Electro Scientific Industries, Inc.
ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 02/05/2014 14:33:13)
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 December 28, 2013
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 February 3, 2014 w as 29,915,584 shares.
 


Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC.
2014 FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
 
Part I
FINANCIAL INFORMATION
 
Financial Statements (Unaudited)
 
 
 
 
 
 
Part II
OTHER INFORMATION
 
 





Table of Contents


ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
Dec 28, 2013
 
Mar 30, 2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
77,174

 
$
88,913

Short-term investments
46,299

 
56,144

Trade receivables, net of allowances of $464 and $442
27,479

 
31,779

Inventories
68,626

 
63,067

Shipped systems pending acceptance
1,179

 
1,007

Deferred income taxes, net
1,714

 
1,682

Other current assets
4,796

 
3,898

Total current assets
227,267

 
246,490

Non-current assets:
 
 
 
Non-current investments
6,024

 
12,329

Property, plant and equipment, net of accumulated depreciation of $97,056 and $98,734
27,830

 
27,894

Non-current deferred income taxes, net
3,680

 
3,766

Goodwill
7,889

 
7,889

Acquired intangible assets, net of accumulated amortization of $17,524 and $15,393
7,696

 
9,088

Other assets
19,199

 
14,752

Total assets
$
299,585

 
$
322,208

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
14,191

 
$
16,958

Accrued liabilities
20,944

 
24,930

Deferred revenue
6,694

 
10,196

Total current liabilities
41,829

 
52,084

Non-current liabilities:
 
 
 
Income taxes payable
6,208

 
5,982

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; 30,095 and 29,583 issued and outstanding
181,844

 
176,631

Retained earnings
69,368

 
87,228

Accumulated other comprehensive income, other
336

 
283

Total shareholders’ equity
251,548

 
264,142

Total liabilities and shareholders’ equity
$
299,585

 
$
322,208

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
 
Three fiscal quarters ended
(In thousands, except per share amounts)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Net sales
$
38,267

 
$
37,930

 
$
144,086

 
$
177,051

Cost of sales
21,986

 
24,697

 
83,787

 
106,645

Gross profit
16,281

 
13,233

 
60,299

 
70,406

Operating expenses:
 
 
 
 
 
 
 
Selling, service and administration
12,408

 
11,696

 
41,206

 
42,473

Research, development and engineering
9,768

 
8,730

 
27,912

 
28,791

Legal settlement proceeds, net

 
(15,365
)
 

 
(15,365
)
Gain on sale of property and equipment, net
(1,301
)
 
(1,226
)
 
(1,301
)
 
(1,226
)
Gain on acquisition of Semiconductor Systems business

 

 
(499
)
 

Net operating expenses
20,875

 
3,835

 
67,318

 
54,673

Operating (loss) income
(4,594
)
 
9,398

 
(7,019
)
 
15,733

Non-operating income (expense):
 
 
 
 
 
 
 
Other-than-temporary impairment of cost based investments

 

 
(3,588
)
 

Interest and other income (expense), net
95

 
(5
)
 
115

 
(64
)
Total non-operating income (expense)
95

 
(5
)
 
(3,473
)
 
(64
)
(Loss) income before income taxes
(4,499
)
 
9,393

 
(10,492
)
 
15,669

Provision for income taxes
141

 
2,625

 
209

 
4,634

Net (loss) income
$
(4,640
)
 
$
6,768

 
$
(10,701
)
 
$
11,035

Net (loss) income per share—basic
$
(0.15
)
 
$
0.23

 
$
(0.36
)
 
$
0.38

Net (loss) income per share—diluted
$
(0.15
)
 
$
0.23

 
$
(0.36
)
 
$
0.37

Weighted average number of shares—basic
30,054

 
29,434

 
29,922

 
29,296

Weighted average number of shares—diluted
30,054

 
30,043

 
29,922

 
29,954

Cash dividends paid per outstanding common share
$
0.08

 
$
2.08

 
$
0.24

 
$
2.24





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

 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Net (loss) income
$
(4,640
)
 
$
6,768

 
$
(10,701
)
 
$
11,035

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $(86), ($134), $22 and $19
(153
)
 
(239
)
 
39

 
37

Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $2, $1, $5 and $4
3

 
3

 
9

 
8

Net unrealized gain (loss) on available-for-sale securities, net of taxes of $(2), ($8), $3 and ($5)
(3
)
 
(15
)
 
5

 
(9
)
Comprehensive (loss) income
$
(4,793
)
 
$
6,517

 
$
(10,648
)
 
$
11,071


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)
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net (loss) income
$
(10,701
)
 
$
11,035

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
 
 
 
Depreciation and amortization
5,636

 
6,867

Amortization of acquired intangible assets
2,133

 
1,810

Share-based compensation expense
5,130

 
6,132

Gain on sale of property and equipment, net
(1,264
)
 
(1,226
)
Gain on acquisition of Semiconductor Systems business
(499
)
 

Other-than-temporary impairment of cost based investments
3,588

 

(Increase) decrease in deferred income taxes
(317
)
 
4,537

Changes in operating accounts, net of acquisitions:

 

Decrease in trade receivables, net
8,047

 
14,315

Increase in inventories
(1,389
)
 
(11,744
)
(Increase) decrease in shipped systems pending acceptance
(172
)
 
1,002

(Increase) decrease in other current assets
(924
)
 
61

Decrease in accounts payable and accrued liabilities
(9,460
)
 
(912
)
Decrease in deferred revenue
(3,681
)
 
(4,343
)
Net cash (used in) provided by operating activities
(3,873
)
 
27,534

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(237,113
)
 
(857,435
)
Proceeds from sales and maturities of investments
253,265

 
885,818

Purchase of property, plant and equipment
(5,344
)
 
(5,127
)
Proceeds from sale of property, plant and equipment
3,617

 
2,020

Cash paid for business acquisitions
(9,731
)
 
(9,466
)
Minority equity investment
(5,000
)
 

Decrease in other assets
(408
)
 
403

Net cash (used in) provided by investing activities
(714
)
 
16,213

CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash dividends paid to shareholders
(7,158
)
 
