Electro Scientific Industries, Inc.
ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 11/09/2011 13:03:36)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended October 1, 2011

OR

 

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

For the transition period from            to            

Commission File Number: 0-12853

 

 

ELECTRO SCIENTIFIC INDUSTRIES, INC.

 

 

 

Oregon   93-0370304

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

13900 N.W. Science Park Drive,

Portland, Oregon

  97229
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number: (503) 641-4141

Registrant’s web address: www.esi.com

 

 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨     Accelerated filer   x
Non-accelerated filer   ¨     Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

The number of shares outstanding of the Registrant’s Common Stock at November 4, 2011 was 28,810,405 shares.

 

 

 


Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

     PAGE NO.  
PART I. FINANCIAL INFORMATION   
    Item 1.    Financial Statements (Unaudited)   
   Condensed Consolidated Balance Sheets - at October 1, 2011 and April 2, 2011      1   
  

Condensed Consolidated Statements of Operations - for the fiscal quarters ended October 1, 2011 and October 2, 2010

     2   
  

Condensed Consolidated Statements of Cash Flows - for the fiscal quarters ended October 1, 2011 and October 2, 2010

     3   
   Notes to Condensed Consolidated Financial Statements      4   
    Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      10   
    Item 3.    Quantitative and Qualitative Disclosures About Market Risk      19   
    Item 4.    Controls and Procedures      19   
PART II. OTHER INFORMATION   
    Item 1.    Legal Proceedings      19   
    Item 1A.    Risk Factors      20   
    Item 6.    Exhibits      28   
SIGNATURES      29   


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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(In thousands)

   Oct 1, 2011      Apr 2, 2011  
ASSETS      

Current assets:

     

Cash and cash equivalents

   $ 84,143       $ 116,412   

Restricted cash

     22,269         10,769   

Short-term investments

     96,503         69,245   
  

 

 

    

 

 

 

Total cash, restricted cash and investments

     202,915         196,426   

Trade receivables, net of allowances of $466 and $429

     29,631         44,100   

Inventories

     75,705         65,362   

Shipped systems pending acceptance

     1,339         5,289   

Deferred income taxes, net

     9,644         9,892   

Other current assets

     4,308         6,784   
  

 

 

    

 

 

 

Total current assets

     323,542         327,853   

Non-current assets:

     

Non-current investments

     23,063         8,097   

Auction rate securities

     —           5,166   

Property, plant and equipment, net of accumulated depreciation of $97,487 and $92,334

     38,730         39,661   

Non-current deferred income taxes, net

     28,865         30,822   

Goodwill

     4,014         4,014   

Acquired intangible assets, net of accumulated amortization of $9,782 and $8,906

     9,159         10,035   

Other assets

     12,469         14,519   
  

 

 

    

 

 

 

Total assets

   $ 439,842       $ 440,167   
  

 

 

    

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY      

Current liabilities:

     

Accounts payable

   $ 15,936       $ 18,650   

Accrued liabilities

     20,021         33,425   

Deferred revenue

     9,363         16,039   
  

 

 

    

 

 

 

Total current liabilities

     45,320         68,114   

Non-current liabilities:

     

Income taxes payable

     9,603         9,754   

Commitments and contingencies

     

Shareholders’ equity:

     

Preferred stock, without par value; 1,000 shares authorized; no shares issued

     —           —     

Common stock, without par value; 100,000 shares authorized;

     

28,805 and 28,299 issued and outstanding

     162,546         153,189   

Retained earnings

     221,870         207,420   

Accumulated other comprehensive income related to auction rate securities

     —           1,445   

Accumulated other comprehensive income, other

     503         245   
  

 

 

    

 

 

 

Total shareholders’ equity

     384,919         362,299   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 439,842       $ 440,167   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     Fiscal quarter ended     Two fiscal quarters ended  

(In thousands, except per share amounts)

   Oct 1, 2011     Oct 2, 2010     Oct 1, 2011     Oct 2, 2010  

Net sales

   $ 81,884      $ 59,554      $ 158,930      $ 118,025   

Cost of sales

     45,943        33,553        89,229        70,551   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     35,941        26,001        69,701        47,474   

Operating expenses:

        

Selling, service and administration

     14,884        15,046        31,380        27,891   

Research, development and engineering

     10,742        10,217        21,976        20,428   

Legal settlement costs

     —          —          550        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net operating expenses

     25,626        25,263        53,906        48,319   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     10,315        738        15,795        (845

Non-operating (expense) income:

        

Gain on sale of previously impaired auction rate securities

     —          —          2,729        —     

Interest and other (expense) income, net

     (406     187        (543     245   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-operating (expense) income

     (406     187        2,186        245   

Income (loss) before income taxes

     9,909        925        17,981        (600

Provision for (benefit from) income taxes

     1,372        1,536        3,531        (190
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 8,537      $ (611   $ 14,450      $ (410
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share – basic

   $ 0.30      $ (0.02   $ 0.51      $ (0.01
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share – diluted

   $ 0.29      $ (0.02   $ 0.49      $ (0.01
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares – basic

     28,747        28,010        28,609        27,901   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares – diluted

     29,426        28,010        29,326        27,901   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011     Oct 2, 2010  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income (loss)

   $ 14,450      $ (410

Adjustments to reconcile net income (loss) to cash provided by operating activities:

    

Depreciation and amortization

     5,411        5,127   

Amortization of acquired intangible assets

     894        1,011   

Share-based compensation expense

     7,153        5,197   

Provision for (recovery of) doubtful accounts

     50        (150

Gain on sale of previously impaired auction rate securities

     (2,729     —     

Loss on disposal of property, plant and equipment

     2        72   

Deferred income taxes

     2,286        (2,285

Changes in operating accounts:

    

Decrease (increase) in trade receivables, net

     14,545        (7,594

Increase in inventories

     (9,704     (1,691

Decrease (increase) in shipped systems pending acceptance

     3,950        (2,179

Decrease in other current assets

     2,598        644   

(Decrease) increase in accounts payable and accrued liabilities

     (16,680     12,088   

(Decrease) increase in deferred revenue

     (6,690     3,062   
  

 

 

   

 

 

 

Net cash provided by operating activities

     15,536        12,892   

CASH FLOWS FROM INVESTING ACTIVITIES

    

Purchases of investments

     (436,281     (162,541

Proceeds from sales and maturities of investments

     394,023        160,072   

Proceeds from sale of auction rate securities

     6,450        —     

(Increase) decrease in restricted cash

     (11,500     55   

Purchase of property, plant and equipment

     (3,445     (2,621

Cash paid to acquire the assets of PyroPhotonics Lasers, Inc.

     —          (8,075

Decrease (increase) in other assets

     217        (8
  

 

 

   

 

 

 

Net cash used in investing activities

     (50,536     (13,118

CASH FLOWS FROM FINANCING ACTIVITIES

    

Stock plan activity, net

     1,686        219   

Excess tax benefit of share-based compensation

     519        —     
  

 

 

   

 

 

 

Net cash provided by financing activities

     2,205        219   

Effect of exchange rate changes on cash

     526        1,092   
  

 

 

   

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

     (32,269     1,085   

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

     116,412        39,335   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 84,143      $ 40,420   
  

 

 

   

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION

    

Cash paid for income taxes

   $ (2,383   $ (1,050

Income tax refunds received

   $ 120      $ 692   

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

 

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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

These unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements are to be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for its fiscal year ended April 2, 2011. These interim statements include all adjustments (consisting of only normal recurring adjustments and accruals) necessary for a fair presentation of results for the interim periods presented. The results for interim periods are not necessarily indicative of the results of operations for the entire year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. Management believes that the estimates used are reasonable. Significant estimates made by management include: revenue recognition; inventory valuation; product warranty reserves; allowance for doubtful accounts; share-based compensation; income taxes including the valuation of deferred tax assets; fair value measurements; valuation of cost method equity investments; and valuation of long-lived assets.

There have been no significant changes to the Company’s significant accounting policies from those presented in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for its fiscal year ended April 2, 2011. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.

2. Recent Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) Accounting Standards Update (ASU) 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASC ASU 2011-08). ASC ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-step impairment test. The Company adopted ASC ASU 2011-08 in the second quarter of 2012.

3. Restricted Cash

As of October 1, 2011 and April 2, 2011, the Company had restricted cash of $22.3 million and $10.8 million, respectively, which collateralizes commercial letters of credit. See Note 14 “Legal Proceedings” for further discussion.

