Stock Option entitles the holder to the
right to receive a cash payment upon exercise of the Phantom Stock Option equal
to the fair market value (as defined) of one share of common stock of SPAB less
the reference price of the Phantom Stock Option. Phantom Stock Options may be
exercised from two to four years from the date of grant. During the years ended
December 31, 1997, 1996 and 1995, 0, 2,000 and 7,000 of the Phantom Stock
Options were canceled, respectively, and in the year ended December 31, 1997, a
total of 18,000 options were exercised. At December 31, 1997, 8,000 of the
Phantom Stock Options remained outstanding. All of the options were fully
exercisable and had a weighted average remaining contractual life of one year.
The Company charged to operations $0.5 million, $0, and $0 in the years ended
December 31, 1997, 1996 and 1995, respectively, under the 1994 Phantom Stock
Option Plan.

47
<PAGE> 48
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

7. INCOME TAXES

Income (loss) before income taxes consisted of the following (in
thousands):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
U.S........................................... $ 9,169 $(5,814) $(3,600)
Foreign....................................... 3,644 2,200 1,899
------- ------- -------
$12,813 $(3,614) $(1,701)
======= ======= =======
</TABLE>

The provision for income taxes in the years ended December 31, 1996 and
1995 represented foreign taxes currently payable at each of the applicable
country's statutory rate. The benefit of income taxes for the year ended
December 31, 1997 consisted of the following:

<TABLE>
<S> <C>
U.S. Federal and state:
Current................................................... $ --
Deferred.................................................. 1,213
--------
1,213
--------
Foreign:
Current................................................... 2,651
Deferred.................................................. (816)
--------
1,835
--------
Decrease in valuation allowance............................. (24,096)
--------
Total............................................. $(21,048)
========
</TABLE>

The following table summarizes the significant differences between the U.S.
Federal statutory rate and the Company's provision for (benefit from) income
taxes for financial statement purposes (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1997 1996 1995
-------- ------- -----
<S> <C> <C> <C>
Tax expense (benefit) at statutory rate........ $ 4,485 $(1,265) $(595)
Foreign taxes.................................. 666 209 28
State taxes, net of Federal benefit............ 316 (161) (92)
Decrease in valuation allowance................ (26,704) -- --
Losses for which no tax benefit was
recognized................................... -- 1,602 913
Other.......................................... 189 249 64
-------- ------- -----
Income tax expense (benefit)................... $(21,048) $ 634 $ 318
======== ======= =====
</TABLE>

The Company's deferred tax assets are comprised of the following (in
thousands):

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1997 1996
------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................ $ -- $20,564
Inventory valuation accounts............................ 3,298 2,608
Accrued expenses........................................ 3,945 2,675
Other................................................... 957 857
------ -------
8,200 26,704
Valuation allowance for deferred tax assets............. -- (26,704)
------ -------
Net deferred tax assets................................... $8,200 $ --
====== =======
</TABLE>

48
<PAGE> 49
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Income taxes have been provided as if the Company were a separate taxable
entity. For periods prior to the three months ended September 30, 1997, income
tax expense reflected foreign taxes only due to the expectation by the Company
at that time of continuing losses in the U.S. Deferred tax assets were
established relating to: (i) net operating loss carryforwards, which included
interest expense from SPAB; (ii) accrued compensation associated with employee
stock options; (iii) inventory valuation reserves; and (iv) other accruals.
These deferred tax assets were offset in total by a valuation allowance due to
the expectation of continued losses in the U.S.

During the quarter ended September 30, 1997, the Company decreased the tax
valuation allowance and recognized a tax benefit relating to the above items
(net of foreign taxes) totaling $23.3 million. The decrease of the valuation
allowance and the recognition of the tax benefit in the quarter was based on
management's expectations regarding future taxable income for the Company.
Management's expectations included the consideration of the conversion of loans
and advances from SPAB to equity in October 1997 which will eliminate related
interest charges in the future.

For U.S. income tax return purposes, the Company was part of a U.S.
consolidated group pursuant to a tax sharing agreement among SPAB affiliated
companies through September 1997. Under this tax sharing agreement, the
Company's net operating loss carryovers referred to above were used to offset
the taxable income of other members of the tax filing group with no benefit to
the Company. Accordingly, the deferred tax asset arising from the net operating
loss carryforwards (amounting to $10.2 million) was recorded as a dividend to
SPAB.

8. COMMITMENTS

The Company leases manufacturing, research and development and office
facilities under non-cancellable operating leases which expire in 1998 through
2006. The Company is responsible for taxes, insurance and maintenance expenses
related to the leased facilities. Under the terms of certain lease agreements,
the leases may be extended, at the Company's option, and certain of the leases
provide for adjustments of the minimum monthly rent.

Future minimum annual lease payments under the leases are as follows (in
thousands):

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998................................................... $2,900
1999................................................... 2,000
2000................................................... 1,400
2001................................................... 850
2002................................................... 600
Thereafter............................................. 400
------
$8,150
======
</TABLE>

Rent expense was $2.5 million, $2.4 million and $2.7 million in the years
ended December 31, 1997, 1996, and 1995, respectively.