(65,723
)
Stock plan activity, net
83

 
73

Excess tax benefit of share-based compensation

 
71

Net cash used in financing activities
(7,075
)
 
(65,579
)
Effect of exchange rate changes on cash
(77
)
 
(708
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
(11,739
)
 
(22,540
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
88,913

 
69,780

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
77,174

 
$
47,240

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for income taxes
$
(3,072
)
 
$
(1,174
)
Income tax refunds received
$
65

 
$
651

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 30, 2013. 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 30, 2013. All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted.
2. Recent Accounting Pronouncements

There have been no recen t accounting pronouncements or changes in accounting pronouncements during the quarter ended December 28, 2013 that are of significance to the Company.
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 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 621,000 restricted stock unit awards during the first three quarters of 2014 , but did not grant any stock options or SARs. The Company granted 552,500 restricted stock unit awards and 5,000 stock options during the first three quarters of 2013 , but did not grant any SARs.

6


Share-based compensation expense was included in the Company’s Condensed Consolidated Statements of Operations as follows:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Cost of sales
$
184

 
$
202

 
$
558

 
$
635

Selling, service and administration
728

 
867

 
3,488

 
4,145

Research, development and engineering
350

 
413

 
1,084

 
1,579

Total share-based compensation expense
$
1,262

 
$
1,482

 
$
5,130

 
$
6,359

No share-based compensation costs were capitalized in the first three quarters of 2014 . As of December 28, 2013 , the Company had $9.2 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 1.9 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 December 28, 2013 and March 30, 2013 was as follows (in thousands):
December 28, 2013
Level 1
 
Level 2
 
Level 3
 
Total
Money market securities
$
3,724

 
$

 
$

 
$
3,724

Commercial paper

 
20,447

 

 
20,447

Corporate Bonds

 
18,550

 

 
18,550

Municipal bonds

 
14,461

 

 
14,461

Government agencies

 
8,034

 

 
8,034

Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen

 
108

 

 
108

New Taiwan Dollar

 
(5
)
 

 
(5
)
Korean Won

 
33

 

 
33

Euro

 
(129
)
 

 
(129
)
British Pound

 
29

 

 
29

Chinese Renminbi

 
(18
)
 

 
(18
)
Singapore Dollar

 
(3
)
 

 
(3
)
March 30, 2013
Level 1
 
Level 2
 
Level 3
 
Total
Money market securities
$
9,457

 
$

 
$

 
$
9,457

Commercial paper

 
51,443

 

 
51,443

Government agencies

 
29,646

 

 
29,646

Corporate bonds

 
18,396

 

 
18,396

Municipal bonds

 
3,389

 

 
3,389

Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen

 
176

 

 
176

New Taiwan Dollar

 
(10
)
 

 
(10
)
Korean Won

 
(46
)
 

 
(46
)
Euro

 
100

 

 
100

British Pound

 
38

 

 
38

Chinese Renminbi

 
(1
)
 

 
(1
)
Singapore Dollar

 
(12
)
 

 
(12
)
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 December 28, 2013 and March 30, 2013 were utilized to calculate fair values.
During the first three quarters of 2014 , there were no transfers between Level 1 and Level 2 assets.


8


Investments
Certain information regarding the Company’s investments at December 28, 2013 and March 30, 2013 was as follows (in thousands):  
 
 
 
Unrealized
 
 
December 28, 2013
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
20,447

 
$

 
$

 
$
20,447

Corporate Bonds
18,549

 
1

 

 
18,550

Municipal Bonds
10,428

 
7

 

 
10,435

Government agencies
6,035

 
1

 

 
6,036

 
$
55,459

 
$
9

 
$

 
$
55,468

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Municipal Bonds
$
4,019

 
$
7

 
$

 
$
4,026

Government agencies
1,998

 

 

 
1,998

 
$
6,017

 
$
7

 
$

 
$
6,024

 
 
 
 
 
 
 
 
 
 
 
Unrealized
 
 
March 30, 2013
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
51,443

 
$

 
$

 
$
51,443

Government agencies
26,556

 
8

 

 
26,564

Corporate Bonds
10,473

 
7

 

 
10,480

Municipal Bonds
2,058

 

 

 
2,058

 
$
90,530

 
$
15

 
$

 
$
90,545

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Corporate Bonds
$
7,923

 
$

 
$
(7
)
 
$
7,916

Government agencies
3,082

 

 

 
3,082

Municipal Bonds
1,330

 
1

 

 
1,331

 
$
12,335

 
$
1

 
$
(7
)
 
$
12,329

For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive (loss) income, the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive (loss) income were insignificant as of December 28, 2013 and March 30, 2013.
Underlying maturities of investments at December 28, 2013 were $55.5 million within one year and $6.0 million between one to five years.
5. Business Acquisitions
Fiscal 2014
On May 3, 2013 , the Company completed the purchase of assets related to the Semiconductor Systems business of GSI Group Inc. for $8.0 million , subject to certain closing working capital adjustments. As of June 29, 2013 the working capital adjustments had not been finalized but were estimated and accrued at $1.6 million . On September 20, 2013, the Company finalized the closing working capital adjustment and paid $1.7 million of cash 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.