4. Fair Value Measurements

Financial Assets Measured at Fair Value

Fair value is defined under ASC Topic 820 “Fair Value Measurements and Disclosures” (ASC Topic 820) as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. ASC Topic 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include the following:

 

   

Level 1 , defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;

 

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Level 2 , defined as inputs other than quoted prices in active markets for similar assets or liabilities that are either directly or indirectly observable; and

 

   

Level 3 , defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of October 1, 2011 and April 2, 2011 was as follows (in thousands):

 

October 1, 2011

   Level 1      Level 2     Level 3      Total  

Money market securities

   $ 8,916       $ —        $ —         $ 8,916   

Commercial paper

     —           75,567        —           75,567   

Government agencies

     —           74,162        —           74,162   

Corporate bonds

     —           14,195        —           14,195   

Forward purchase or (sale) contracts:

          

Japanese Yen

     —           80        —           80   

Taiwan Dollar

     —           (82     —           (82

Korean Won

     —           (381     —           (381

Euro

     —           75        —           75   

British Pound

     —           (75     —           (75

Chinese Renminbi

     —           (7     —           (7

April 2, 2011

   Level 1      Level 2     Level 3      Total  

Money market securities

   $ 5,261       $ —        $ —         $ 5,261   

Commercial paper

     —           97,332        —           97,332   

Government agencies

     —           63,667        —           63,667   

Forward purchase or (sale) contracts:

          

Japanese Yen

     —           135        —           135   

Taiwan Dollar

     —           —          —           —     

Korean Won

     —           98        —           98   

Euro

     —           (26     —           (26

British Pound

     —           (23     —           (23

Auction rate securities

     —           —          5,166         5,166   

Preferred stock

     —           —          —           —     

For Level 1 assets, the Company utilized quoted prices in active markets for identical assets.

For Level 2 assets, exclusive of forward contracts, the Company utilized quoted prices in active markets for similar assets. For forward contracts, spot prices at September 30, 2011 and April 1, 2011 were utilized to calculate fair values.

The Level 3 assets consisted of auction rate securities (ARS) and preferred stock acquired through the conversion of ARS. Since auctions of ARS had not recently occurred, estimated fair values were based primarily upon the income approach using a discounted cash flow model which took into account the following: (i) the underlying structure of each security; (ii) the present value of future principal and interest payments discounted at rates that reflect current market conditions; (iii) consideration of the probabilities of default, restructuring or redemption by the issuer (trigger events); (iv) estimates of the recovery rates in the event of default for each security; (v) the financial condition, results, ratings of and financial claims on the bond insurers and issuers; and (vi) the underlying trust assets of the securities.

As of October 1, 2011, the Company did not have any ARS investments. During the first quarter of 2012, the Company sold all of its remaining ARS for approximately $6.0 million and all of its preferred stock for approximately $0.5 million. These ARS had a total estimated fair value of $5.2 million as of April 2, 2011, which consisted of $10.7 million par value ARS and $4.0 million par value ARS which were converted by the bond issuer to its preferred stock in 2009. The Company recorded a gain of $2.7 million in the first quarter of 2012, which included $1.4 million in reclassification of previously recorded unrealized gain out of accumulated other comprehensive income.

 

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As of October 1, 2011, the Company had $6.0 million invested in Series D Preferred Stock and $3.0 million invested in Series E Preferred Stock of OmniGuide, Inc., representing an 11% interest. At each reporting period end, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of these investments. If there are no events or circumstances identified that would adversely affect the fair value of the investments, the fair values of the investments are not calculated as it is not practicable to do so. As of October 1, 2011 and April 2, 2011, management had not identified any events or circumstances that indicated the investments were impaired; therefore, the full carrying value of $9.0 million was included in Other assets on the Condensed Consolidated Balance Sheets at October 1, 2011 and April 2, 2011.

Investments

Certain information regarding the Company’s investments at October 1, 2011 and April 2, 2011 was as follows (in thousands):

 

October 1, 2011

   Unrealized  
     Cost      Gain      Loss     Fair Value  

Available-for-sale securities (current):

          

Commercial paper

   $ 75,566       $ 1       $ —        $ 75,567   

Government agencies

     64,136         25         —          64,161   

Corporate bonds

     1,133         —           —          1,133   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 140,835       $ 26       $ —        $ 140,861   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale securities (non-current):

          

Corporate bonds

   $ 13,098       $ —         $ (36   $ 13,062   

Government agencies

     10,000         1         —          10,001   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 23,098       $ 1       $ (36   $ 23,063   
  

 

 

    

 

 

    

 

 

   

 

 

 

April 2, 2011

   Unrealized  
     Cost      Gain      Loss     Fair Value  

Available-for-sale securities (current):

          

Commercial paper

   $ 97,330       $ 2       $ —        $ 97,332   

Government agencies

     55,550         20         —          55,570   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 152,880       $ 22       $ —        $ 152,902   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale securities (non-current):

          

Government agencies

   $ 8,087       $ 10       $ —        $ 8,097   

Auction rate securities

     10,700         1,445         (6,979     5,166   

Preferred stock

     4,000         —           (4,000     —     
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 22,787       $ 1,455       $ (10,979   $ 13,263   
  

 

 

    

 

 

    

 

 

   

 

 

 

There were no sales of available-for-sale securities in the second quarter of 2012 or 2011 nor in the first quarter of 2011. In addition to the sales of ARS in the first quarter of 2012, the Company sold certain available-for-sale securities for approximately $3.5 million at cost. For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income, the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive income were insignificant as of October 1, 2011 and April 2, 2011.

Underlying maturities of investments as October 1, 2011 were $140.9 million within one year and $23.1 million between one to five years.

 

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5. Inventories

Inventories are principally valued at standard costs, which approximate the lower of cost (first-in, first-out) or market. Components of inventories were as follows:

 

(In thousands)

   Oct 1, 2011      Apr 2, 2011  

Raw materials and purchased parts

   $ 47,514       $ 45,650   

Work-in-process

     13,354         11,274   

Finished goods

     14,837         8,438   
  

 

 

    

 

 

 
   $ 75,705       $ 65,362   
  

 

 

    

 

 

 

6. Other Current Assets

Other current assets consisted of the following:

 

(In thousands)

   Oct 1, 2011      Apr 2, 2011  

Prepaid expenses

   $ 2,297       $ 3,840   

Value added tax receivable

     1,643         2,481   

Other

     368         463   
  

 

 

    

 

 

 
   $ 4,308       $ 6,784   
  

 

 

    

 

 

 

7. Other Assets

Other assets consisted of the following:

 

(In thousands)

   Oct 1, 2011      Apr 2, 2011  

Minority equity investment

   $ 8,966       $ 8,966   

Consignment and demo equipment, net

     2,544         4,624   

Other

     959         929   
  

 

 

    

 

 

 
   $ 12,469       $ 14,519   
  

 

 

    

 

 

 

8. Accrued Liabilities

Accrued liabilities consisted of the following:

 

(In thousands)

   Oct 1, 2011      Apr 2, 2011  

Payroll-related liabilities

   $ 6,456       $ 13,486   

Product warranty accrual

     5,117         4,415   

Pension benefit liabilities

     2,129         1,808   

Professional fees payable

     1,415         1,653   

Purchase order commitments and receipts

     1,323         922   

Value added taxes payable

     709         1,028   

Customer deposits

     524         5,499   

Restructuring costs payable

     338         711   

Income taxes payable

     290         1,540   

Legal settlement costs payable

     —           1,208   

Other

     1,720         1,155   
  

 

 

    

 

 

 
   $ 20,021       $ 33,425   
  

 

 

    

 

 

 

 

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9. Product Warranty Accrual

The following is a reconciliation of the change in the aggregate accrual for product warranty:

 

     Fiscal quarter ended     Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011     Oct 2, 2010     Oct 1, 2011     Oct 2, 2010  

Product warranty accrual, beginning

   $ 4,708      $ 3,709      $ 4,415      $ 2,576   

Warranty charges incurred, net

     (1,800     (1,584     (3,951     (2,783

Provision for warranty charges

     2,209        1,986        4,653        4,318   
  

 

 

   

 

 

   

 

 

   

 

 

 

Product warranty accrual, ending

   $ 5,117      $ 4,111      $ 5,117      $ 4,111   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net warranty charges incurred include labor charges and costs of replacement parts for system repairs under warranty. These costs are recorded net of any estimated cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. The provision for warranty charges reflects the estimate of future anticipated net warranty costs to be incurred for all products under warranty at quarter end and is recorded to cost of sales.

