Electro Scientific Industries, Inc.
ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 11/03/2014 16:44:47)
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 27, 2014
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, including area code: 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   ý     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   ý     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 
ý
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   ý
The number of shares outstanding of the Registrant’s Common Stock as of October 31, 2014 was 30,217,403 shares.
 


Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC.
2015 FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
 
Part I
FINANCIAL INFORMATION
 
Financial Statements (Unaudited)
 
 
 
 
 
 
Part II
OTHER INFORMATION
 
Item 2.
Share Repurchase Program
 
 





Table of Contents


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
Sep 27, 2014
 
Mar 29, 2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
79,255

 
$
68,461

Short-term investments
18,548

 
38,444

Trade receivables, net of allowances of $416 and $404
39,390

 
37,813

Inventories
55,749

 
58,902

Shipped systems pending acceptance
5,180

 
2,054

Deferred income taxes, net
145

 
161

Other current assets
4,019

 
4,674

Total current assets
202,286

 
210,509

Non-current assets:
 
 
 
Non-current investments

 
3,985

Property, plant and equipment, net of accumulated depreciation of $99,922 and $98,333
26,867

 
27,930

Non-current deferred income taxes, net
677

 
704

Goodwill
7,889

 
7,889

Acquired intangible assets, net of accumulated amortization of $19,233 and $18,378
5,988

 
6,845

Other assets
12,309

 
12,347

Total assets
$
256,016

 
$
270,209

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,659

 
$
14,465

Accrued liabilities
21,059

 
20,524

Deferred income tax liability, net
170

 
170

Deferred revenue
16,440

 
10,515

Total current liabilities
50,328

 
45,674

Non-current liabilities:
 
 
 
Income taxes payable
1,177

 
1,654

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; 30,610 and 30,155 issued and outstanding
183,833

 
183,193

Retained earnings
20,008

 
39,336

Accumulated other comprehensive income, other
670

 
352

Total shareholders’ equity
204,511

 
222,881

Total liabilities and shareholders’ equity
$
256,016

 
$
270,209

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


3

Table of Contents

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)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Net sales
$
42,856

 
$
59,647

 
$
77,886

 
$
105,819

Cost of sales
27,075

 
35,015

 
48,870

 
61,801

Gross profit
15,781

 
24,632

 
29,016

 
44,018

Operating expenses:
 
 
 
 
 
 
 
Selling, service and administration
12,915

 
14,251

 
26,015

 
28,798

Research, development and engineering
8,424

 
9,719

 
17,569

 
18,144

Gain on acquisition of Semiconductor Systems business

 
(35
)
 

 
(499
)
Net operating expenses
21,339

 
23,935

 
43,584

 
46,443

Operating (loss) income
(5,558
)
 
697

 
(14,568
)
 
(2,425
)
Non-operating (expense) income:
 
 
 
 
 
 
 
Other-than-temporary impairment of cost based investments

 
(3,588
)
 

 
(3,588
)
Interest and other (expense) income, net
(244
)
 
80

 
(198
)
 
20

Total non-operating (expense) income, net
(244
)
 
(3,508
)
 
(198
)
 
(3,568
)
Loss before income taxes
(5,802
)
 
(2,811
)
 
(14,766
)
 
(5,993
)
Provision for (benefit from) income taxes
441

 
(33
)
 
(272
)
 
68

Net loss
$
(6,243
)
 
$
(2,778
)
 
$
(14,494
)
 
$
(6,061
)
Net loss per share—basic
$
(0.20
)
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.20
)
Net loss per share—diluted
$
(0.20
)
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.20
)
Weighted average number of shares—basic
30,552

 
29,967

 
30,452

 
29,856

Weighted average number of shares—diluted
30,552

 
29,967

 
30,452

 
29,856

Cash dividends paid per outstanding common share
$
0.08

 
$
0.08

 
$
0.16

 
$
0.16





ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)

 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Net loss
$
(6,243
)
 
$
(2,778
)
 
$
(14,494
)
 
$
(6,061
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $179, $108, $179 and $108
(216
)
 
291

 
318

 
192

Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $2, $2, $4 and $3
4

 
3

 
7

 
6

Net unrealized (loss) gain on available-for-sale securities, net of taxes of $(5), $5, $(5) and $5
(6
)
 
27

 
(7
)
 
8

Comprehensive loss
$
(6,461
)
 
$
(2,457
)
 
$
(14,176
)
 
$
(5,855
)

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


4

Table of Contents


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Two fiscal quarters ended
(In thousands)
Sep 27, 2014
 
Sep 28, 2013
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(14,494
)
 
$
(6,061
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
3,909

 
3,521

Amortization of acquired intangible assets
857

 
1,546

Share-based compensation expense
2,363

 
3,868

(Gain) loss on sale of property and equipment, net
(56
)
 
37

Gain on acquisition of Semiconductor Systems business

 
(499
)
Other-than-temporary impairment of cost based investments

 
3,588

Increase in deferred income taxes
(170
)
 
(126
)
Changes in operating accounts, net of acquisitions:

 

(Increase) decrease in trade receivables, net
(2,085
)
 
1,101

Decrease (increase) in inventories
2,851

 
(170
)
(Increase) decrease in shipped systems pending acceptance
(3,126
)
 
458

Decrease (increase) in other current assets
679

 
(801
)
Increase (decrease) in accounts payable and accrued liabilities
245

 
(7,051
)
Increase (decrease) in deferred revenue
5,925

 
(2,520
)
Net cash used in operating activities
(3,102
)
 
(3,109
)
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(279,918
)
 
(193,421
)
Proceeds from sales and maturities of investments
303,793

 
201,615

Purchase of property, plant and equipment
(2,365
)
 
(2,279
)
Proceeds from sale of property, plant and equipment
154

 

Cash paid for business acquisitions

 
(9,731
)
Minority equity investment

 
(5,000
)
Increase in other assets
(857
)
 
(67
)
Net cash provided by (used in) investing activities
20,807

 
(8,883
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash dividends paid to shareholders
(4,834
)
 
(4,765
)
Stock plan activity, net
(262
)
 
(430
)
Share repurchases
(1,456
)
 

Net cash used in financing activities
(6,552
)
 
(5,195
)
Effect of exchange rate changes on cash
(359
)
 
249

NET CHANGE IN CASH AND CASH EQUIVALENTS
10,794

 
(16,938
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
68,461

 
88,913

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
79,255

 
$
71,975

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for interest
$
(2
)
 
$

Cash paid for income taxes
$
(489
)
 
$
(2,540
)
Income tax refunds received
$
557

 
$
19

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

5

Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC.
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 March 29, 2014 . 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; accrued restructuring costs; share-based compensation; income taxes including the valuation of deferred tax assets; fair value measurements; valuation of cost method equity investments; valuation of long-lived assets; valuation of goodwill; and valuation of acquired technology.