9


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 will be amortized over their estimated useful lives which range from one to three years.
In the first three quarters of 2014, the Company also incurred approximately $1.3 million in acquisition related costs which are included in Selling, service and administration expenses in the Condensed Consolidated Statements of Operations.
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.
Fiscal 2013
On June 14, 2012, the Company acquired Eolite Systems (Eolite), a designer and manufacturer of unique fiber lasers, for $9.7 million in cash for all its outstanding shares. The purchase price of $9.5 million , net of cash acquired, was allocated to the underlying assets acquired and liabilities assumed based on their fair values. Analyses 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 provides the Company with direct access to differentiated, higher power laser technology which can be used in a broad set of microfabrication applications. The Company has allocated $3.9 million of the purchase price to goodwill. The premium paid over the fair value of the individual assets acquired and liabilities assumed reflects the Company’s view that this acquisition will increase the Company’s ability to customize lasers to specific customer applications with differentiated capability. None of the goodwill is deductible for tax purposes.
As a result of the acquisition, the Company recorded $5.5 million of identifiable intangible assets including approximately $5.0 million of developed technology, $0.4 million in customer relationships, and $0.1 million in trademarks and backlog. The acquired intangibles will be amortized over their estimated useful lives which range from one to nine years.
In the first three quarters of 2013, the Company also incurred approximately $0.9 million in acquisition-related costs which are included in Selling, service and administration expenses in the Condensed Consolidated Statements of Operations.
The operating results of this acquisition are included in the Company’s results of operations since the date of acquisition. Pro forma financial information has not been provided for the acquisition of Eolite 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)
Dec 28, 2013
 
Mar 30, 2013
Raw materials and purchased parts
$
49,298

 
$
44,332

Work-in-process
13,353

 
8,985

Finished goods
5,975

 
9,750

 
$
68,626

 
$
63,067

7. Other Current Assets
Other current assets consisted of the following:
(In thousands)
Dec 28, 2013
 
Mar 30, 2013
Prepaid expenses
$
2,931

 
$
2,240

Value added tax receivable
672

 
763

Other
1,193

 
895

 
$
4,796

 
$
3,898


10


8. Other Assets
Other assets consisted of the following:
(In thousands)
Dec 28, 2013
 
Mar 30, 2013
Minority equity investment
$
10,378

 
$
8,966

Consignment and demo equipment, net
6,830

 
4,263

Long term deposits and other
1,991

 
1,523

 
$
19,199

 
$
14,752

Minority equity investment represents the Company's investment in OmniGuide, Inc. During the second quarter of 2014, the Company invested $5 million in Series F Preferred Stock of OmniGuide, Inc. As of December 28, 2013 , the Company had $6.0 million invested in Series D Preferred Stock, $3.0 million invested in Series E Preferred Stock, and $5.0 million invested in Series F Preferred Stock of OmniGuide, Inc., representing a 15% interest. At each reporting period end, the Company determines whether events or circumstances have occurred that are likely to have a significant adverse effect on the fair value of these investments. If there are no events or circumstances identified that would adversely affect the fair value of the investments, the fair values of the investments are not calculated. In 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, the Company performed a valuation of the investment which resulted in a $3.6 million impairment charge of our Series D and Series E investments.
9. Accrued Liabilities
Accrued liabilities consisted of the following:
(In thousands)
Dec 28, 2013
 
Mar 30, 2013
Payroll-related liabilities
$
7,805

 
$
7,918

Product warranty accrual
4,623

 
5,411

Professional fees payable
1,762

 
1,322

Pension benefit liabilities
1,667

 
1,501

Purchase order commitments and receipts
1,257

 
2,533

Customer deposits
685

 
225

Freight accrual
536

 
646

Income taxes payable
429

 
2,884

Restructuring costs payable
327

 
485

Value added taxes payable
272

 
258

Other
1,581

 
1,747

 
$
20,944

 
$
24,930

10. Product Warranty
The following is a reconciliation of the changes in the aggregate product warranty accrual:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Product warranty accrual, beginning
$
5,563

 
$
6,096

 
$
5,411

 
$
4,187

Warranty charges incurred, net
(1,755
)
 
(1,603
)
 
(5,298
)
 
(5,513
)
Provision for warranty charges
815

 
1,297

 
4,510

 
7,116

Product warranty accrual, ending
$
4,623

 
$
5,790

 
$
4,623

 
$
5,790

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.

11


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
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Deferred revenue, beginning
$
7,855

 
$
9,456

 
$
10,196

 
$
10,751

Revenue deferred
5,294

 
5,394

 
18,892

 
43,340

Revenue recognized
(6,455
)
 
(8,330
)
 
(22,394
)
 
(47,571
)
Deferred revenue, ending
$
6,694

 
$
6,520

 
$
6,694

 
$
6,520

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
 
Three fiscal quarters ended
(In thousands, except per share data)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Net (loss) income
$
(4,640
)
 
$
6,768

 
$
(10,701
)
 
$
11,035

Weighted average shares used for basic earnings per share
30,054

 
29,434

 
29,922

 
29,296

Incremental diluted shares

 
609

 

 
658

Weighted average shares used for diluted earnings per share
30,054

 
30,043

 
29,922

 
29,954

Net (loss) income per share:
 
 
 
 
 
 
 
Net (loss) income — basic
$
(0.15
)
 
$
0.23

 
$
(0.36
)
 
$
0.38

Net (loss) income — diluted
$
(0.15
)
 
$
0.23

 
$
(0.36
)
 
$
0.37

Awards of options, stock appreciation rights (SARs) and unvested restricted stock units (RSUs) representing an additional 3.8 million and 2.5 million shares of stock for the third quarter of 2014 and 2013 , respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.
For the three quarters ended December 28, 2013 and December 29, 2012 , awards of options, SARs, and unvested RSUs representing an additional 4.0 million and 2.3 million shares, 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
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Interconnect & Microfabrication Group (IMG)
$
25,378

 
$
30,537

 
$
98,096

 
$
147,506

Semiconductor Group (SG)
8,535

 
3,322

 
25,083

 
9,938

Components Group (CG)
4,354

 
4,071

 
20,907

 
19,607

 
$
38,267

 
$
37,930

 
$
144,086

 
$
177,051


12


Net sales by geographic area, based on the location of the end user, were as follows:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
Dec 28, 2013
 
Dec 29, 2012
 
Dec 28, 2013
 
Dec 29, 2012
Asia
$
29,087

 
$
28,928

 
$
117,361

 
$
154,962

Americas
4,761

 
6,990

 
15,470

 
15,696

Europe
4,419

 
2,012

 
11,255

 
6,393

 
$
38,267

 
$
37,930

 
$
144,086

 
$
177,051

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 planned completion date for remaining actions to be taken under this plan is April 30, 2014. See the Company's Form 10-K for the year ended March 30, 2013 for additional information related to restructuring and cost management plans.
In the first three quarters of 2014 , net restructuring credits of $31 thousand were recognized due to changes in estimates. At December 28, 2013 and March 30, 2013, the amount of unpaid restructuring costs included in accrued liabilities was $0.3 million and $0.5 million , respectively.
The following table presents the amounts related to restructuring costs payable (in thousands):
Restructuring costs payable balance as of March 30, 2013
$
485