10. Deferred Revenue

Generally, revenue is recognized upon fulfillment of acceptance criteria at the Company’s factory and title transfer which frequently occurs at the time of delivery to a common carrier. Revenue is deferred whenever title transfer is pending and/or acceptance criteria have not yet been fulfilled. Deferred revenue occurrences include sales to Japanese customers, shipments of substantially new products and shipments with custom specifications and acceptance criteria. In sales involving multiple element arrangements, the fair value of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.

The following is a reconciliation of the changes in deferred revenue:

 

     Fiscal quarter ended     Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011     Oct 2, 2010     Oct 1, 2011     Oct 2, 2010  

Deferred revenue, beginning

   $ 21,964      $ 10,591      $ 16,039      $ 13,193   

Revenue deferred

     7,124        11,890        29,037        19,504   

Revenue recognized

     (19,725     (6,108     (35,713     (16,324
  

 

 

   

 

 

   

 

 

   

 

 

 

Deferred revenue, ending

   $ 9,363      $ 16,373      $ 9,363      $ 16,373   
  

 

 

   

 

 

   

 

 

   

 

 

 

11. Earnings Per Share

The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings per share:

 

     Fiscal quarter ended     Two fiscal quarters ended  

(In thousands, except per share data)

   Oct 1, 2011      Oct 2, 2010     Oct 1, 2011      Oct 2, 2010  

Net income (loss)

   $ 8,537       $ (611   $ 14,450       $ (410
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average shares used for basic earnings per share

     28,747         28,010        28,609         27,901   

Incremental diluted shares

     679         —          717         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average shares used for diluted earnings per share

     29,426         28,010        29,326         27,901   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss) per share:

          

Net income (loss) – basic

   $ 0.30       $ (0.02   $ 0.51       $ (0.01
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss) – diluted

   $ 0.29       $ (0.02   $ 0.49       $ (0.01
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Awards of options, stock-settled stock appreciation rights (SARs), unvested restricted stock units (RSUs) and shares associated with the Company’s Employee Stock Purchase Plan (ESPP) representing an additional 2.9 million and 4.9 million shares for the second quarter ended October 1, 2011 and October 2, 2010, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.

For the two quarters ended October 1, 2011 and October 2, 2010, awards of options, SARs, unvested RSUs and ESPP shares representing an additional 2.8 million and 4.8 million shares, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.

12. Comprehensive Income (Loss)

The components of comprehensive income, net of tax, were as follows:

 

     Fiscal quarter ended     Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011     Oct 2, 2010     Oct 1, 2011     Oct 2, 2010  

Net income (loss)

   $ 8,537      $ (611   $ 14,450      $ (410

Foreign currency translation adjustment

     (145     602        280        707   

Net unrealized (loss) gain on available-for-sale securities

     (24     2        (27     21   

Reclassification of unrealized gains on auction rate securities

     —          —          (1,445     —     

Net unrealized gain on auction rate securities

     —          585        —          194   

Other comprehensive income

     2        3        4        5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 8,370      $ 581      $ 13,262      $ 517   
  

 

 

   

 

 

   

 

 

   

 

 

 

13. Product and Geographic Information

Net sales by product type were as follows:

 

     Fiscal quarter ended      Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011      Oct 2, 2010      Oct 1, 2011      Oct 2, 2010  

Interconnect/ Micro-machining Group (IMG)

   $ 51,227       $ 33,090       $ 99,439       $ 53,701   

Semiconductor Group (SG)

     24,171         13,160         42,196         32,217   

Components Group (CG)

     6,486         13,304         17,295         32,107   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 81,884       $ 59,554       $ 158,930       $ 118,025   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net sales by geographic area, based on the location of the end user, were as follows:

 

     Fiscal quarter ended      Two fiscal quarters ended  

(In thousands)

   Oct 1, 2011      Oct 2, 2010      Oct 1, 2011      Oct 2, 2010  

Asia

   $ 73,886       $ 54,099       $ 142,819       $ 104,884   

Americas

     4,118         3,529         9,860         7,630   

Europe

     3,880         1,926         6,251         5,511   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 81,884       $ 59,554       $ 158,930       $ 118,025   
  

 

 

    

 

 

    

 

 

    

 

 

 

14. Legal Proceedings

All Ring Patent Infringement Prosecution

The Company’s proceedings against All Ring Tech Co., Ltd (All Ring) in Taiwan for alleged patent infringement are ongoing. As a part of these proceedings, the Company established three letters of credit for approximately $19.5 million in July 2009, September 2009 and June 2011, which are collateralized by $22.3 million of restricted cash. The total restricted cash balance was included in Restricted cash on the Condensed Consolidated Balance Sheets as of October 1, 2011.

 

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In June 2011, the Kaohsiung District Court of Taiwan announced its judgment, finding that All Ring had infringed on the Company’s 207469 patent, ordering All Ring to pay the Company approximately $24.0 million plus interest accrued from November 4, 2005 through the payment date at a rate of 5%, and enjoining All Ring from selling any system infringing the 207469 patent. On June 16, 2011, All Ring posted a cash bond for approximately $24.0 million to prevent the provisional execution of the judgment. All Ring appealed this judgment to the Intellectual Property Court on June 28, 2011 and on October 31, 2011, the Company filed its response to All Ring’s appeal. See the Company’s Form 10-K for the year ended April 2, 2011 for further background and additional information related to these proceedings.

In the ordinary course of business, the Company is involved in various other legal matters, either asserted or unasserted, and investigations. In the opinion of management, ultimate resolution of these matters will not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The statements contained in this report that are not statements of historical fact, including without limitation, statements containing the words “believes,” “expects,” “anticipates” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ as a result of many factors, including the risks described in Part II, Item 1A “Risk Factors.”

Business Overview

Electro Scientific Industries, Inc. and its subsidiaries (ESI) is a leading supplier of innovative laser-based manufacturing solutions for the microtechnology industry. Our advanced laser systems enable precise structuring and testing of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, communications and other industries. These features enable our customers to achieve functionality, or improve yield and productivity in their manufacturing processes that can be critical to their profitability. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Canada, Europe and the United States.

Our advanced laser microengineering systems allow semiconductor, microelectronics, and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance and improve production yields. Laser microengineering comprises a set of precise micron-level processes, including advanced micromachining, via drilling, wafer scribing and dicing, material ablation, semiconductor memory-link cutting, electronic device trimming, and nano-level structuring to alter material characteristics such as color and texture. These processes require application-specific laser systems able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems improve production yields or enable improved performance for semiconductor devices, flexible interconnect material, high-density interconnect (HDI) circuits, advanced semiconductor packaging, light emitting diodes (LEDs), flat panel liquid crystal displays (LCDs) and other high value components.

Additionally, we produce high-capacity test and optical inspection equipment that is critical to the quality control process during the production of multilayer ceramic capacitors (MLCCs). Our equipment ensures that each component meets the electrical, physical and optical tolerances required to perform properly.

Summary of Sequential Quarterly Results

The financial results of the quarter ended October 1, 2011, which represented the second fiscal quarter of 2012, reflected strong sales and earnings as revenue increased to $81.9 million. However, total order volume for the second quarter of 2012 declined to approximately $41 million, compared to approximately $99 million for the first quarter of 2012, which ended July 2, 2011. The sequential decrease in orders was primarily due to a large advanced micromachining order received in the first quarter that did not repeat in the second quarter. In addition, the slowing macro-economic environment caused our memory, LED and passive component customers to halt capacity additions.

Orders for our Interconnect/ Micromachining Group (IMG) products decreased approximately 50% compared to the prior quarter. Orders for micromachining products tend to vary in volume between periods and our very large first quarter order was an example of this type of uneven demand. Within this group, the demand for our flex interconnect products continued to be strong, driven by growth in the market for smart phone and tablet devices, which requires smaller components.

 

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Table of Contents

Orders for our Semiconductor Group (SG) products decreased approximately 80% in the second quarter of 2012 compared to the prior quarter as memory repair customers deferred adding capacity as a result of slowing demand for personal computers. In addition, orders declined in LED as a result of a significant overcapacity in the industry, especially for makers of LED backlights for display.

Orders for our Components Group (CG) products decreased approximately 45% compared to the prior quarter. The decrease was primarily due to a decline in orders from our MLCC customers as they utilize existing capacity to meet their production demands.

Net sales of $81.9 million for the second quarter of 2012 increased $4.9 million compared to $77.0 million for the prior quarter. Sales for our IMG products increased $3.0 million due to fulfillment of backlog orders from micromachining customers. SG sales increased $6.2 million with steady shipments to our memory repair customers combined with an increase in deliveries for our LED scribing tools. CG sales decreased $4.3 million as our MLCC customers absorbed capacity created by systems delivered in prior quarters.