9. ENVIRONMENTAL MATTERS

Since 1984, the Company has been identified by federal and state
authorities as one of several potentially responsible parties ("PRPs") in
conjunction with past releases of industrial solvents to soil and groundwater at
one of the Company's facilities. The site has been listed on the National
Priorities List, or "Superfund List," and the Company is subject to orders
requiring it to perform remediation on- and off-site. Applicable federal law
imposes joint and several liability on each PRP for the cleanup of this site.
Pursuant to these orders, the Company and other PRPs are jointly performing and
funding remediation that includes soil treatment, on-site

49
<PAGE> 50
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

and off-site groundwater extraction, treatment and monitoring. All of the
required soil and groundwater remediation and monitoring systems currently
required by the order are in place, and consequently the initial capital
expenditures for such systems have been incurred. Generally the Company has
determined its share of total estimated clean up and remediation costs and has
accrued the amount that it believes to be its share of the total cost.

Measurement of environmental accruals is subject to uncertainties,
including the evolving nature of environmental regulations and their
enforcement, the amount of time required to complete remediation, and the extent
to which other PRPs will bear their share of the remediation costs. The Company
estimates that at December 31, 1997 the remediation process will be completed at
a cost ranging from approximately $2.1 million to $4.3 million. It is possible
that the Company's recorded estimate of its obligation may change. At December
31, 1997 and 1996, the Company had accrued its best estimate of the liability of
approximately $2.1 million (of which $1.5 million was included in long term
liabilities) and $2.2 million (of which $1.8 million was included in long term
liabilities), respectively, for anticipated future remediation costs associated
with the Superfund site referred to above. During the years ended December 31,
1997, 1996 and 1995, the Company paid approximately $0.1 million, $0.5 million,
and $0.2 million, respectively, for remediation of this site.

In October 1997, the Company was served with a complaint that had been
filed in the Superior Court of the State of California seeking an unspecified
amount of damages for personal injuries and property damage incurred by
residents of a single location alleged to have resulted from the Company's and
others' negligent and/or intentional handling of toxic chemicals. While the
Company believes it has meritorious defenses to the claims asserted in this
lawsuit and intends to vigorously defend itself in this case the amount of loss,
if any, that may result upon resolution of this complaint is not currently
estimable nor have any amounts been accrued in the financial statements.
Accordingly, there can be no assurance that the complaint will be resolved
without adverse impact to the Company's financial position or results of
operations.

10. WORLDWIDE OPERATIONS

The Company operates in one segment, the development, manufacturing and
distribution of lasers and laser systems for the industrial, OEM and research
and development markets.

Included in the following tables in operating income (loss) for the North
American and Export geographic region was $15.8 million, $6.9 million and $1.9
million in the years ended December 31, 1997, 1996 and 1995, respectively,
related to the legal and compensation expenses discussed in Note 11.

50
<PAGE> 51
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Information about the Company's geographic areas is as follows (in
thousands):

<TABLE>
<CAPTION>
NORTH
AMERICA
EUROPE JAPAN AND EXPORT ELIMINATIONS TOTAL
------- ------- ---------- ------------ --------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Net sales:
External........................... $31,535 $31,334 $ 96,305 $ -- $159,174
Internal........................... -- -- 42,986 (42,986) --
------- ------- -------- -------- --------
$31,535 $31,334 $139,291 $(42,986) $159,174
======= ======= ======== ======== ========
Operating income (loss).............. $ 1,134 $ 2,393 $ (5,186) $ (600) $ (2,259)
======= ======= ======== ======== ========
Identifiable assets.................. $16,504 $15,284 $125,632 $(16,896) $140,524
======= ======= ======== ======== ========
Year ended December 31, 1996:
Net sales:
External........................... $30,449 $30,517 $ 74,468 $ -- $135,434
Internal........................... -- -- 37,825 (37,825) --
------- ------- -------- -------- --------
$30,449 $30,517 $112,293 $(37,825) $135,434
======= ======= ======== ======== ========
Operating income (loss).............. $ 1,251 $ 937 $ (2,733) $ (227) $ (772)
======= ======= ======== ======== ========
Identifiable assets.................. $11,765 $12,183 $ 71,530 $ (8,630) $ 86,848
======= ======= ======== ======== ========
Year ended December 31, 1995:
Net sales:
External........................... $28,223 $30,479 $ 53,825 $ -- $112,527
Internal........................... -- -- 37,755 (37,755) --
------- ------- -------- -------- --------
$28,223 $30,479 $ 91,580 $(37,755) $112,527
======= ======= ======== ======== ========
Operating income (loss).............. $ 1,091 $ 809 $ (211) $ 154 $ 1,843
======= ======= ======== ======== ========
</TABLE>

External sales are based on the location of the Company's sales and service
subsidiary. Transfers between geographic areas consist of products that are sold
at amounts generally above cost and are consistent with governing tax
regulations. Identifiable assets are those assets used in each geographic area.
Export sales are United States foreign direct sales to unaffiliated customers
primarily in Europe and Asia Pacific. Export sales totaled $9.2 million in 1997,
$10.1 million in 1996, and $8.6 million in 1995.