Employee severance and related benefits:
 
Cash payments
(153
)
Other adjustments
(5
)
Restructuring costs payable balance as of December 28, 2013
$
327

15. Shareholders’ Equity
Share Repurchase Program
On December 9, 2011, the Board of Directors authorized a share repurchase program totaling $20.0 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. The Company did not repurchase any shares under this program in either the first three quarters of 2013 or 2014 . 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 third quarter of 2013:
Date Declared
 
Record Date
 
Payable Date
 
Amount per Share
November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$0.08
August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$0.08
May 14, 2013
 
June 5, 2013
 
June 19, 2013
 
$0.08
February 7, 2013
 
February 28, 2013
 
March 14, 2013
 
$0.08
November 8, 2012
 
November 21, 2012
 
December 5, 2012
 
$0.08
A special dividend of $2.00 per share was declared by the Board of Directors on December 3, 2012 after the successful settlement of a patent dispute. The special dividend should not be considered a recurring event.
The Company paid aggregate dividends of $7.2 million and $65.7 million in the first three quarters of 2014 and 2013 , respectively.

13


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 and 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, light emitting diodes (LEDs), 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 quarter ended December 28, 2013 , which represented the third quarter of 2014 , reflected a sequential decline in sales and earnings as a result of timing of design wins in our advanced micromachining business and absorption of capacity in some of our markets. Revenue decreased to $38.3 million from $59.6 million in the third quarter of 2014 which ended December 28, 2013 . Total order volume for the third quarter of 2014 declined from $46.2 million to $35.6 million , primarily driven by timing of orders for advanced microfabrication equipment, and timing of service contract bookings.
Total shipments were $37.4 million in the third quarter of 2014 compared to $56.9 million in the second quarter of 2014 . By product group, Semiconductor Group (SG) shipments increased by approximately 21% , Interconnect & Microfabrication Group (IMG) shipments decreased by approximately 39% , and Components Group (CG) shipments decreased by approximately 58% .
Net sales were $38.3 million in the third quarter of 2014 compared to $59.6 million in the second quarter of 2014 . All three business groups showed a sequential decline in sales and orders. IMG decreased due to lower flex, microfabrication and service sales. CG decreased due to MLCC customers absorbing capacity following strong shipments in the second quarter. Finally, SG sales decreased due to shipment push-outs and acceptance delays.
Gross profit was $16.3 million in the third quarter of 2014 compared to a gross profit of $24.6 million in the second quarter of 2014 . Gross margin was 42.5% on net sales of $38.3 million in the third quarter of 2014 compared to a gross profit of 41.3% on net sales of $59.6 million in the second quarter of 2014 . The increase in gross margin was primarily driven by favorable product mix, partially offset by lower sales volume.

14


Net operating expenses of $20.9 million in the third quarter of 2014 decreased $3.1 million from $23.9 million in the second quarter of 2014 . This decrease is due to a $1.8 million decrease in selling, service and administration (SS&A) and a $1.3 million gain on sale of property. RD&E expense remained fairly flat compared to the prior quarter. SS&A expense decreased primarily due to reduced compensation and other variable expenses based on lower business volume and less amortization of acquired intangible assets.
Operating loss was $4.6 million in the third quarter of 2014 compared to an operating income of $0.7 million in the second quarter of 2014 , a change of $5.3 million . The operating loss was primarily due to lower sales volumes in the third quarter partially offset by a decreased operating expenses and the gain on sale of property.
Non-operating income was $0.1 million in the third quarter of 2014 compared to expense of $3.5 million in the second quarter of 2014 . The change is primarily due to the $3.6 million impairment against our minority equity investment in OmniGuide, Inc recorded in the second quarter of 2014.
Provision for income taxes was $141 thousand in the third quarter of 2014 compared to a benefit of $33 thousand in the second quarter of 2014 .
Net loss was $4.6 million in the third quarter of 2014 compared to a net loss of $2.8 million in the second quarter of 2014 .
Quarter Ended December 28, 2013 Compared to Quarter Ended December 29, 2012
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
Dec 28, 2013
 
Dec 29, 2012
Net sales
100.0
 %
 
100.0
 %
Cost of sales
57.5

 
65.1

Gross profit
42.5

 
34.9

Selling, service and administration
32.4

 
30.8

Research, development and engineering
25.5

 
23.0

Legal settlement proceeds, net

 
(40.5
)
Gain on sale of property and equipment, net
(3.4
)
 
(3.2
)
Operating (loss) income
(12.0
)
 
24.8

Interest and other income, net
0.2

 

(Loss) income before income taxes
(11.8
)
 
24.8

Provision for income taxes
0.3

 
7.0

Net (loss) income
(12.1
)%
 
17.8
 %
Net Sales
The following table presents net sales information by product group:
 
Fiscal quarter ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
25,378

 
66.3
%
 
$
30,537

 
80.5
%
Semiconductor Group (SG)
8,535

 
22.3

 
3,322

 
8.8

Components Group (CG)
4,354

 
11.4

 
4,071

 
10.7

 
$
38,267

 
100.0
%
 
$
37,930

 
100.0
%
Net sales for the third quarter of 2014 increased $0.3 million or 1% from net sales for the third quarter of 2013 . Sales in IMG decreased by 17% , while SG and CG increased by 157% and 7% , respectively.
IMG sales for the third quarter of 2014 decreased $5.2 million compared to the third quarter of 2013 . The decrease in IMG sales was driven by last year's shipments of advanced microfabrication systems which were higher, following large design wins in early 2013, which exceeded the order volume experienced in 2014.