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 March 29, 2014 . All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.

2. Recent Accounting Pronouncements
Recent Accounting Pronouncements issued by the financial accounting standards board (FASB) and the SEC did not have a material impact on the Company's financial statements.

3. Share-Based Compensation

The Company recognizes expense related to the fair value of its share-based compensation awards using the Black-Scholes model to estimate the fair value of awards on the date of grant, except for unvested restricted stock unit awards (RSUs) which are valued at the fair value of the Company's stock on the date of award. The Company recognizes compensation expense for all share-based compensation awards on a straight-line basis over the requisite service period of the award.

Stock-settled stock appreciation rights (SARs) grant the right to receive shares of the Company's stock equivalent to the increase in stock value of a specified number of shares over a specified period of time, divided by the stock price at the time of exercise. The Company uses the Black-Scholes model to estimate the fair value of SARs. Similar to options, SARs are recorded at the fair value of the award at grant date and the expense is recognized on a straight-line basis over the requisite service period of the award.
The Company granted a total of 513,700 RSUs and 260,000 SARs during the first two quarters of 2015 , but did not grant any stock options. The Company granted 616,000 RSUs and did not grant any SARs or stock options during the first two quarters of 2014 .

6


Share-based compensation expense was included in the Company’s Condensed Consolidated Statements of Operations as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Cost of sales
$
151

 
$
189

 
$
320

 
$
374

Selling, service and administration
602

 
666

 
1,467

 
2,760

Research, development and engineering
280

 
379

 
576

 
734

Total share-based compensation expense
$
1,033

 
$
1,234

 
$
2,363

 
$
3,868

No share-based compensation costs were capitalized in the first two quarters of 2015 . As of September 27, 2014 , the Company had $6.9 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 2.2 years.
4. Fair Value Measurements
Financial Assets Measured at Fair Value
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;
Level 2 , defined as inputs that are observable either directly or indirectly such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and other inputs that can be corroborated by observable market data; and
Level 3 , defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

7


The Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis as of September 27, 2014 and March 29, 2014 was as follows (in thousands):
September 27, 2014
Level 1
 
Level 2
 
Level 3
 
Total
Money market securities
$
3,235

 
$

 
$

 
$
3,235

Commercial paper

 
20,397

 

 
20,397

Corporate bonds

 
5,164

 

 
5,164

Municipal bonds

 
3,966

 

 
3,966

Government agencies

 
2,002

 

 
2,002

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen

 
113

 

 
113

New Taiwan Dollar

 
21

 

 
21

Korean Won

 
(137
)
 

 
(137
)
Euro

 
411

 

 
411

British Pound

 
(90
)
 

 
(90
)
Chinese Renminbi

 
(2
)
 

 
(2
)
Singapore Dollar

 
(17
)
 

 
(17
)
March 29, 2014
Level 1
 
Level 2
 
Level 3
 
Total
Money market securities
$
9,456

 
$

 
$

 
$
9,456

Corporate bonds

 
17,328

 

 
17,328

Municipal bonds

 
12,725

 

 
12,725

Government agencies

 
8,037

 

 
8,037

Commercial paper

 
6,700

 

 
6,700

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen

 
25

 

 
25

New Taiwan Dollar

 
(6
)
 

 
(6
)
Korean Won

 
(44
)
 

 
(44
)
Euro

 
39

 

 
39

British Pound

 
(19
)
 

 
(19
)
Chinese Renminbi

 
(2
)
 

 
(2
)
Singapore Dollar

 
1

 

 
1

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 27, 2014 and March 29, 2014 were utilized to calculate fair values.
During the first two quarters of 2015 , there were no transfers between Level 1, 2 or 3 assets.


8


Investments
Certain information regarding the Company’s investments at September 27, 2014 and March 29, 2014 was as follows (in thousands):  
 
 
 
Unrealized
 
 
September 27, 2014
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
20,397

 
$

 
$

 
$
20,397

Corporate Bonds
5,164

 

 

 
5,164

Municipal Bonds
3,958

 
8

 

 
3,966

Government agencies
2,000

 
2

 

 
2,002

 
$
31,519

 
$
10

 
$

 
$
31,529

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Municipal Bonds
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
Unrealized
 
 
March 29, 2014
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Corporate Bonds
$
17,321

 
$
7

 
$

 
$
17,328

Municipal Bonds
8,737

 
4

 

 
8,741

Government agencies
8,035

 
2

 

 
8,037

Commercial paper
6,700

 

 

 
6,700

 
$
40,793

 
$
13

 
$

 
$
40,806

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Municipal Bonds
$
3,976

 
$
9

 
$

 
$
3,985

 
$
3,976

 
$
9

 
$

 
$
3,985

For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income (loss), 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 (loss) were insignificant as of September 27, 2014 and March 29, 2014 .
At September 27, 2014 , $31.5 million in investments had maturities within one year.
5. Business Acquisitions
Fiscal 2014
On May 3, 2013, the Company purchased the assets related to the Semiconductor Systems business of GSI Group Inc. for a total purchase price of $9.7 million . The acquisition provides the Company with direct access to industry-leading wafer marking, wafer trimming and circuit trimming laser systems. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their fair values and resulted in a net gain on bargain purchase of $0.5 million . The fair value of the acquired net assets of $10.5 million was in excess of the total purchase consideration of $9.7 million , primarily due to the recognition of certain intangible assets. The resulting gain of $0.8 million was partially offset by $0.3 million of deferred tax liabilities. Analysis supporting the purchase price allocation included a valuation of assets and liabilities as of the closing date, an analysis of intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value. The acquisition was an asset purchase for tax purposes.
As a result of the acquisition, the Company recorded approximately $8.2 million of inventory, $3.9 million of accounts receivable and other current assets, $0.7 million of identifiable intangible assets, $2.3 million of current liabilities, and a gain on bargain purchase of $0.8 million . The $0.7 million of identifiable intangible assets includes approximately $0.5 million of backlog and $0.2 million of developed technology. The acquired intangibles are amortized over their estimated useful lives, which range from one to three years.
In 2014, the Company also incurred approximately $1.5 million in acquisition related costs which are included in Selling, service and administration expenses in the Condensed Consolidated Statements of Operations.