Gross margin remained relatively flat at 43.9% on net sales of $81.9 million for the second quarter of 2012 compared to 43.8% on net sales of $77.0 million for the prior quarter.

Net operating expenses of $25.6 million in the second quarter of 2012 decreased $2.7 million compared to the prior quarter. This decrease was primarily due to a decrease of $1.6 million in selling, service and administration (SS&A), $0.5 million in research, development and engineering (RD&E) and $0.6 million in legal settlement costs. SS&A expense decreased primarily due to share-based compensation expense. Share-based compensation expense during the first quarter included the accelerated expensing associated with the Chief Executive Officer’s retirement eligibility date and the immediate vesting of the annual board of director share grants, which did not repeat during the second quarter. RD&E decreased primarily due to lower project materials cost. Legal settlement costs decreased because the court and legal fees associated with the All Ring litigation incurred during the first quarter were non-recurring in the second quarter.

Operating income was $10.3 million in the second quarter of 2012, an increase of $4.8 million compared to operating income of $5.5 million in the prior quarter. The increase was primarily due to higher sales combined with lower operating expenses discussed above.

The effective tax rate was 13.8% for the second quarter of 2012, resulting from an income tax provision of $1.4 million, compared to an effective rate of 26.7% for the prior quarter that resulted from an income tax provision of $2.2 million. The decrease in the effective tax rate was primarily due to the fluctuation in the estimated level of annual income for fiscal 2012, the quarterly income level and the mix of income and relative tax rates between jurisdictions.

Net income for the second quarter of 2012 was $8.5 million compared to $5.9 million in the prior quarter due to the impact of the items discussed above.

 

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Quarter Ended October 1, 2011 Compared to Quarter Ended October 2, 2010

Results of Operations

The following table presents results of operations data as a percentage of net sales:

 

     Fiscal quarter ended  
     Oct 1, 2011     Oct 2, 2010  

Net sales

     100.0     100.0

Cost of sales

     56.1        56.3   
  

 

 

   

 

 

 

Gross margin

     43.9        43.7   

Selling, service and administration

     18.2        25.2   

Research, development and engineering

     13.1        17.2   
  

 

 

   

 

 

 

Operating income

     12.6        1.3   

Interest and other (expense) income, net

     (0.5     0.3   
  

 

 

   

 

 

 

Income before income taxes

     12.1        1.6   

Provision for income taxes

     1.7        2.6   
  

 

 

   

 

 

 

Net income (loss)

     10.4     (1.0 )% 
  

 

 

   

 

 

 

Net Sales

Net sales were $81.9 million for the second quarter of 2012, an increase of $22.3 million or 37% compared to net sales of $59.6 million for the second quarter of 2011. The increase in revenue was primarily driven by strong shipments in IMG as well as the delivery of backlog from capacity orders in SG, partially offset by a decrease in CG as capacity expansion by MLCC customers dropped off.

The following table presents net sales information by product group:

 

    Fiscal quarter ended  

(In thousands, except percentages)

  Oct 1, 2011     Oct 2, 2010  
    Net Sales     % of Net Sales     Net Sales     % of Net Sales  

Interconnect/ Micro-machining Group (IMG)

  $ 51,227        62.6   $ 33,090        55.6

Semiconductor Group (SG)

    24,171        29.5        13,160        22.1   

Components Group (CG)

    6,486        7.9        13,304        22.3   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 81,884        100.0   $ 59,554        100.0
 

 

 

   

 

 

   

 

 

   

 

 

 

IMG sales in the second quarter of 2012 increased $18.1 million or 55% compared to the second quarter of 2011. The increase was primarily driven by the shipment of the majority of the very large micromachining order received in our first quarter, and continued strong demand for our flex via drilling products.

SG sales in the second quarter of 2012 increased $11.0 million or 84% compared to the second quarter of 2011. The overall increase in sales was primarily driven by delivery of backlog orders in memory repair, combined with an increase in deliveries and acceptances for our LED scribing tools.

CG sales in the second quarter of 2012 decreased $6.8 million or 51% compared to the second quarter of 2011. The decrease was a result of our MLCC customers absorbing capacity created by systems delivered in prior quarters.

 

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The following table presents net sales information by geographic region:

 

     Fiscal quarter ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Net Sales      % of Net Sales     Net Sales      % of Net Sales  

Asia

   $ 73,886         90.3   $ 54,099         90.9

Americas

     4,118         5.0        3,529         5.9   

Europe

     3,880         4.7        1,926         3.2   
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 81,884         100.0   $ 59,554         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Compared to the second quarter of 2011, net sales for the second quarter of 2012 increased $19.8 million or 37% in Asia, increased $0.6 million or 17% in the Americas and increased $2.0 million or 101% in Europe. The increase in Asia was driven by increases in our IMG and SG product groups as utilization and capacity requirements of our Asian manufacturing customers continued to increase. Net sales in the Americas and Europe remain a lower percentage of total sales as purchases in these regions are primarily for specialized uses or research and development purposes, as compared to the trend by our Asian customers to source their high-volume manufacturing in that region.

Gross Profit

The following table presents gross profit information:

 

     Fiscal quarter ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Gross Profit      % of Net Sales     Gross Profit      % of Net Sales  

Gross Profit

   $ 35,941         43.9   $ 26,001         43.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Gross profit for the second quarter of 2012 was $35.9 million, an increase of $9.9 million compared to gross profit of $26.0 million for the second quarter of 2011. Gross profit as a percentage of net sales increased slightly to 43.9% for the second quarter of 2012 from 43.7% for the second quarter of 2011. These increases were primarily related to higher revenue levels and increased production capacity utilization.

Operating Expenses

The following table presents operating expense information:

 

     Fiscal quarter ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Expense      % of Net Sales     Expense      % of Net Sales  

Selling, service and administration

   $ 14,884         18.2   $ 15,046         25.2

Research, development and engineering

     10,742         13.1        10,217         17.2   
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 25,626         31.3   $ 25,263         42.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Selling, Service and Administration

Selling, service and administration (SS&A) expenses primarily consist of labor and other employee-related expenses including share-based compensation expense, travel expenses, professional fees, sales commissions and facilities costs. SS&A expenses were $14.9 million for the second quarter of 2012, which was slightly lower than $15.0 million in the second quarter of 2011. This decrease was primarily driven by efforts to control overall expenses despite a selective increase in headcount, which predominantly occurred in Asia.

 

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Research, Development and Engineering

Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials, equipment costs and facilities costs. RD&E expenses totaled $10.7 million for the second quarter of 2012, an increase of $0.5 million compared to the second quarter of 2011. This increase was primarily due to labor costs associated with selective increases in headcount and to a lesser extent, higher project materials cost.

Non-operating Income and Expense

Interest and Other (Expense) Income, net

Interest and other income, net, consists of interest income and expense, market gains and losses on assets held for our deferred compensation plan, realized and unrealized foreign exchange gains and losses, bank charges, investment management fees and other miscellaneous non-operating items. Net interest and other expense was $0.4 million during the second quarter of 2012 compared to net interest and other income of $0.2 million for the second quarter of 2011.

The decrease in income was primarily attributable to losses on assets held for our deferred compensation plan, which approximated $0.3 million for the quarter, and to a lesser extent, to an increase in foreign currency losses as well as a decrease in interest income. Interest income declined as our Auction Rate Securities (ARS), which were sold in the previous two quarters, were earning above market interest rates.

Income Taxes

The following table presents income tax information:

 

     Fiscal quarter ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Income Tax
Provision
     Effective
Tax Rate
    Income Tax
Provision
     Effective
Tax Rate
 

Income tax provision

   $  1,372         13.8   $  1,536         166.1
  

 

 

    

 

 

   

 

 

    

 

 

 

The income tax provision for the second quarter of 2012 was $1.4 million on pretax income of $9.9 million, an effective tax rate of 13.8%. For the second quarter of 2011, the income tax provision was $1.5 million on pretax income of $0.9 million, an effective tax rate of 166.1%. The lower effective tax rate for second quarter of 2012 was primarily due to the fluctuation in the level of expected annual income between the two years, the relative quarterly income level, and the mix of income between jurisdictions and their relative tax rates.

Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations. We anticipate no significant changes in unrecognized tax benefits in the next twelve months as the result of examinations or lapsed statutes of limitation.