15


SG sales for the third quarter of 2014 increased $5.2 million compared to the third quarter of 2013 . The increase was primarily driven by the sales in our newly acquired Semiconductor Systems business.
CG sales for the third quarter of 2014 increased $0.3 million compared to the third quarter of 2013 , fairly consistent with the seasonally lower levels of the previous year.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
29,087

 
76.0
%
 
$
28,928

 
76.3
%
Americas
4,761

 
12.4

 
6,990

 
18.4

Europe
4,419

 
11.6

 
2,012

 
5.3

 
$
38,267

 
100.0
%
 
$
37,930

 
100.0
%
Gross Profit
 
Fiscal quarter ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
16,281

 
42.5
%
 
$
13,233

 
34.9
%
Gross profit was $16.3 million for the third quarter of 2014 , an increase of $3.0 million compared to the third quarter of 2013 . This increase was primarily driven by favorable product mix, warranty improvements, lower material and manufacturing costs and to a lesser extent, by slightly higher production volume. Gross profit as a percentage of net sales was 42.5% and 34.9% for the third quarter s of 2014 and 2013 , respectively.
Operating Expenses
 
Fiscal quarter ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, service and administration
$
12,408

 
32.4
 %
 
$
11,696

 
30.8
 %
Research, development and engineering
9,768

 
25.5

 
8,730

 
23.0

Legal settlement proceeds, net

 

 
(15,365
)
 
(40.5
)
Gain on sale of property and equipment, net
(1,301
)
 
(3.4
)
 
(1,226
)
 
(3.2
)
 
$
20,875

 
54.5
 %
 
$
3,835

 
10.1
 %
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 third quarter of 2014 increased $0.7 million compared to the third quarter of 2013 . This increase was primarily attributable to increases in expenses associated with the addition of the Semiconductor systems business and a slightly higher installed base, partially offset by lower asset depreciation, variable pay, share-based compensation and the impact of restructuring actions taken in the fourth quarter of FY2013.

16


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 third quarter of 2014 increased $1.0 million compared to the third quarter of 2013 . This increase was primarily due to the addition of the Semiconductor systems business and higher project development costs, partially offset by the impact of restructuring actions taken in the fourth quarter of 2013.
Legal Settlement Proceeds, net
Legal settlement proceeds, net for the third quarter of 2013 were $15.4 million , which consisted of All Ring litigation legal settlement proceeds and related non-recurring legal matters.
Gain on Sale of Property and Equipment, net
During the third quarter of 2014, we sold a facility in Portland, Oregon for $3.6 million , resulting in a pre-tax gain of $1.3 million . The 2013 gain on sale for $1.2 million was primarily due to a facility sale in China which resulted in a pre-tax gain of $1.3 million, partially offset by the loss on disposal of certain fixed assets.
Non-operating Income and Expense
Non-operating income and expense consists 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, investment management fees, and other miscellaneous non-operating items. Net non-operating income was $95 thousand in the third quarter of 2014 and net non-operating expense was $5 thousand in the third quarter of 2013 . The increase in income was primarily attributable to market gains on assets held in deferred compensation accounts.
Income Taxes
 
Fiscal quarter ended
 
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
Provision for income taxes
$
141

 
(3.1
)%
 
$
2,625

 
27.9
%
The income tax provision for the third quarter of 2014 was $141 thousand on pretax loss of $4.5 million , an effective tax rate of (3.1)% . For the third quarter of 2013 , the income tax provision was $2.6 million on pretax income of $9.4 million , an effective rate of 27.9% . The change in the effective tax rate is primarily due to the relative quarterly income level, the mix of income between foreign and domestic jurisdictions and their relative tax rates, the impact of the valuation allowance on domestic tax assets, and a discrete benefit resulting from the filing of the Company's tax returns.
Net (Loss) Income
 
Fiscal quarter ended
 
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Income
 
% of Net Sales
Net (loss) income
$
(4,640
)
 
(12.1
)%
 
$
6,768

 
17.8
%
As a result of the factors discussed above, net loss for the third quarter of 2014 was $4.6 million , or $0.15 per basic and diluted share, compared to net income of $6.8 million , or $0.23 per basic and diluted share, for the third quarter of 2013 .






17


Three Quarters Ended December 28, 2013 Compared to Three Quarters Ended December 29, 2012
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Three fiscal quarters ended
 
Dec 28, 2013
 
Dec 29, 2012
Net sales
100.0
 %
 
100.0
 %
Cost of sales
58.2

 
60.2

Gross profit
41.8

 
39.8

Selling, service and administration
28.6

 
24.0

Research, development and engineering
19.4

 
16.3

Legal settlement proceeds, net

 
(8.7
)
Gain on sale of property and equipment, net
(0.9
)
 
(0.7
)
Gain on acquisition of Semiconductor Systems business
(0.4
)
 

Operating (loss) income
(4.9
)
 
8.9

Other-than-temporary impairment of cost based investments
(2.5
)
 

Interest and other (expense) income, net
0.1

 
(0.1
)
Total non-operating income (expense)
(2.4
)
 
(0.1
)
(Loss) income before income taxes
(7.3
)
 
8.8

Provision for income taxes
0.1

 
2.6

Net (loss) income
(7.4
)%
 
6.2
 %
Net Sales
The following table presents net sales information by product group:
 
Three fiscal quarters ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Interconnect & Microfabrication Group (IMG)
$
98,096

 
68.1
%
 
$
147,506

 
83.3
%
Semiconductor Group (SG)
25,083

 
17.4

 
9,938

 
5.6

Components Group (CG)
20,907

 
14.5
%
 
19,607

 
11.1
%
 
$
144,086

 
100.0
%
 
$
177,051

 
100.0
%
Net sales for the first three quarters of 2014 decreased $33.0 million or 18.6% from net sales for the first three quarters of 2013 . Sales in IMG decreased by 33.5% , while sales in SG and CG increased by 152.4% and 6.6% , respectively.
IMG sales for the first three quarters of 2014 decreased $49.4 million compared to the first three quarters of 2013 . The decrease in IMG sales was primarily driven by the shipment of advanced microfabrication systems following large design wins in early 2013 which did not repeat at the same level in 2014.
SG sales for the first three quarters of 2014 increased $15.1 million compared to the first three quarters of 2013 . The increase in SG sales was primarily driven by the addition of our Semiconductor Systems business, which we acquired in the first quarter of 2014.
CG sales for the first three quarters of 2014 increased $1.3 million compared to the first three quarters of 2013 . The increase was primarily driven by improved sales of the new multilayer ceramic capacitor testers.