9


The operating results of this purchase are included in the Company’s results of operations since the date of acquisition. Pro forma financial information has not been provided for the purchase as it was not material to the Company’s overall financial position.
6. 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)
Sep 27, 2014
 
Mar 29, 2014
Raw materials and purchased parts
$
42,022

 
$
38,747

Work-in-process
10,295

 
12,914

Finished goods
3,432

 
7,241

 
$
55,749

 
$
58,902

7. Other Current Assets
Other current assets consisted of the following:
(In thousands)
Sep 27, 2014
 
Mar 29, 2014
Prepaid expenses
$
2,332

 
$
2,601

Value added tax receivable
860

 
779

Other
827

 
1,294

 
$
4,019

 
$
4,674


10


8. Other Assets
Other assets consisted of the following:
(In thousands)
Sep 27, 2014
 
Mar 29, 2014
Consignment and demo equipment, net
$
5,713

 
$
5,938

Minority equity investments
4,263

 
4,263

Other
2,333

 
2,146

 
$
12,309

 
$
12,347

Minority equity investments represent the Company's investment in OmniGuide, Inc., which is accounted for as a cost method investment. At the end of each reporting period, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of investments. If there are no identified events or circumstances that may have a significant adverse effect on the fair value of investments and the fair value of those investments are not practicable to calculate, the fair value is not calculated.
The total carrying value of the Company's investment in OmniGuide, Inc., was $9.0 million at March 30, 2013 and an additional investment of $5.0 million was made in the second quarter of 2014 for a total investment of $14.0 million life-to-date, or a 15% interest. In the second quarter of 2014, OmniGuide, Inc., engaged in a Series F Preferred Stock round of equity financing priced below previous rounds, which was considered a triggering event and the Company recorded a $3.6 million impairment charge on its Series D and Series E investment at that time. In the fourth quarter of 2014, further triggering events were identified due to poor operating results through the end of the year combined with decreasing cash levels and we performed an updated valuation of our investments at that time and, as a result, recorded an additional $6.1 million impairment charge.
The Company's minority equity investment may be further impaired if OmniGuide, Inc., is unable to raise sufficient funding to continue operations in the near term, if the terms of any such funding are unfavorable to our position, if business results deteriorate, or if the company is sold for an amount that results in proceeds to us less than our carrying value. The total carrying value of $4.3 million at September 27, 2014 and March 29, 2014 is included in Other assets on the Condensed Consolidated Balance Sheets.
9. Accrued Liabilities
Accrued liabilities consisted of the following:
(In thousands)
Sep 27, 2014
 
Mar 29, 2014
Payroll liabilities
$
8,301

 
$
6,166

Product warranty accrual
3,152

 
4,215

Purchase order commitments and receipts
2,019

 
2,569

Professional fees payable
1,663

 
1,933

Pension benefit liabilities
1,991

 
1,912

Freight accrual
304

 
503

Income taxes payable
313

 
162

Customer deposits
852

 
375

Value added taxes payable
413

 
332

Restructuring and cost management amounts payable
442

 
1,050

Other
1,609

 
1,307

 
$
21,059

 
$
20,524

10. Product Warranty
The following is a reconciliation of the changes in the aggregate product warranty accrual:

11


 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Product warranty accrual, beginning
$
3,487

 
$
5,193

 
$
4,215

 
$
5,411

Warranty charges incurred, net
(1,780
)
 
(1,722
)
 
(3,720
)
 
(3,543
)
Provision for warranty charges
1,445

 
2,092

 
2,657

 
3,695

Product warranty accrual, ending
$
3,152

 
$
5,563

 
$
3,152

 
$
5,563

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.

12


11. 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 relative selling price 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)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Deferred revenue, beginning
$
12,268

 
$
10,766

 
$
10,515

 
$
10,196

Revenue deferred
15,141

 
6,657

 
26,949

 
13,598

Revenue recognized
(10,969
)
 
(9,568
)
 
(21,024
)
 
(15,939
)
Deferred revenue, ending
$
16,440

 
$
7,855

 
$
16,440

 
$
7,855

12. Earnings (Loss) 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)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Net loss
$
(6,243
)
 
$
(2,778
)
 
$
(14,494
)
 
$
(6,061
)
Weighted average shares used for basic earnings per share
30,552

 
29,967

 
30,452

 
29,856

Incremental diluted shares

 

 

 

Weighted average shares used for diluted earnings per share
30,552

 
29,967

 
30,452

 
29,856

Net loss per share:
 
 
 
 
 
 
 
Net loss — basic
$
(0.20
)
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.20
)
Net loss — diluted
$
(0.20
)
 
$
(0.09
)
 
$
(0.48
)
 
$
(0.20
)
Awards of options, SARs and unvested RSUs representing an additional 2.8 million and 4.1 million shares of stock for the second quarter of 2015 and 2014 , respectively, and for the two quarters ended September 27, 2014 and September 28, 2013 , respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.
13. Product and Geographic Information
Net sales by product type were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Interconnect & Microfabrication Group (IMG)
$
26,600