Net Income (Loss)

The following table presents net income (loss) information:

 

     Fiscal quarter ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Net Income      % of Net Sales     Net Loss     % of Net Sales  

Net income (loss)

   $ 8,537         10.4   $ (611     (1.0 )% 
  

 

 

    

 

 

   

 

 

   

 

 

 

Net income for the second quarter of 2012 was $8.5 million, or $0.30 per basic share and $0.29 per diluted share, compared to a net loss of $0.6 million, or $0.02 per basic and diluted share for the second quarter of 2011. The improvement was primarily due to improved gross profit on higher revenues in the second quarter of 2012.

 

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Two Quarters Ended October 1, 2011 Compared to Two Quarters Ended October 2, 2010

Results of Operations

The following table presents results of operations data as a percentage of net sales:

 

     Two fiscal quarters ended  
     Oct 1, 2011     Oct 2, 2010  

Net sales

     100.0     100.0

Cost of sales

     56.1        59.8   
  

 

 

   

 

 

 

Gross margin

     43.9        40.2   

Selling, service and administration

     19.9        23.6   

Research, development and engineering

     13.8        17.3   

Legal settlement costs

     0.3        —     
  

 

 

   

 

 

 

Operating income (loss)

     9.9        (0.7

Gain on sale of previously impaired auction rate securities

     1.7        —     

Interest and other (expense) income, net

     (0.3     0.2   
  

 

 

   

 

 

 

Income (loss) before income taxes

     11.3        (0.5

Provision for (benefit from) income taxes

     2.2        (0.2
  

 

 

   

 

 

 

Net income (loss)

     9.1     (0.3 )% 
  

 

 

   

 

 

 

Net Sales

Net sales were $158.9 million for the first two quarters of 2012, an increase of $40.9 million or 35% compared to net sales of $118.0 million for the first two quarters of 2011. The increase was primarily driven by the high shipment level of our IMG products as well as strong demand for our SG products, partially offset by a decrease in CG as capacity expansion by MLCC customers dropped off.

The following table presents net sales information by product group:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Net Sales      % of Net Sales     Net Sales      % of Net Sales  

Interconnect/ Micro-machining Group (IMG)

   $ 99,439         62.5   $ 53,701         45.5

Semiconductor Group (SG)

     42,196         26.6        32,217         27.3   

Components Group (CG)

     17,295         10.9        32,107         27.2   
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 158,930         100.0   $ 118,025         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

IMG sales in the first two quarters of 2012 increased $45.7 million or 85% compared to the first two quarters of 2011. The increase was primarily driven by the shipment of the majority of the very large micromachining order received in our first quarter, and continued strong demand for our flex via drilling products.

SG sales in the first two quarters of 2012 increased $10.0 million or 31% compared to the first two quarters of 2011. The overall increase in sales was driven by delivery of backlog orders in memory repair, combined with an increase in deliveries and acceptances for our LED scribing tools.

CG sales in the first two quarters of 2012 decreased $14.8 million or 46% compared to the first two quarters of 2011. The decrease was primarily due to our MLCC customers’ absorbing capacity created by systems delivered in prior quarters.

 

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The following table presents net sales information by geographic region:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Net Sales      % of Net Sales     Net Sales      % of Net Sales  

Asia

   $ 142,819         89.9   $ 104,884         88.8

Americas

     9,860         6.2        7,630         6.5   

Europe

     6,251         3.9        5,511         4.7   
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 158,930         100.0   $ 118,025         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Compared to the first two quarters of 2011, net sales for the first two quarters of 2012 increased across all geographic regions: $37.9 million or 36% in Asia, $2.2 million or 29% in the Americas and $0.7 million or 13% in Europe. The majority of our systems are sold into Asia as our customers’ manufacturing facilities primarily reside in that region. The increase in Asia was driven by increases in our IMG and SG product groups as utilization and capacity requirements of our Asian manufacturing customers continued to increase. Net sales in the Americas and Europe remain a lower percentage of total sales as purchases in these regions are primarily for specialized uses or research and development purposes, as compared to the trend by our Asian customers to source their high-volume manufacturing in that region.

Gross Profit

The following table presents gross profit information:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Gross Profit      % of Net Sales     Gross Profit      % of Net Sales  

Gross Profit

   $ 69,701         43.9   $ 47,474         40.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Gross profit for the first two quarters of 2012 was $69.7 million, an increase of $22.2 million compared to gross profit of $47.5 million for the first two quarters of 2011. Gross profit as a percentage of net sales increased to 43.9% for the first two quarters of 2012 from 40.2% for the two quarters of 2011. These increases were primarily related to higher revenue levels, increased production capacity utilization and the sale of lower margin legacy products in the first quarter of 2011.

Operating Expenses

The following table presents operating expense information:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Expense      % of Net Sales     Expense      % of Net Sales  

Selling, service and administration

   $ 31,380         19.9   $ 27,891         23.6

Research, development and engineering

     21,976         13.8        20,428         17.3   

Legal settlement costs

     550         0.3        —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 53,906         34.0   $ 48,319         40.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Selling, Service and Administration

SS&A expenses were $31.4 million for the first two quarters of 2012, an increase of $3.5 million compared to the first two quarters of 2011. Excluding the impact of $0.9 million of acquisition settlement proceeds received during the first quarter of 2011, the increase was $2.6 million. This increase was primarily related to share-based compensation, which was driven by accelerated expensing associated with the Chief Executive Officer’s retirement eligibility date and increased estimated attainment of performance based grants in the first quarter of 2012. Additionally, labor and travel costs were higher due to selective headcount increases, primarily in Asia, and activities associated with higher business volumes experienced progressively throughout fiscal 2011 and the first half of fiscal 2012.

 

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Research, Development and Engineering

RD&E expenses totaled $22.0 million for the first two quarters of 2012, an increase of $1.5 million compared to the first two quarters of 2011. This increase was primarily due to labor costs associated with selective increases in headcount and to a lesser extent, higher project materials cost.

Legal Settlement Costs

Legal settlement costs for the first two quarters of 2012 were $0.6 million, which consisted of court and legal fees associated with the All Ring litigation and other non-recurring legal matters. There were no legal settlement costs in the first two quarters of 2011.

Non-operating Income and Expense

Gain on Sale of Previously Impaired Auction Rate Securities (ARS)

During the first quarter of 2012, we sold all of our remaining ARS with a total par value of $14.7 million for approximately $6.5 million. We recorded a total gain of $2.7 million, which included $1.4 million in reclassification of previously recorded unrealized gains out of accumulated other comprehensive income. There were no sales of ARS during the first two quarters of 2011.

Interest and Other Income (expense), net

Net interest and other expense was $0.5 million for the first two quarters of 2012 compared to net interest and other income of $0.2 million for the first two quarters of 2011. The decrease in income was primarily due to losses on assets held for our deferred compensation plan, unfavorable foreign currency impact and, to a lesser extent, lower interest yields on our investments due to the sale of ARS in the previous two quarters. Interest income declined as our ARS were earning above market interest rates.

Income Taxes

The following table presents income tax information:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Income Tax
Provision
     Effective
Tax Rate
    Income Tax
Benefit
    Effective
Tax Rate
 
         

Income tax provision (benefit)

   $ 3,531         19.6   $ (190     31.7
  

 

 

    

 

 

   

 

 

   

 

 

 

The income tax provision for the first two quarters of 2012 was $3.5 million on pretax income of $18.0 million, an effective tax rate of 19.6%. For the first two quarters of 2011, the income tax benefit was $0.2 million on pretax loss of $0.6 million, an effective tax rate of 31.7%. The lower effective tax rate for the first two quarters of 2012 was primarily due to the fluctuation in the level of expected annual income between the two years, the relative quarterly income level, and the mix of income between jurisdictions and their relative tax rates.

Our effective tax rate is subject to fluctuation based upon the mix of income and relative tax rates between jurisdictions, and the occurrence and timing of numerous discrete events such as changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination, finalization of income tax returns, the relationship of fixed deductions to overall changes in estimated and actual pretax income or loss and the tax jurisdictions where income or loss is generated. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a material effect on our financial position, expected cash flows or results of operations. We anticipate no significant changes in unrecognized tax benefits in the next twelve months as the result of examinations or lapsed statutes of limitation.