18


The following table presents net sales information by geographic region:
 
Three fiscal quarters ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
117,361

 
81.5
%
 
$
154,962

 
87.5
%
Americas
15,470

 
10.7

 
15,696

 
8.9

Europe
11,255

 
7.8

 
6,393

 
3.6

 
$
144,086

 
100.0
%
 
$
177,051

 
100.0
%
Gross Profit
 
Three fiscal quarters ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Gross Profit
$
60,299

 
41.8
%
 
$
70,406

 
39.8
%
Gross profit was $60.3 million for the first three quarters of 2014 and decreased $10.1 million compared to the first three quarters of 2013 . This decrease was primarily due to lower sales and production volumes. Gross profit as a percentage of net sales increased to 41.8% for the first three quarters of 2014 from 39.8% for the first three quarters of 2013 . This increase was primarily due to a more favorable product mix and to a lesser extent by improvements in manufacturing resulting in lower expenses.
Operating Expenses
 
Three fiscal quarters ended
   
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, service and administration
$
41,206

 
28.6
 %
 
$
42,473

 
24.0
 %
Research, development and engineering
27,912

 
19.4

 
28,791

 
16.3

Legal settlement proceeds, net

 

 
(15,365
)
 
(8.7
)
Gain on sale of property and equipment, net
(1,301
)
 
(0.9
)
 
(1,226
)
 
(0.7
)
Gain on acquisition of Semiconductor Systems business
(499
)
 
(0.4
)
 

 

 
$
67,318

 
46.7
 %
 
$
54,673

 
30.9
 %
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 three quarters of 2014 decreased $1.3 million compared to the first three quarters of 2013 . This decrease was primarily attributable to the impact of restructuring actions taken at the end of 2013, decreases in variable expense associated with lower sales volume, and, to a lesser extent, by lower legal fees, asset depreciation and share-based compensation costs, partially offset by increased expenses resulting from addition of the Semiconductor Systems business.
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 three quarters of 2014 decreased $0.9 million compared to the first three quarters of 2013 . This decrease was primarily due to decrease in labor costs due to selective headcount reductions, lower variable pay, lower share-based compensation expense and lower asset depreciation, partially offset by the addition of the Semiconductor Systems business.



19


Legal Settlement Proceeds, net
Legal settlement proceeds, net for the third quarter of 2013 were $15.4 million , which consisted of All Ring litigation legal settlement proceeds and related non-recurring legal matters.
Gain on Sale of Property and Equipment, net
During the third quarter of 2014, we sold a facility in Portland, Oregon for $3.6 million , resulting in a pre-tax gain of $1.3 million . The 2013 gain on sale for $1.2 million was primarily due to a facility sale in China which resulted in a pre-tax gain of $1.3 million, partially offset by the loss on disposal of certain fixed assets.
Gain on acquisition of Semiconductor Systems Business
Gain on acquisition of Semiconductor Systems business was $0.5 million in 2014. This 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.
Non-operating Income and Expense
Non-operating income and expense, net, consists 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, investment management fees, and other miscellaneous non-operating items.
Non-operating income and expense were as follows:
 
Three fiscal quarters ended
 
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Non-Operating Income (Expense)
 
% of Net Sales
 
Non-Operating Income (Expense)
 
% of Net Sales
Other-than-temporary impairment of cost based investments
$
(3,588
)
 
(2.5
)%
 
$

 
 %
Interest and other income (expense), net
$
115

 
0.1
 %
 
$
(64
)
 
(0.1
)%
Total non-operating income (expense)
$
(3,473
)
 
(2.4
)%
 
$
(64
)
 
(0.1
)%
Other-than-temporary impairment of cost based investments
Other-than-temporary impairment of cost based investments was $3.6 million in first three quarters of 2014 and relates to our minority interest investment in OmniGuide, Inc. During the second quarter, OmniGuide, Inc. engaged in a Series F Preferred Stock round of equity financing at pricing below previous rounds which was considered a triggering 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.
Interest and other (expense) income, net
Net interest and other income was $115 thousand in the first three quarters of 2014 compared to net interest and other expense of $64 thousand in the first three quarters of 2013 . The increase in income was primarily attributable to market gains on assets held in deferred compensation accounts.
Income Taxes
 
Three fiscal quarters ended
 
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
Provision for income taxes
$
209

 
(2.0
)%
 
$
4,634

 
29.6
%
The income tax provision for the first three quarters of 2014 was $0.2 million on pretax loss of $10.5 million , an effective tax rate of (2.0)% . For the first three quarters of 2013 , the income tax provision was $4.6 million on pretax income of $15.7 million , an effective rate of 29.6% . The change in the effective tax rate is primarily due to the relative income level, the mix of income between foreign and domestic jurisdictions and their relative tax rates, the impact of the valuation allowance on domestic tax assets, and a discrete benefit resulting from the closure of various open foreign tax returns and filing of the Company's tax returns.

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Net (Loss) Income
 
Three fiscal quarters ended
 
Dec 28, 2013
 
Dec 29, 2012
(In thousands, except percentages)
Net Loss
 
% of Net Sales
 
Net Income
 
% of Net Sales
Net (loss) income
$
(10,701
)
 
(7.4
)%
 
$
11,035

 
6.2
%
As a result of the factors discussed above, net loss for the first three quarters of 2014 was $10.7 million , or $0.36 per basic and diluted share, compared to net income of $11.0 million , or $0.38 per basic and $0.37 per diluted share, for the first three quarters of 2013 .
Financial Condition and Liquidity
At December 28, 2013 , our principal sources of liquidity were cash and cash equivalents of $77.2 million , short-term investments of $46.3 million and accounts receivable of $27.5 million . At December 28, 2013 , we had a current ratio of 5.43 and held no long-term debt. Working capital of $185.4 million decreased $9.0 million compared to the March 30, 2013 balance of $194.4 million substantially impacted by the purchase of the Semiconductor Systems business for $9.7 million , the $5.0 million investment in OmniGuide, Inc. and the payment of quarterly dividends. We also held approximately $6.0 million of non-current investments at December 28, 2013 .
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 third quarter of 2013:
Date Declared
 