 
$
38,301

 
$
47,548

 
$
72,718

Semiconductor Group (SG)
9,767

 
10,935

 
20,516

 
16,548

Components Group (CG)
6,489

 
10,411

 
9,822

 
16,553

 
$
42,856

 
$
59,647

 
$
77,886

 
$
105,819


13


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)
Sep 27, 2014
 
Sep 28, 2013
 
Sep 27, 2014
 
Sep 28, 2013
Asia
$
34,516

 
$
49,439

 
$
59,234

 
$
88,274

Americas
2,482

 
7,110

 
8,656

 
10,676

Europe
5,858

 
3,098

 
9,996

 
6,869

 
$
42,856

 
$
59,647

 
$
77,886

 
$
105,819

14. Restructuring and Cost Management Plans
In 2013, the Company initiated a restructuring plan to improve efficiency, transition from memory repair and other legacy products, and focus on laser microfabrication for consumer electronics, emerging technologies related to semiconductor 3D packaging, and proprietary laser technology. The plan is substantially complete, however restructuring and wind-down related activities will continue through 2015. See the Company's Form 10-K for the year ended March 29, 2014 for additional information related to restructuring and cost management plans.
In the first two quarters of 2015, net restructuring costs of $0.6 million were recognized. At September 27, 2014 and March 29, 2014 , the amount of unpaid restructuring costs included in accrued liabilities was $0.4 million and $1.1 million , respectively.
The following table presents the amounts related to restructuring costs payable (in thousands):
Restructuring & cost management amounts payable as of March 29, 2014
$
1,050

Employee severance and related benefits:
 
Cash payments
(608
)
Restructuring & cost management amounts payable as of September 27, 2014
$
442

15. Shareholders’ Equity
Share Repurchase Program
On December 9, 2011, the Board of Directors authorized a share repurchase program totaling $20 million to acquire shares of the Company’s outstanding common stock. The repurchases 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.
In the first quarter of 2015 the Company repurchased 207,738 shares for $1.5 million under this authorization at an average price of $7.01 per share, calculated inclusive of commissions and fees. Cash used to settle the repurchase as of September 27, 2014 totaled $1.5 million . The Company did not repurchase any shares during the second quarter of 2015.
In 2014 the Company repurchased 19,832 shares for $0.2 million at an average price of $9.65 per share. The Company has repurchased a total of 227,570 shares life to date under this authorization as a part of its publicly announced plan.
There is no fixed completion date for the repurchase program.
Dividends
In December 2011, the Board of Directors adopted a dividend policy under which the Company intends to pay quarterly cash dividends. The following table summarizes the quarterly dividend declared and paid by the Company since the second quarter of 2014 :
Date Declared
 
Record Date
 
Payment Date
 
Amount per Share
August 21, 2014
 
September 2, 2014
 
September 12, 2014
 
$0.08
May 15, 2014
 
May 27, 2014
 
June 10, 2014
 
$0.08
February 13, 2014
 
February 27, 2014
 
March 13, 2014
 
$0.08
November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$0.08
August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$0.08

14


The Company paid aggregate dividends of $4.8 million for the first two quarters of 2015 and 2014 .
The Company currently anticipates that it will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on the Company’s financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of the shareholders.
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.”
Overview of Business
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 of micron to submicron features in components and devices which are used in a wide variety of end products in the consumer electronics, computer, semiconductor, communications and other markets. 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 microfabrication systems allow microelectronics, semiconductor, and other microtechnology manufacturers to physically alter select device features during high-volume production in order to increase performance, enable functionality, alter physical characteristics or improve production yields. Laser microfabrication comprises a set of precise micron-level processes, including drilling, scribing, dicing, singulation, cutting, ablating, trimming, and precision marking on multiple types of materials. These processes require application-specific laser systems that are able to meet our customers’ exacting performance and productivity requirements. Our laser-based systems improve production yields or enable improved performance for flexible and rigid high density interconnect printed circuit boards, semiconductor devices, advanced semiconductor packaging, touch-panel glass, flat panel liquid crystal displays (LCDs) and other high value components.
Additionally, we produce high-capacity test and 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 and physical tolerances required to perform properly. Lastly, we produce systems that use photonic technology to perform precision inspection for quality control and defect identification.
Summary of Sequential Quarterly Results
The financial results of the second quarter of 2015 ended September 27, 2014 , reflected sequential growth in sales and earnings. Net sales increased to $42.9 million from $35.0 million in the first quarter of 2015 which ended June 28, 2014 . However, total order volume for the second quarter of 2015 declined from $47.3 million to $43.0 million , primarily due to lower follow-on demand for advanced microfabrication equipment and seasonally lower orders in flex via drilling.
Total shipments were $47.0 million in the second quarter of 2015 compared to $37.5 million in the first quarter of 2015 . By product group, IMG shipments increased by approximately 30% primarily due to the growth in flex via drilling and advanced microfabrication equipment, CG increased by approximately 75% due to the shipments of ceramic capacitor testers, and SG shipments decreased by approximately 4% .
Net sales were $42.9 million in the second quarter of 2015 compared to $35.0 million in the first quarter of 2015 . By product group, IMG increased $5.7 million primarily due to an increase in microfabrication equipment and flex via drilling sales, CG increased $3.2 million primarily due to increased system sales for ceramic capacitor testers, and SG revenue decreased by $1.0 million primarily due to decreased service sales.
Gross profit was $15.8 million in the second quarter of 2015 compared to a gross profit of $13.2 million in the first quarter of 2015 . This increase was primarily due to increased sales and production volumes. Gross margin was 36.8% on net sales of $42.9 million in the second quarter of 2015 compared to a gross margin of 37.8% on net sales of $35.0 million in the first quarter of 2015 . The gross margin decrease was primarily driven by timing and increases in service repair and inventory charges, partially offset by improved absorption of fixed costs resulting from higher production volumes in the second quarter.