 

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Net Income (Loss)

The following table presents net income (loss) information:

 

     Two fiscal quarters ended  

(In thousands, except percentages)

   Oct 1, 2011     Oct 2, 2010  
     Net Income      % of Net Sales     Net Loss     % of Net Sales  

Net income (loss)

   $ 14,450         9.1   $ (410     (0.3 )% 
  

 

 

    

 

 

   

 

 

   

 

 

 

Net income for the first two quarters of 2012 was $14.5 million, or $0.51 per basic share and $0.49 per diluted share, compared to a net loss of $0.4 million, or $0.01 per basic and diluted share for the first two quarters of 2011. The improvement was primarily due to improved gross profit on higher revenues in the first two quarters of 2012, offsetting the impact of higher net operating expenses, and the $2.7 million gain on the sale of previously impaired ARS investments.

Financial Condition and Liquidity

At October 1, 2011, our principal sources of liquidity were cash and cash equivalents of $84.1 million, short-term investments of $96.5 million and accounts receivable of $29.6 million. We also held $22.3 million in restricted cash which represented collateral for commercial letters of credit. Our current ratio was 7.1 to 1.0 and we held no long-term debt. Working capital of $278.2 million was up slightly compared to the April 2, 2011 balance of $259.7 million.

In 2008, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our outstanding common stock primarily to offset dilution from equity compensation programs. Repurchases under the program are to be made at management’s discretion in the open market or in privately negotiated transactions in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. We did not repurchase any shares under this program during the two quarters ended October 1, 2011 and October 2, 2010. As of October 1, 2011, a total of 372,825 shares have been repurchased under this authorization for $5.3 million at an average price of $14.16 per share, calculated inclusive of commissions and fees. There is no fixed completion date for the repurchase program.

As of October 1, 2011, we did not have any ARS investments. During the first quarter of 2012, we sold all of the remaining ARS for approximately $6.0 million and all of the preferred stock for approximately $0.5 million. These ARS had a total estimated fair value of $5.2 million as of April 2, 2011, which consisted of $10.7 million par value ARS and $4.0 million par value ARS which were converted by the bond issuer to its preferred stock in 2009. We recorded a gain of $2.7 million in the first quarter of 2012, which included $1.4 million in reclassification of previously recorded unrealized gain out of accumulated other comprehensive income.

Sources and Uses of Cash

Net cash flows provided by operating activities totaled $15.5 million for the two quarters ended October 1, 2011 due to net income of $14.5 million and $13.0 million in non-cash items, which was partially offset by $12.0 million in net reductions within working capital. The primary use of cash from working capital consisted of $16.7 million from decreases in accounts payable and other liabilities, $6.7 million from net decreases in deferred revenue and $9.7 million in increases in inventory, partially offset by $14.5 million in decreases of trade receivables, decreases in shipped systems pending acceptance of $4.0 million and net decreases in current assets of $2.6 million.

For the two quarters ended October 1, 2011, net cash used in investing activities of $50.5 million was due to the purchase of securities of $436.3 million, an increase in restricted cash of $11.5 million, and purchases of property, plant and equipment of $3.4 million, partially offset by $394.0 million in proceeds from maturities of securities and $6.5 million in sales of ARS. Net cash provided by financing activities of $2.2 million was primarily due to proceeds from exercise of stock options and stock plans.

We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations, share repurchase program and contractual obligations for at least the next twelve months.

 

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Critical Accounting Policies and Estimates

We reaffirm the “Critical Accounting Policies and Estimates” in Part II Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations reported in our Form 10-K for the year ended April 2, 2011.

Contractual Obligations

There have been no significant changes in our contractual obligations subsequent to those reported in our Form 10-K for the year ended on April 2, 2011.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the market risk disclosure contained in our Form 10-K for the year ended April 2, 2011.

Item 4. Controls and Procedures

Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our President and Chief Executive Officer (CEO) and our Chief Financial Officer (CFO) required by Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on management’s evaluation of those disclosure controls and procedures. This disclosure should be read in conjunction with the Section 302 Certifications for a complete understanding of the topics presented.

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our CEO and CFO, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on that evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the second quarter of 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

All Ring Patent Infringement Prosecution

Our proceedings against All Ring Tech Co., Ltd (All Ring) in Taiwan for alleged patent infringement are ongoing. As a part of these proceedings, we established three letters of credit for approximately $19.5 million in July 2009, September 2009 and June 2011, which are collateralized by $22.3 million of restricted cash. The total restricted cash balance was included in Restricted cash on the Condensed Consolidated Balance Sheets as of October 1, 2011.

In June 2011, the Kaohsiung District Court of Taiwan announced its judgment, finding that All Ring had infringed on our 207469 patent, ordering All Ring to pay us approximately $24.0 million plus interest accrued from November 4, 2005 through the payment date at a rate of 5%, and enjoining All Ring from selling any system infringing the 207469 patent. On June 16, 2011, All Ring posted a cash bond for approximately $24.0 million to prevent the provisional execution of the judgment. All Ring appealed this judgment to the Intellectual Property Court on June 28, 2011 and on October 31, 2011, we filed our response to All Ring’s appeal. See our Form 10-K for the year ended April 2, 2011 for further background and additional information related to these proceedings. In the ordinary course of business, we are involved in various other legal matters, either asserted or unasserted, and investigations. In the opinion of management, ultimate resolution of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.

 

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Item 1A. Risk Factors

The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may differ materially. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to, the following:

Risks Related to Our Competition and Customers

Volatility of Our Customers’ Industries

Our business is dependent upon the capital expenditures of manufacturers of microelectronics, semiconductors and LEDs used in consumer electronics, computers, wireless communications and other electronic products. The capital equipment market for semiconductor, microelectronics and consumer electronics manufacturers has historically been characterized by sudden and severe cyclical variations in product supply and demand due to a number of factors including capacity utilization, demand for customers’ products, inventory levels relative to demand and access to affordable capital. The timing, severity and duration of these market cycles are difficult or impossible to predict. As a result, business levels can vary significantly from quarter to quarter or year to year. Significant downturns in the market for semiconductor and microelectronics used in electronic devices or in the market for consumer electronics reduce demand for our products and may materially and adversely affect our business, financial condition and operating results. For example, the economic slowdown that began in 2008 resulted in a decrease in orders for all of our product groups for each quarter throughout 2009, with virtually no orders for our memory repair systems throughout 2010. Additionally, some of our customers’ ability to access credit was adversely affected, limiting their ability to purchase our products. Starting in the second quarter of 2012, we again began to experience a significant reduction in orders due to increased uncertainties regarding global economic conditions. The degree of the impact of any downturn on our business depends on a number of factors, including: the strength of the global and US economies; the overall level of demand for consumer electronics products; the stability of global financial systems; and the overall health of the semiconductor, microelectronics, LED and consumer electronics industries.

Highly Competitive Markets

We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to, and new generations of, products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We believe that to be competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements. We may not be able to compete successfully in the future and increased competition may result in price reductions, reduced profit margins and loss of market share.

Increased Price Pressure

We have experienced and continue to experience price pressure in the sale of our products, from both competitors and customers. Pricing pressures typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products. In addition, we may agree to pricing concessions with our customers in connection with volume orders. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.

 

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Revenues are Largely Dependent on Few Customers

We depend on a few significant customers for a large portion of our revenues. In 2011, our top ten customers accounted for approximately 62% of total net sales, with one customer accounting for approximately 24% of total net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in various partnership and technology arrangements between customers, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may, therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. If we were to lose any of our significant customers or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected.

Revenues are Largely Based on the Sale of a Small Number of Product Units

We derive a substantial portion of our revenue from the sale of a relatively small number of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:

 

   

changes in the timing and terms of product orders by our customers;

 

   

changes in the mix of products and services that we sell;

 

   

timing and market acceptance of our new product introductions; and

 

   

delays or problems in the planned introduction of new products, or in the performance of any such products following delivery to customers.

As a result of these risks, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance.

Risks Related to Our Supply Chain and Production

Variability of Production Capacity

To meet rapidly changing demand in the industries we serve, we must effectively manage our resources and production capacity. During periods of decreasing demand for our products, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our supply chain. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in next-generation product technology and to support and service our products. Conversely, when upturns occur in the markets we serve, we may have difficulty rapidly and effectively increasing our manufacturing capacity or procuring sufficient materials to meet sudden increases in customer demand that could result in the loss of business to our competitors and harm to our relationships with our customers. If we are not able to timely and appropriately adapt to changes in our business environment, our business, financial condition or results of operations may be materially and adversely affected.