Record Date
 
Payable Date
 
Amount per Share
November 7, 2013
 
November 19, 2013
 
December 4, 2013
 
$0.08
August 8, 2013
 
August 19, 2013
 
September 3, 2013
 
$0.08
May 14, 2013
 
June 5, 2013
 
June 19, 2013
 
$0.08
February 7, 2013
 
February 28, 2013
 
March 14, 2013
 
$0.08
November 8, 2012
 
November 21, 2012
 
December 5, 2012
 
$0.08
A special dividend of $2.00 per share was declared by the Board of Directors on December 3, 2012 after the successful settlement of a patent dispute. The special dividend should not be considered a recurring event.
We paid aggregate dividends of $7.2 million and $65.7 million for the first third quarter s of 2014 and 2013 , respectively.
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.
In December 2011, the Board of Directors authorized a share repurchase program totaling $20.0 million to acquire shares of our 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. We did not repurchase any shares under this program in 2014 or 2013 . There is no fixed completion date for the repurchase program.







21


Sources and Uses of Cash
Net cash used in operating activities of $3.9 million for the three quarters ended December 28, 2013 , was due to $10.7 million in net loss and $7.6 million of cash outflows from working capital, partially offset by $14.4 million in non-cash charges. For the three quarters ended December 28, 2013 , the primary uses of cash from working capital consisted of a $9.5 million decrease in accounts payable and accrued liabilities, $3.7 million decrease in deferred revenue, $1.4 million increase in inventories, $0.9 million increase in other current assets and $0.2 million increase in shipped systems pending acceptance, partially offset by $8.0 million decrease in trade receivables.
For the three quarters ended December 28, 2013 , net cash used in investing activities of $0.7 million was the result of $237.1 million of purchases of investments, $9.7 million of net cash paid for acquisition of the Semiconductor Systems business, $5.0 million in additional investment in OmniGuide, Inc., $5.3 million of purchases of property, plant and equipment and $0.4 million increase in other assets, partially offset by $253.3 million of proceeds from sales and maturities of investments and $3.6 million of proceeds from the sale of property.
For the three quarters ended December 28, 2013 , net cash used in financing activities of $7.1 million primarily resulted from $7.2 million of cash dividends paid to shareholders offset by $0.1 million from net stock plan activity.
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 30, 2013.
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 30, 2013.

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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 third quarter of 2014 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.

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Item 1A. Risk Factors
The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time, we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may differ materially. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to, the following:
Risks Related to Our Competition and Customers
Volatility of Our Customers’ Industries
Our business is dependent upon the capital expenditures of manufacturers of microelectronics, semiconductors and light emitting diodes (LEDs) used in consumer electronics, 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 downturns in the market for microelectronics, semiconductors, and LEDs 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 factors, our total order volume declined in 2012 compared to 2011 and continued to decline in 2013. In addition, due to changes in the memory repair industry, we do not expect to experience material sales of memory repair systems in future up cycles. 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, LEDs and consumer electronics industries.
Highly Competitive Markets
We face substantial competition from established competitors throughout the world, some of which have greater financial, engineering, manufacturing and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to, and new generations of, products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. We believe that to be competitive we must continue to expend significant financial resources in order to, among other things, invest in new product development and enhancements. We may not be able to compete successfully in the future and increased competition may result in price reductions, reduced profit margins and loss of market share.
Increased Price Pressure
We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Pricing pressures from competitors typically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products. In addition, we may agree to pricing concessions with our customers in connection with volume orders. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.
Revenues are Largely Dependent on Few Customers
We depend on a few significant customers for a large portion of our revenues. In 2013, our top ten customers accounted for approximately 61% of total net sales, with one customer accounting for approximately 31% of total net sales. We anticipate that sales of our products to a relatively small number of customers will continue to account for a significant portion of our revenues. Consolidation between customers, changes in 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

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bankruptcies or customer departures from their respective industries all may result in even fewer customers accounting for a high percentage of our revenue. Furthermore, none of our customers have any long-term obligation to continue to buy our products or services and may therefore delay, reduce or cease ordering our products or services at any time. The cancellation, reduction or deferral of purchases of our products by even a single customer could significantly reduce our revenues in any particular quarter. If we were to lose any of our significant customers or suffer a material reduction in their purchase orders, revenue could decline and our business, financial condition and results of operations could be materially and adversely affected.
Revenues are Largely Based on the Sale of a Small Number of Product Units
We derive a substantial portion of our revenue from the sale of a relatively small number of products. Accordingly, our revenues, margins and other operating results could fluctuate significantly from quarter to quarter depending upon a variety of factors in addition to those described above, including:

changes in the timing 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;
customer adoption of new technologies or manufacturing processes requiring use of our equipment;
timing of new application design wins; 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 increased demand requirements, adversely impacting our ability to fulfill orders and win business with our customers.
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

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interruption in the receipt of inventory, customer prioritization or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations.
Charges for Excess or Obsolete Inventory
One factor on which we compete is the ability to ship products on schedules required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine inventory to be purchased. We also order materials based on our technology roadmap, which represents management’s assessment of technology that will be utilized in new products that we develop. Certain types of inventory, including lasers and optical equipment, are particularly expensive and may only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which would negatively affect our financial results. Also, if we alter our technology or product development strategy, we may have inventory that may not be usable under the new strategy, which may also result in material accounting charges. For example, during 2013, we recorded $21.0 million of charges in cost of sales for an inventory write-off associated 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, which is effective for the 2013 calendar year and requires a disclosure report to be filed by May 31, 2014, 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 90% of net sales in 2013 , with 85% 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 and China, 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
difficulty in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.