15


Net operating expense of $21.3 million in the second quarter of 2015 decreased $0.9 million from $22.2 million in the first quarter of 2015 . Research, development, and engineering (RD&E) decreased $0.7 million primarily due to lower project materials and consulting costs. Selling, service and administration (SS&A) expenses decreased $0.2 million primarily due to lower variable costs and share-based compensation.
Operating loss was $5.6 million in the second quarter of 2015 compared to an operating loss of $9.0 million in the first quarter of 2015 , a decrease of $3.4 million. The decrease in operating loss was due to higher sales volumes combined with lower operating expenses.
Non-operating expense was $0.2 million in the second quarter of 2015 compared to income of $0.05 million in the first quarter of 2015 . This change was primarily due to an increase in foreign exchange losses and a decrease in unrealized gains on investments.
Provision for income taxes was $0.4 million in the second quarter of 2015 compared to a tax benefit of $0.7 million in the first quarter of 2015 . This change was primarily due to a $0.9 million tax benefit recorded in the first quarter of 2015 for release of tax reserve related to the legal settlement with All Ring, and a $0.2 million increase in foreign taxes in the second quarter of 2015.
Net loss was $6.2 million in the second quarter of 2015 compared to a net loss of $8.3 million in the first quarter of 2015 .
Quarter Ended September 27, 2014 Compared to Quarter Ended September 28, 2013
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
Sep 27, 2014
 
Sep 28, 2013
Net sales
100.0
 %
 
100.0
 %
Cost of sales
63.2

 
58.7

Gross profit
36.8

 
41.3

Selling, service and administration
30.1

 
23.9

Research, development and engineering
19.7

 
16.3

Gain on acquisition of Semiconductor Systems business

 
(0.1
)
Operating (loss) income
(13.0
)
 
1.2

Other-than-temporary impairment of cost based investments

 
(6.0
)
Interest and other (expense) income, net
(0.6
)
 
0.1

Total non-operating (expense) income, net
(0.6
)
 
(5.9
)
Loss before income taxes
(13.5
)
 
(4.7
)
Provision for (benefit from) income taxes
1.1

 

Net loss
(14.6
)%
 
(4.7
)%
Net Sales
The following table presents net sales information by product group:
 
Fiscal quarter ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
26,600

 
62.1
%
 
$
38,301

 
64.2
%
Components Group (CG)
6,489

 
15.1

 
10,411

 
17.5

Semiconductor Group (SG)
9,767

 
22.8

 
10,935

 
18.3

 
$
42,856

 
100.0
%
 
$
59,647

 
100.0
%
Net sales for the second quarter of 2015 decreased $16.8 million or 28% from net sales for the second quarter of 2014 . Sales in IMG decreased by 31% , while CG and SG decreased by 38% and 11% , respectively.
IMG sales for the second quarter of 2015 decreased $11.7 million compared to the second quarter of 2014 . The decrease in IMG sales was primarily driven by strong shipments of advanced microfabrication systems in the second quarter of 2014,

16


and to a lesser extent by excess capacity, particularly in Korea, from our flex customers in the second quarter of 2015 as compared to the second quarter of 2014.
CG sales for the second quarter of 2015 decreased $3.9 million compared to the second quarter of 2014 . The decrease was primarily driven by lower MLCC revenues as those customers continued to utilize existing capacity.
SG sales for the second quarter of 2015 decreased $1.2 million compared to the second quarter of 2014 . The decrease in SG sales was primarily driven by reduced demand for our circuit trim systems.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
34,516

 
80.5
%
 
$
49,439

 
82.9
%
Americas
2,482

 
5.8

 
7,110

 
11.9

Europe
5,858

 
13.7

 
3,098

 
5.2

 
$
42,856

 
100.0
%
 
$
59,647

 
100.0
%
Gross Profit
 
Fiscal quarter ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
15,781

 
36.8
%
 
$
24,632

 
41.3
%
Gross profit was $15.8 million for the second quarter of 2015 , a decrease of $8.9 million compared to the second quarter of 2014 . Gross margin was 36.8% and 41.3% for the second quarter of 2015 and 2014 , respectively. These decreases were primarily driven by lower sales and production volumes and less favorable absorption of fixed costs, partially offset by favorable changes in mix within IMG and SG systems.
Operating Expenses
 
Fiscal quarter ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Expense / (Income)
 
% of Net Sales
 
Expense / (Income)
 
% of Net Sales
Selling, service and administration
$
12,915

 
30.1
%
 
$
14,251

 
23.9
 %
Research, development and engineering
8,424

 
19.7

 
9,719

 
16.3

Gain on acquisition of Semiconductor Systems business

 

 
(35
)
 
(0.1
)
 
$
21,339

 
49.8
%
 
$
23,935

 
40.1
 %
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 for the second quarter of 2015 decreased $1.3 million compared to the second quarter of 2014 . This decrease was primarily attributable to lower variable expenses due to lower business volumes combined with decreases in travel, facilities, consulting and amortization expenses, partially offset by higher audit and legal fees.
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 costs, equipment costs and facilities costs. RD&E expenses for the second quarter of 2015 decreased $1.3 million compared to the second quarter of 2014 . This decrease was primarily due to lower project materials and consulting charges, and to a lesser degree by lower legal and share-based compensation expense.
Gain on acquisition of Semiconductor Systems Business

17


Gain on acquisition of Semiconductor Systems business was $0.04 million in the second quarter of 2014. This portion of the overall gain of $0.5 million was a result of the finalization of the net working capital adjustment to the purchase price of the Semiconductor Systems business and the final determination of the fair value of the assets purchased.
Non-operating Income and Expense
 
Fiscal quarter ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Interest and Other (Expense) Income, net
 
% of Net Sales
 
Interest and Other (Expense) Income, net
 
% of Net Sales
Other-than-temporary impairment of cost based investments
$

 
 %
 
$
(3,588
)
 
(6.0
)%
Interest and other (expense) income, net
(244
)
 
(0.6
)
 
80

 
0.1

Interest and other expense, net
$
(244
)
 
(0.6
)%
 
$
(3,508
)
 
(5.9
)%

Other-than-temporary impairment of cost based investments
Other-than-temporary impairment of cost based investments was $3.6 million in the second quarter of 2014 and related to our minority interest investment in OmniGuide, Inc. During the second quarter of 2014, OmniGuide, Inc. engaged in a Series F Preferred Stock round of equity financing at pricing below previous rounds which was considered a triggering event. As a result of that event we performed a valuation of the investment which resulted in a $3.6 million impairment charge of our Series D and Series E investments in that quarter.
Interest and other (expense) income, net
Interest and other expense, net, consists primarily of net interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges and investment management fees. Net interest and other expense was $0.2 million in second quarter of 2015 compared to income of $0.08 million in second quarter of 2014 . This change was primarily due to increases in foreign exchange losses and market losses on assets held in employees' deferred compensation account.
Income Taxes
 