Problems with Critical Suppliers

We use a wide range of components from numerous suppliers in the manufacture of our products, including custom electronic, laser, optical and mechanical components. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, some key parts are available only from a single supplier or a limited group of suppliers in the short term. In addition, some of the lasers we use in our products are difficult to manufacture, and as a result we may not receive an adequate supply of lasers in a timely fashion to fill orders. Operations at our suppliers’ facilities are subject to disruption or discontinuation for a variety of reasons, including changes in business relationships, competitive factors, financial difficulties, work stoppages, fire, natural disasters or other causes. Any such disruption or discontinuation to our suppliers’ operations could interrupt or reduce our manufacturing activities and delay delivery of our products, any or all of which could materially and adversely affect our results of operations. In addition, when markets recover from the recent economic downturn, there is a heightened risk that one or more of our suppliers may not be able to meet increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers.

 

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Problems with Contract Manufacturers

We have arrangements with contract manufacturers to complete the manufacturing of certain of our products or product subcomponents. Any significant interruption in our contract manufacturers’ ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, financial difficulties, natural disasters, delay or interruption in the receipt of inventory, customer prioritization or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations.

Charges for Excess or Obsolete Inventory

One factor on which we compete is the ability to ship products on schedules required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine inventory to be purchased. We also order materials based on our technology roadmap, which represents management’s assessment of technology that will be utilized in new products that we develop. Certain types of inventory, including lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which would negatively affect our financial results. Also, if we alter our technology or product development strategy, we may have inventory that may not be usable under the new strategy, which may also result in material accounting charges.

Risks Related to Our Organization

Operating a Global Business

International shipments accounted for 93% of net sales in 2011, with 89% of our net sales to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. We also have significant foreign operations, including a Singapore manufacturing facility, research and development facilities in Taiwan and China, and sales and service offices in various countries. Under our globalization strategy, we intend to increase our foreign operations in the future. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:

 

   

periodic local or geographic economic downturns and unstable political conditions;

 

   

price and currency exchange controls;

 

   

fluctuation in the relative values of currencies;

 

   

difficulty in repatriating money, whether as a result of tax laws or otherwise;

 

   

difficulties protecting intellectual property;

 

   

compliance with labor laws and other laws governing employees;

 

   

local labor disputes;

 

   

shipping delays and disruptions;

 

   

unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and

 

   

difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.

 

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Our business and operating results could also be impacted, directly or indirectly, by natural disasters, outbreaks of infectious disease, military action, international conflicts, terrorist activities, civil unrest and associated political instability. Many of our facilities, including our Portland, Oregon headquarters, are in areas with known earthquake risk. Some of these events or circumstances may also result in heightened security concerns with respect to domestic and international travel and commerce, which may further affect our business and operating results. In particular, due to these uncertainties, we are subject to the following additional risks:

 

   

future tightening of immigration controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities or our ability to hire new non-U.S. employees in such facilities;

 

   

more frequent instances of shipping delays;

 

   

demand for our products may not increase or may decrease; and

 

   

our customers or suppliers may experience financial difficulties or cease operations.

Implementation and Modification of Globalization Strategy

We are implementing our globalization strategy in which we are moving certain operational resources and capabilities to different countries in Asia to be closer to many of our significant customers and to reduce costs. We believe this strategy will enhance customer relationships, improve our responsiveness, and reduce our manufacturing costs for certain products. We opened a manufacturing facility in Singapore in the fourth quarter of 2010 for certain IMG and CG products.

Our globalization strategy is subject to a variety of complexities and risks, many of which we have little experience managing, and which may divert a substantial amount of management’s time. These risks include:

 

   

challenges in designing new facilities that can be scaled for future expansion, replicating current processes and bringing new facilities up to full operation;

 

   

unpredictable costs, redundancy costs and cost overruns for developing new facilities and acquiring equipment;

 

   

building local management teams, technical personnel and other staff for functions that we have not previously conducted outside of the United States;

 

   

technical obstacles such as poor production or process yield and loss of quality control during the ramp of a new facility;

 

   

re-qualifications and other procedures that may be required by our customers;

 

   

our ability to bring up local suppliers to meet our quality and cycle-time needs;

 

   

our ability to reduce costs in the United States as we add costs in Asia;

 

   

rapidly changing business conditions that may require plans to be changed or abandoned before they are fully implemented; and

 

   

challenges posed by distance and by differences in language and culture.

These and other factors could delay the development and implementation of our strategy, as well as impair our gross margins, delay shipments and deliveries, cause us to lose sales, require us to write off investments already made, damage our reputation and harm our business, financial condition and operating results. If we decide to change our current globalization strategy, we may incur charges for certain costs incurred.

Acquisitions and Divestitures

We may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies, such as our September 2010 acquisition of certain assets of PyroPhotonics Lasers, Inc. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:

 

   

difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of the acquired businesses;

 

   

implementation of our enterprise resource planning (ERP) system into the acquired company’s operations;

 

   

diversion of management’s attention from other operational matters;

 

   

the potential loss of key employees of the acquired company;

 

   

lack of synergy or inability to realize expected synergies resulting from the acquisition;

 

   

acquired assets becoming impaired as a result of technological advancements or worse-than-expected performance by the acquired company;

 

   

difficulties establishing satisfactory internal controls at the acquired company;

 

   

risks and uncertainties relating to the performance of the combined company following the transaction; and

 

   

acquiring unanticipated liabilities for which we will not be indemnified.

 

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Furthermore, the accounting for an acquisition could result in significant charges resulting from amortization or write-off of intangible assets we acquire. Our inability to effectively manage these risks could result in our inability to realize the anticipated benefits of an acquisition on a timely basis, or at all, and materially and adversely affect our business, financial condition and results of operations. In addition, all acquisition transaction costs must be expensed as incurred rather than capitalized, which may have a material adverse effect on our results of operations.

The means by which we finance an acquisition may also significantly affect our business or the value of the shares of our common stock. If we issue common stock to pay for an acquisition, the ownership percentage of our existing shareholders will be diluted and the value of the shares held by our existing shareholders could be reduced. If we use cash on hand to pay for an acquisition, the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. If we borrow funds in connection with an acquisition, we would be required to use cash to service the debt and to comply with financial and other covenants.

We may from time to time also make strategic investments in development stage companies. Investments in development stage companies are subject to a high degree of risk. We cannot assure you that we will not lose all or a portion of our investment in any such company.

Hiring and Retention of Personnel

Our continued success depends in part upon the services of our key managerial, financial and technical personnel. The loss of key personnel, or our inability to attract, assimilate and retain qualified personnel, could result in the loss of customers, inhibit our ability to operate and grow our business and otherwise have a material adverse effect on our business and results of operations. We have previously had to, and may in the future have to, impose salary reductions on employees during economic downturns in an effort to maintain our financial position. These actions may have an adverse effect on employee loyalty and may make it more difficult for us to attract and retain key personnel. Competition for qualified personnel in the industries in which we compete is intense, and we may not be successful in attracting and retaining qualified personnel. We may incur significant costs in our efforts to recruit and retain key personnel, which could affect our financial position and results of operations.

Risks Related to Technology

Markets Characterized by Rapid Technological Change

The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes and the requirements of current and potential customers. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. The introduction by us or by our competitors of new or enhanced products, or alternative technologies, may cause our customers to defer, change or cancel orders for our existing products or cease purchasing our products altogether. For example, for many years the semiconductor memory industry has explored alternative redundancy technologies such as electrical redundancy technology. If our customers were to achieve sufficient yield improvement with one of these technologies, and adopt it into their manufacturing process, there would be a material adverse effect on the size of the addressable market of our memory yield improvement systems. Further, we cannot assure that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technology changes or emerging industry standards. If we are unable to develop new or enhanced products to address product or technology changes or new industry standards on a timely basis or at all, or if our new or enhanced products are not accepted by the market, or if our customers adopt alternative technologies, our business, results of operations and financial condition may be adversely affected.

 

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Need to Invest in Research and Development

Our industry is characterized by the need for continued investment in research and development. Because of intense competition in the industries in which we compete, if we were to fail to invest sufficiently in research and development, our products could become less attractive to our current and potential customers or obsolete, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area, our operating results could be materially harmed if our net sales decline. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales.

Products are Highly Complex

Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us. As a result, we may have to replace certain components or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products, loss of sales and increased expenses and warranty costs, which would harm our business and adversely affect our revenues and profitability.