For 1997, 1996 and 1995, corporate headquarter costs of $4.4 million, $3.8
million, and $3.7 million, respectively, were included in the North American
geographic area. Included in corporate headquarter costs were expense
allocations from SPAB totalling $0.3 million in each of 1997, 1996, and 1995.

11. OTHER STATEMENT OF OPERATIONS ITEMS

Included in other operating expenses in the years ended December 31, 1997,
1996 and 1995, was $1.7 million, $1.9 million, and $0.9 million, respectively,
of legal expenses associated with a lawsuit which was settled in the second
quarter of 1997. As a result of the settlement, the Company received $17.0
million of net proceeds which was included as other income in the year ended
December 31, 1997.

Also included in other operating expenses in the years ended December 31,
1997, 1996 and 1995, was $14.1 million, $5.0 million, $1.0 million,
respectively, of compensation expense associated with certain stock options of
two subsidiaries. The stock options for one subsidiary were modified so as to
establish the measurement date and the amount of compensation expense the
Company is required to record and, for the other subsidiary, were cancelled for
a combination of cash and common stock of the Company. Accordingly, the Company
does not expect to incur additional compensation expense relating to these stock
options in the

51
<PAGE> 52
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

future. In the fourth quarter of 1997, the Company paid approximately $14.9
million and issued 408,043 shares of common stock to cancelled the stock options
of the second subsidiary. The cash payments were funded through an equity
contribution by SPAB.

12. SUBSEQUENT EVENT

In January 1998, the Company issued 360,000 shares of common stock in
accordance with an overallotment option granted to the underwriters of the
Company's initial public offering. Net proceeds were approximately $3.2 million.

13. UNAUDITED QUARTERLY FINANCIAL DATA

The following is a summary of quarterly financial results:

<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1997
Net sales............................. $35,080 $38,368 $39,613 $46,113
Gross margin.......................... 12,545 14,618 14,720 18,519
Net income (loss)..................... (3,963) 13,470 20,725 3,629
Pro forma net income (loss) per share:
Basic............................... (0.30) 1.04 1.59 0.27
Diluted............................. (0.30) 1.04 1.59 0.26

1996
Net sales............................. $27,283 $30,723 $32,409 $45,019
Gross margin.......................... 9,336 10,803 10,692 16,283
Net income (loss)..................... (1,353) (1,948) (2,081) 1,134
Pro forma net income (loss) per share:
Basic............................... (0.10) (0.15) (0.16) 0.09
Diluted............................. (0.10) (0.15) (0.16) 0.09
</TABLE>

52
<PAGE> 53
SPECTRA-PHYSICS LASERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and Stockholders
Spectra-Physics Lasers, Inc.

In connection with our audits of the consolidated financial statements of
Spectra-Physics Lasers, Inc. as of December 31, 1996 and 1997, and for each of
the three years in the period ended December 31, 1997, which financial
statements are included in this Form 10-K, we have also audited the financial
statement schedule listed in Item 14(a) herein.

In our opinion, this financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information required to be included therein.

COOPERS & LYBRAND L.L.P.

San Jose, California
January 16, 1998

53
<PAGE> 54

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END OF
OF YEAR ADDITIONS DEDUCTIONS YEAR
------------ --------- ---------- ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
December 31, 1995............................ $ 647 $ 60 $ (379) $ 328
December 31, 1996............................ 328 33 -- 361
December 31, 1997............................ 361 179 -- 540
WARRANTY RESERVES:
December 31, 1995............................ $2,080 $1,821 $(1,621) $2,280
December 31, 1996............................ 2,280 2,429 (2,276) 2,433
December 31, 1997............................ 2,433 3,437 (3,068) 2,802
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 1997
BALANCE SHEET AND STATEMENT OF OPERATIONS INCLUDED IN THE COMPANY'S 1997 FORM
10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 33,487
<SECURITIES> 0
<RECEIVABLES> 39,511
<ALLOWANCES> 540
<INVENTORY> 25,857
<CURRENT-ASSETS> 111,464
<PP&E> 69,842
<DEPRECIATION> 44,362
<TOTAL-ASSETS> 140,524
<CURRENT-LIABILITIES> 42,523
<BONDS> 0
0
0
<COMMON> 158
<OTHER-SE> 96,166
<TOTAL-LIABILITY-AND-EQUITY> 140,524
<SALES> 159,174
<TOTAL-REVENUES> 159,174
<CGS> 98,772
<TOTAL-COSTS> 98,772
<OTHER-EXPENSES> 62,661
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (4,005)
<INCOME-PRETAX> 12,813
<INCOME-TAX> (21,048)
<INCOME-CONTINUING> 33,861
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 33,861
<EPS-PRIMARY> 2.57
<EPS-DILUTED> 2.57

</TABLE>