Fiscal quarter ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Benefit
 
Effective
Tax Rate
Provision for (benefit from) income taxes
$
441

 
(7.6
)%
 
$
(33
)
 
1.2
%
The provision for income taxes for the second quarter of 2015 was $0.4 million on the pretax loss of $5.8 million , an effective tax rate of (7.6)% resulting primarily from foreign taxes. For the second quarter of 2014 , the benefit from income taxes was $0.03 million on pretax loss of $2.8 million , an effective rate of 1.2% . The change in the effective tax rate was primarily due to a tax benefit recorded in the second quarter of 2014 related to the release of uncertain tax positions.
Net Loss
 
Fiscal quarter ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Loss
 
% of Net Sales
Net loss
$
(6,243
)
 
(14.6
)%
 
$
(2,778
)
 
(4.7
)%
Net loss for the second quarter of 2015 was $6.2 million , or $0.20 per basic and diluted share, compared to net loss of $2.8 million , or $0.09 per basic and diluted share for the second quarter of 2014 .

18


Two Quarters Ended September 27, 2014 Compared to Two Quarters Ended September 28, 2013
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Two fiscal quarters ended
 
Sep 27, 2014
 
Sep 28, 2013
Net sales
100.0
 %
 
100.0
 %
Cost of sales
62.7

 
58.4

Gross profit
37.3

 
41.6

Selling, service and administration
33.5

 
27.3

Research, development and engineering
22.6

 
17.1

Gain on acquisition of Semiconductor Systems business

 
(0.5
)
Operating loss
(18.7
)
 
(2.3
)
Other-than-temporary impairment of cost based investments

 
(3.4
)
Interest and other expense, net
(0.3
)
 

Total non-operating (expense) income, net
(0.3
)
 
(3.4
)
Loss before income taxes
(19.0
)
 
(5.7
)
Provision for (benefit from) income taxes
(0.4
)
 

Net loss
(18.6
)%
 
(5.7
)%
Net Sales
The following table presents net sales information by product group:
 
Two fiscal quarters ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
47,548

 
61.1
%
 
$
72,718

 
68.8
%
Components Group (CG)
9,822

 
12.6

 
16,553

 
15.6

Semiconductor Group (SG)
20,516

 
26.3

 
16,548

 
15.6

 
$
77,886

 
100.0
%
 
$
105,819

 
100.0
%
Net sales for the first two quarters of 2015 decreased $27.9 million or 26.4% from net sales for the first two quarters of 2014 . Sales in IMG decreased by 34.6% , CG decreased by 40.7% while sales in SG increased by 24.0% .
IMG sales for the first two quarters of 2015 decreased $25.2 million compared to the first two quarters of 2014 . The decrease in IMG sales was primarily driven by shipments of advanced microfabrication systems to Korea in 2014 which did not repeat at the same level in 2015.
CG sales for the first two quarters of 2015 decreased $6.7 million compared to the first two quarters of 2014 . The decrease was primarily driven by reduced demand for MLCC systems in 2015 due to continued utilization of existing capacity.
SG sales for the first two quarters of 2015 increased $4.0 million compared to the first two quarters of 2014 . The increase in SG sales was primarily driven by the sales in the Semiconductor Systems business which was acquired during the first quarter of 2014.

19


The following table presents net sales information by geographic region:
 
Two fiscal quarters ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
59,234

 
76.1
%
 
$
88,274

 
83.4
%
Americas
8,656

 
11.1

 
10,676

 
10.1

Europe
9,996

 
12.8

 
6,869

 
6.5

 
$
77,886

 
100.0
%
 
$
105,819

 
100.0
%
Gross Profit
 
Two fiscal quarters ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
29,016

 
37.3
%
 
$
44,018

 
41.6
%
Gross profit was $29.0 million for the first two quarters of 2015 and decreased $15.0 million compared to the first two quarters of 2014 . Gross margin was 37.3% and 41.6% for the first two quarters of 2015 and 2014 , respectively. These decreases were primarily driven by lower IMG sales and production volumes and less favorable absorption of fixed costs, partially offset by changes in mix within IMG and SG.
Operating Expenses
 
Two fiscal quarters ended
   
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, service and administration
$
26,015

 
33.5
%
 
$
28,798

 
27.3
 %
Research, development and engineering
17,569

 
22.6

 
18,144

 
17.1

Gain on acquisition of Semiconductor Systems business

 

 
(499
)
 
(0.5
)
 
$
43,584

 
56.0
%
 
$
46,443

 
43.9
 %
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 for the first two quarters of 2015 decreased $2.8 million compared to the first two quarters of 2014 . This decrease was primarily attributable to lower expenses for variable and share-based compensation, facilities, depreciation and amortization and travel, partially offset by higher audit and legal fees.
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 costs, equipment costs and facilities costs. RD&E expenses for the first two quarters of 2015 decreased $0.6 million compared to the first two quarters of 2014 . This decrease was primarily due to lower variable and share-based compensation expenses, project material costs and travel expenses, partially offset by higher labor costs.
Gain on acquisition of Semiconductor Systems Business
Gain on acquisition of Semiconductor Systems business was $0.5 million in 2014. The purchase resulted in an overall gain as the estimated fair value of the assets purchased was in excess of the total purchase consideration, primarily due to the recognition of certain intangible assets, comprised of developed technology and order backlog.