Risks Related to Legal Matters

Protection of Proprietary Rights – Generally

Our success depends significantly upon the protection of our proprietary rights. We attempt to protect our proprietary rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. We incur substantial costs to obtain and maintain patents and to defend our intellectual property rights. For example, we initiated litigation against All Ring Tech Co., Ltd. in Taiwan in August 2005 alleging that certain of our patent rights had been violated. We rely upon the laws of the United States and foreign countries where we develop, manufacture or sell our products to protect our proprietary rights. We may not be successful in protecting these proprietary rights, these rights may not provide the competitive advantages that we expect, or other parties may challenge, invalidate or circumvent these rights.

Protection of Proprietary Rights – Foreign Jurisdictions

Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. Many United States companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins.

Intellectual Property Infringement Claims

Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. While we attempt in our designs to avoid patent infringement, from time to time we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. Competitors or others have in the past and may in the future assert infringement claims against our customers or us with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.

If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.

Tax Audits and Changes in Tax Law

We are periodically under audit by United States and foreign tax authorities and may have exposure to additional tax liabilities as a result. Significant judgment is required in determining our provision for income and other tax liabilities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made.

 

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Legal Proceedings

From time to time we are subject to various legal proceedings, including breach of contract and claims that involve possible infringement of patent or other intellectual property rights of third parties. It is inherently difficult to assess the outcome of litigation matters, and there can be no assurance that we will prevail in any litigation. Any litigation could result in substantial cost and diversion of management’s attention, which by itself could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such litigation could result in loss of our property rights, subject us to significant liabilities, require us to seek licenses from others or prevent us from manufacturing or selling our products, any of which could materially adversely affect our business, financial condition, results of operations or cash flows.

Provisions Restricting Our Acquisition

Our articles of incorporation and bylaws contain provisions that could make it harder for a third party to acquire us without the consent of our Board of Directors. Our Board of Directors has also adopted a shareholder rights plan, or “poison pill,” which would significantly dilute the ownership of a hostile acquirer. In addition, the Oregon Control Share Act and the Oregon Business Combination Act limit the ability of parties who acquire a significant amount of voting stock to exercise control over us. These provisions may have the effect of lengthening the time required for a person to acquire control of us through a proxy contest or the election of a majority of our Board of Directors, and may deter efforts to obtain control of us and may make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by our shareholders.

Risks Related to Financial Matters

Unfavorable Currency Exchange Rate Fluctuations

Currency exchange rate fluctuations could have an adverse effect on our sales and results of operations and we could experience losses with respect to forward exchange contracts into which we may enter. Unfavorable currency fluctuations could require us to increase prices to foreign customers, which could result in lower net sales by us to those customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our results of operations could be materially and adversely affected. In addition, some of our foreign sales are denominated in the currency of the country in which these products are sold and the currency we receive in payment for such sales could be less valuable at the time of receipt as a result of exchange rate fluctuations. From time to time, we enter into forward exchange contracts to hedge the value of accounts receivable primarily denominated in Japanese yen and other currencies. However, we cannot be certain that our efforts will be adequate to protect us against significant currency fluctuations or that such efforts will not expose us to additional exchange rate risks, which could adversely affect our results of operations.

Fluctuations in Effective Tax Rate

As a global company, we are subject to taxation in the United States and numerous foreign jurisdictions. Our effective tax rate is subject to fluctuation from one period to the next because the income tax rates for each year are a function of many factors, including: (a) taxable income levels and the effects of a mix of profits (losses) earned by ESI and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates; (b) our ability to utilize deferred tax assets; (c) taxes, refunds, interest or penalties resulting from tax audits; (d) the magnitude of various credits and deductions as a percentage of total taxable income; and (e) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rate to fluctuate between periods, which could have a material adverse effect on our financial position and results of operations.

 

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Impairment of Intangible Assets

We held a total of $9.2 million in acquired intangible assets and $4.0 million in goodwill at October 1, 2011. We review our acquired intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment using a qualitative and quantitative approach at least annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below the carrying value. If such an adverse event occurred and had the effect of changing one of the critical assumptions or estimates related to the fair value of our intangible assets or goodwill, an impairment charge could result. Any such impairment charges may have a material negative impact on our financial condition and operating results.

Stock Price Volatility

The market price of our common stock has fluctuated widely. During fiscal 2011, our stock price fluctuated between a high of $17.44 per share and a low of $10.46 per share. Consequently, the current market price of our common stock may not be indicative of future market prices, and we may be unable to sustain or increase the value of an investment in our common stock. Factors affecting our stock price, many of which our outside of our control, may include:

 

   

variations in operating results from quarter to quarter;

 

   

changes in earnings estimates by analysts or our failure to meet analysts’ expectations;

 

   

changes in the market price per share of our public company customers;

 

   

market conditions in the semiconductor and other industries into which we sell products;

 

   

general economic conditions;

 

   

political changes, hostilities or natural disasters;

 

   

low trading volume of our common stock;

 

   

the number of analysts covering our common stock; and

 

   

the number of firms making a market in our common stock.

In addition, the stock market has recently experienced significant price and volume fluctuations. These fluctuations have particularly affected the market prices of the securities of high-technology companies like ours. These market fluctuations could adversely affect the market price of our common stock.

Impairment of Investments

Our investment portfolio is primarily comprised of commercial paper, debt securities issued by US governmental agencies and municipal debt securities. These investments are intended to be highly liquid and low risk. If the markets for these securities were to deteriorate for any reason, including as a result of a downgrade in the credit rating of US government securities, the liquidity and value of these investments could be negatively affected, which could result in impairment charges. Any such impairment charges may have a material impact on our financial condition and operating results.

 

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Item 6. Exhibits

This list is intended to constitute the exhibit index.

 

    3.1    Third Restated Articles of Incorporation, as amended. Incorporated by reference to Exhibit 3.1 of the Company’s Annual Report on Form 10-K filed on June 15, 2010.
    3.2    2009 Amended and Restated Bylaws. Incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K filed on May 19, 2009 (the “May 19 8-K”).
    4.1    Rights Agreement, dated as of May 18, 2009, between Electro Scientific Industries, Inc. and Mellon Investor Services. Incorporated by reference to Exhibit 4.1 of the May 19 8-K.
  31.1    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document *
101.SCH    XBRL Taxonomy Extension Schema Document *
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document *
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document *
101.LAB    XBRL Taxonomy Extension Label Linkbase Document *
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document *

 

* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities and Exchange Act of 1934, and otherwise are not subject to liability under those sections.

 

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SIGNATURES

Pursuant to the requirements 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.

 

Dated: November 9, 2011     ELECTRO SCIENTIFIC INDUSTRIES, INC.
  By  

/s/ Nicholas Konidaris

    Nicholas Konidaris
    President and Chief Executive Officer
    (Principal Executive Officer)
  By  

/s/ Paul Oldham

    Paul Oldham
    Vice President of Administration,
    Chief Financial Officer and Corporate Secretary
    (Principal Financial Officer)
  By  

/s/ Kerry Mustoe

    Kerry Mustoe
    Vice President, Corporate Controller and Chief Accounting Officer
    (Principal Accounting Officer)

 

29

Exhibit 31.1

CERTIFICATION PURSUANT TO

SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Nicholas Konidaris, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific Industries, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 9, 2011

/s/ Nicholas Konidaris

Nicholas Konidaris
President and Chief Executive Officer

Exhibit 31.2

CERTIFICATION PURSUANT TO

SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002

I, Paul Oldham, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Electro Scientific Industries, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: November 9, 2011

/s/ Paul Oldham

Paul Oldham
Vice President of Administration, Chief Financial Officer and Corporate Secretary

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this quarterly report on Form 10-Q of Electro Scientific Industries, Inc. (the “Company”) for the quarterly period ended October 1, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Nicholas Konidaris, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes Oxley Act of 2002, that to the best of my knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Nicholas Konidaris

Nicholas Konidaris
President and Chief Executive Officer
Dated: November 9, 2011

This certification is made solely for the purpose of 18 U.S.C. Section 1350, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to Electro Scientific Industries, Inc. and will be retained by Electro Scientific Industries, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this quarterly report on Form 10-Q of Electro Scientific Industries, Inc. (the “Company”) for the quarterly period ended October 1, 2011 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Paul Oldham, Vice President of Administration, Chief Financial Officer and Corporate Secretary of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes Oxley Act of 2002, that to the best of my knowledge:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Paul Oldham

Paul Oldham
Vice President of Administration, Chief Financial Officer and Corporate Secretary
Dated: November 9, 2011

This certification is made solely for the purpose of 18 U.S.C. Section 1350, and not for any other purpose. A signed original of this written statement required by Section 906 has been provided to Electro Scientific Industries, Inc. and will be retained by Electro Scientific Industries, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.