20


Non-operating Income and Expense
 
Two fiscal quarters ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Interest and Other Expense, net
 
% of Net Sales
 
Interest and Other Expense, net
 
% of Net Sales
Other-than-temporary impairment of cost based investments
$

 
 %
 
$
(3,588
)
 
(3.4
)%
Interest and other (expense) income, net
$
(198
)
 
(0.3
)%
 
$
20

 
 %
Total non-operating (expense) income, net
$
(198
)
 
(0.3
)%
 
$
(3,568
)
 
(3.4
)%
Other-than-temporary impairment of cost based investments
Other-than-temporary impairment of cost based investments was $3.6 million in the second quarter of 2014 and related to our minority interest investment in OmniGuide, Inc. During the second quarter of 2014, OmniGuide, Inc. engaged in a Series F Preferred Stock round of equity financing at pricing below previous rounds which was considered a triggering event. As a result of that event we performed a valuation of the investment which resulted in a $3.6 million impairment charge of our Series D and Series E investments in that quarter.
Interest and other (expense) income, net
Interest and other expense, net, consists primarily of interest income and expense, market gains and losses on assets held in employees’ deferred compensation accounts, realized and unrealized foreign exchange gains and losses, bank charges and investment management fees. Net interest and other expense was $0.2 million in the first two quarters of 2015 compared to net interest and other income of $0.02 million in the first two quarters of 2014 . This change was primarily due to foreign exchange losses.
Income Taxes
 
Two fiscal quarters ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Income Tax Benefit
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
Provision for (benefit from) income taxes
$
(272
)
 
1.8
%
 
$
68

 
(1.1
)%
The income tax benefit for the first two quarters of 2015 was $0.3 million on pretax loss of $14.8 million , an effective tax rate of 1.8% . For the first two quarters of 2014 , the income tax provision was $0.1 million on pretax loss of $6.0 million , an effective rate of (1.1)% . The change in the effective tax rate was primarily due to change in the level of loss and the mix of earnings recognized by our foreign jurisdictions.
Net Loss
 
Two fiscal quarters ended
 
Sep 27, 2014
 
Sep 28, 2013
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Loss
 
% of Net Sales
Net loss
$
(14,494
)
 
(18.6
)%
 
$
(6,061
)
 
(5.7
)%
Net loss for the first two quarters of 2015 was $14.5 million , or $0.48 per basic and diluted share, compared to net loss of $6.1 million , or $0.20 per basic and diluted share for the first two quarters of 2014 .
Financial Condition and Liquidity
At September 27, 2014 , our principal sources of liquidity were cash and cash equivalents of $79.3 million , short-term investments of $18.5 million and accounts receivable of $39.4 million . At September 27, 2014 , we had a current ratio of 4.02 and held no long-term debt. Working capital of $152.0 million decreased $12.9 million compared to the March 29, 2014 balance of $164.8 million , substantially impacted by operating losses, the payment of quarterly dividends and share repurchases.
In December 2011, the Board of Directors adopted a dividend policy under which we intend to pay quarterly cash dividends. The following table summarizes the quarterly dividend declared and paid by us since the second quarter of 2014 :

21


Date Declared
 
Record Date
 
Payment Date
 
Amount per Share
August 21, 2014
 
September 2, 2014
 
September 12, 2014
 
$0.08
May 15, 2014
 
May 27, 2014
 
June 10, 2014
 
$0.08
February 13, 2014
 
February 27, 2014
 
March 13, 2014
 
$0.08
November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$0.08
August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$0.08
We paid aggregate dividends of $4.8 million for the first two quarters of 2015 and 2014 .
We currently anticipate that we will continue to pay cash dividends on a quarterly basis in the future, although the declaration, timing and amount of any future cash dividends are at the discretion of the Board of Directors and will depend on our financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of our shareholders.
Sources and Uses of Cash
Net cash used in operating activities of $3.1 million for the two quarters ended September 27, 2014 , was a result of $7.6 million of net loss adjusted for non-cash items, partially offset by a $2.8 million increase to deferred margin and a $1.7 million decrease to working capital.
Net cash provided by investing activities of $20.8 million was primarily the result of $23.9 million net proceeds from sales, maturities and purchases of investments, partially offset by $2.4 million of capital expenditures for purchases of property, plant and equipment (PP&E) and increases in other assets. Accounts payable balance includes $0.3 million for amounts owed on PP&E purchases as of September 27, 2014 .
For the first two quarters of 2015, net cash used in financing activities of $6.6 million was primarily due to $4.8 million of cash dividends paid to shareholders and $1.5 million of share repurchase settlements.
We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations, any dividends which may be declared, our share repurchase program and contractual obligations for at least the next twelve months.
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 March 29, 2014 .
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 March 29, 2014 .

22


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 more 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 2015 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
In the ordinary course of business, we are involved in various 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.

23

Table of Contents

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, computers, wireless communications and other electronic products. The capital equipment market for microelectronics, semiconductor, 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, timing of customers’ new product introductions and demand for their 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 volatility in investment cycles in the market for microelectronics, and semiconductors 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 results of operations. For example, starting in the second half of fiscal 2012, we experienced the negative impact of an uncertain economic environment, slower market growth and overcapacity in several of our markets, which resulted in overall lower order and revenue levels. As a result of these circumstances, our total order volume declined in 2013 compared to 2012 and continued to decline in 2014. The degree of the impact of any downturn on our business depends on a number of factors, including: the strength of the global and United States economies; the overall level of demand for consumer electronics products; the stability of global financial systems; and the overall health of the microelectronics, semiconductor, 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 have also experienced new entrants to our markets offering aggressive price and payments terms in an attempt to gain market share. Some competitors, particularly in China, also develop low cost competitive products, in some cases employing processes or technology developed by us. 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.
We intend to enter into existing markets that are adjacent to our current markets. In these markets we will be competing against established competitors with recognized brands, customer relationships and proven products. If we fail to compete successfully against these competitors our ability to penetrate these markets will be limited, which could have an adverse effect on our financial results.
Increased Price Pressure
We have experienced and continue to experience pricing 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 or lower cost products. In addition, we may agree to pricing concessions or extended payment terms with our customers in connection with volume orders or to improve cost of ownership in highly competitive applications. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.
Revenues are Largely Dependent on Few Customers
We depend on a few significant customers for a large portion of our revenues. In 2014, our top ten customers accounted for approximately 41% of total net sales, with one customer, Apple, Inc., and its affiliates, accounting for approximately 15% of

24

Table of Contents

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 technologies or solutions used by customers, changes in products manufactured by customers or in end-user demand for those products, selection of suppliers other than us, customer bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue and reduced demand from any single major customer. Also, business levels with several of our top customers are dependent on our winning new designs and features each product cycle, and there is no guarantee of future business based on past design wins. 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. For example, revenues from Apple, Inc., decreased from $67 million or 31% of revenue in 2013 to $27 million or 15% of revenue in 2014. 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 of orders and terms or acceptance of product shipments 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.
Reliance on 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 economic downturns, there is a heightened risk that one or more of our suppliers may not be able to meet our increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers.


25

Table of Contents

Utilization of 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 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. For example, during 2014, we recorded $12.8 million of charges in cost of sales for inventory written off in connection with discontinued products.
Uncertainties Resulting from Conflict Minerals Regulation
On August 22, 2012, the SEC adopted a new rule requiring disclosures of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by companies filing public reports. The new rule requires a disclosure report to be filed annually with the SEC and this report will require companies to perform due diligence, disclose, and report whether such minerals originate from the Democratic Republic of Congo or an adjoining country. The new rule could affect sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products, including tantalum, tin, gold, and tungsten. The number of suppliers who provide conflict-free minerals may be limited. In addition, there may be material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our products, as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities. Since our supply chain is complex, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the due diligence procedures that we implement, which may harm our reputation. In addition, we may encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are unable to do so.
Risks Related to Our Organization
Operating a Global Business
International shipments accounted for 83% of net sales in 2014, with 76% of our net shipments 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 manufacturing facilities in Singapore, research and development facilities in Canada, France and Taiwan, 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, enforcing internal controls, collecting accounts receivable, and managing suppliers, distributors and representatives.

26

Table of Contents

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 continuing to implement and expand 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 to reduce costs and to develop low cost follow-on solutions to our products. We believe this strategy will enhance customer relationships, improve our responsiveness, reduce our manufacturing costs for certain products and allow us to compete with low cost competitors who develop systems employing processes developed by us. We opened a manufacturing facility in Singapore in the fourth quarter of 2010, which manufactures certain IMG, SG, CG and laser ablation products and is now our primary system manufacturing facility.
Our globalization strategy is subject to a variety of complexities and risks, many of which may divert a substantial amount of management’s time. These risks include:
challenges in designing 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 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 elsewhere;
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 continuing development, expansion 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 results of operations. If we decide to change our 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 2013 acquisition of Eolite Systems and 2014 acquisition of the Semiconductor Systems business from GSI Group, Inc. Acquisitions involve numerous risks, many of which are unpredictable and beyond our control, including:
difficulties and increased costs in connection with integration of 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.

27

Table of Contents

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.
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. On several occasions in recent years executives and other employees have received limited or no annual bonuses due to our financial performance relative to the performance parameters in our annual bonus plans. These events 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.
Our ability to retain key personnel and execute our strategy may also be adversely affected by the transition to a new CEO. In February 2014 Edward C. Grady became our President and Chief Executive Officer, replacing Nicholas Konidaris who held the position since 2004.
Need to Broaden our Marketing and Channel Capability
The laser microfabrication industry is comprised of a broad set of markets and applications and represents significant opportunities for growth. In order to access these opportunities, we need to broaden our approach from being customer-centric to being market-based. This will require the hiring, development, and application of new marketing capability and channel access. Our ability to successfully access and compete in these broader markets will be partially dependent on our development of these new skills and capabilities. Our inability to do so may harm our business and adversely affect our revenues and profitability.
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. Further, we cannot assure that our new products will gain timely 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, financial condition and results of operations may be adversely affected.
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

28

Table of Contents

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. We also will incur research and development expenses as we develop products for the adjacent markets we intend to enter. 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. 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.
We also defend our patent and intellectual property portfolio. We initiated litigation in 2014 against each of Humo Laboratory, LTD. in Japan and Eo Technics Co., Ltd., in South Korea for infringement of key patents. There is no assurance that this litigation will be successful, and we may incur significant legal fees to prosecute these claims.
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

29

Table of Contents

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.
We currently benefit from a tax incentive program in Singapore pursuant to which we pay no Singapore income tax with respect to our manufacturing income. The incentive commenced on July 1, 2006 and will continue through June 30, 2016 assuming we are able to satisfy applicable requirements. The Company has failed to meet certain of the associated requirements in the past, and has obtained a waiver for certain periods. There is no assurance we will be able to satisfy these requirements and failure to meet such requirements may lead to reduction in future or past tax benefits. The Company believes that it is more likely than not the Company will continue to receive the associated tax incentives and there is no indication that past benefits received would be rescinded.
Legal Proceedings
From time to time we are subject to various legal proceedings, including breach of contract claims and claims that involve possible infringement of patent or other intellectual property rights of third parties or by 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 results of operations. 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, 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 euros 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. In addition, we currently have a valuation allowance against domestic tax assets as a result of historic losses recorded in the United States. 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.
Impairment of Intangible Assets

30

Table of Contents

We held a total of $6 million in acquired intangible assets and $8 million in goodwill at September 27, 2014 . 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 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.
We performed a review of our acquired intangible assets in the fourth quarter of 2014, including a review for impairment based on certain triggering events and no significant impairments of intangible assets were detected.
We performed our annual goodwill impairment analysis during the fourth quarter of 2014 and determined that goodwill was not impaired. If at any time management determines that an impairment exists the Company may be required to record the impairment as part of operating income, which will result in a reduction in earnings and a corresponding reduction in our net asset value in the period such impairment is identified. The assessment of whether goodwill is impaired is sensitive to stock price and the assumed control premium. A significant deterioration in either may trigger impairment. Our stock price has recently traded around or below our book value of equity, thereby placing more emphasis on the determination of a reasonable control premium.
Stock Price Volatility
The market price of our common stock has fluctuated widely. During the second quarter of 2015, our stock price fluctuated between a high of $7.70 per share and a low of $5.98 per share, and subsequent to the end of the fiscal quarter and prior to October 31, 2014 has been as low as $6.13. 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 are 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 consumer electronics, 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;
change in our dividend policy;
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 experienced significant price and volume fluctuations in recent years. 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.
Reduction or C