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

future tightening of immigration controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities or our ability to hire new non-U.S. employees in such facilities;
more frequent instances of shipping delays;
demand for our products may not increase or may decrease; and
our customers or suppliers may experience financial difficulties or cease operations.
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. There is no assurance we will be able to satisfy these requirements. Failure to meet such requirements may lead to reduction in future benefits.
Implementation and Modification of Globalization Strategy
We are implementing our globalization strategy in which we are moving certain operational resources and capabilities to different countries in Asia to be closer to many of our significant customers and to reduce costs. We believe this strategy will enhance customer relationships, improve our responsiveness, and reduce our manufacturing costs for certain products. We opened a manufacturing facility in Singapore in the fourth quarter of 2010, which manufactures certain IMG, LED, CG and laser ablation products and is now our primary system manufacturing facility. Additionally, we have a manufacturing facility in Beijing China, which manufactures certain laser products.
Our globalization strategy is subject to a variety of complexities and risks, many of which we have little experience managing, and which may divert a substantial amount of management’s time. These risks include:

challenges in designing new facilities that can be scaled for future expansion, replicating current processes and bringing new facilities up to full operation;
unpredictable costs, redundancy costs and cost overruns for developing new facilities and acquiring equipment;
building local management teams, technical personnel and other staff for functions that we have not previously conducted outside of the United States;
technical obstacles such as poor production or process yield and loss of quality control during the ramp of a new facility;
re-qualifications and other procedures that may be required by our customers;
our ability to bring up local suppliers to meet our quality and cycle-time needs;
our ability to reduce costs in the United States as we add costs in Asia;
rapidly changing business conditions that may require plans to be changed or abandoned before they are fully implemented; and
challenges posed by distance and by differences in language and culture.
These and other factors could delay the development and implementation of our strategy, as well as impair our gross margins, delay shipments and deliveries, cause us to lose sales, require us to write off investments already made, damage our reputation and harm our business, financial condition and results of operations. If we decide to change our current globalization strategy, we may incur charges for certain costs incurred.
Acquisitions and Divestitures
We may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies, such as our June 2012 acquisition of Eolite Systems and our May 2013 acquisition of the assets 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 the personnel, operations, technologies and products of the acquired businesses;
implementation of our enterprise resource planning (ERP) system into the acquired company’s operations;
diversion of management’s attention from other operational matters;

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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.
Furthermore, the accounting for an acquisition could result in significant charges resulting from amortization or write-off of intangible assets we acquire. Our inability to effectively manage these risks could result in our inability to realize the anticipated benefits of an acquisition on a timely basis, or at all, and materially and adversely affect our business, financial condition and results of operations. In addition, all acquisition transaction costs must be expensed as incurred rather than capitalized, which may have a material adverse effect on our results of operations.
The means by which we finance an acquisition may also significantly affect our business or the value of the shares of our common stock. If we issue common stock to pay for an acquisition, the ownership percentage of our existing shareholders will be diluted and the value of the shares held by our existing shareholders could be reduced. If we use cash on hand to pay for an acquisition, the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. If we borrow funds in connection with an acquisition, we would be required to use cash to service the debt and to comply with financial and other covenants.
We may from time to time also make strategic investments in development stage companies. Investments in development stage companies are subject to a high degree of risk. We could lose all or a portion of our investment in any such company or could be required to recognize an impairment charge with respect to our investment, as we did in the second quarter of 2014 regarding our investment in OmniGuide, Inc.
Hiring and Retention of Personnel
Our continued success depends in part upon the services of our key managerial, financial and technical personnel. The loss of key personnel, or our inability to attract, assimilate and retain qualified personnel, could result in the loss of customers, inhibit our ability to operate and grow our business and otherwise have a material adverse effect on our business and results of operations. We have previously had to, and may in the future have to, impose salary reductions on employees during economic downturns in an effort to maintain our financial position. These actions may have an adverse effect on employee loyalty and may make it more difficult for us to attract and retain key personnel. Competition for qualified personnel in the industries in which we compete is intense, and we may not be successful in attracting and retaining qualified personnel. We may incur significant costs in our efforts to recruit and retain key personnel, which could affect our financial position and results of operations.
Risks Related to Technology
Markets Characterized by Rapid Technological Change
The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes and the requirements of current and potential customers. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. The introduction by us or by our competitors of new or enhanced products, or alternative technologies, may cause our customers to defer, change or cancel orders for our existing products or cease purchasing our products altogether. For example, our semiconductor memory customers are exploring alternative redundancy technologies such as electrical redundancy technology. We believe our historical semiconductor memory customers are converting these technologies into their manufacturing process for newer products, thereby materially reducing the size of the addressable market of our memory yield improvement systems. Further, we cannot assure that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technology changes or emerging industry standards. If we are unable to develop new or enhanced products to address product or technology changes or new industry standards on a timely basis or at all, or if our new or enhanced products are not accepted by the market, or if our customers adopt alternative technologies, our business, financial condition and results of operations may be adversely affected.

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Need to Invest in Research and Development
Our industry is characterized by the need for continued investment in research and development. Because of intense competition in the industries in which we compete, if we were to fail to invest sufficiently in research and development, our products could become less attractive to our current and potential customers or obsolete, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area, our operating results could be materially harmed if our net sales decline. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales.
Products are Highly Complex
Our products are highly complex, and our extensive product development, manufacturing and testing processes may not be adequate to detect all defects, errors, failures and quality issues that could impact customer satisfaction or result in claims against us. As a result, we may have to replace certain components or provide remediation in response to the discovery of defects in products after they are shipped. The occurrence of any defects, errors, failures or quality issues could result in cancellation of orders, product returns, diversion of our resources, legal actions by our customers and other losses to us or to our customers. These occurrences could also result in the loss of, or delay in, market acceptance of our products, loss of sales and increased expenses and warranty costs, which would harm our business and adversely affect our revenues and profitability.
Risks Related to Legal Matters
Protection of Proprietary Rights – Generally
Our success depends significantly upon the protection of our proprietary rights. We attempt to protect our proprietary rights through patents, copyrights, trademarks, maintenance of trade secrets and other measures, including entering into confidentiality agreements. We incur substantial costs to obtain and maintain patents and to defend our intellectual property rights. We rely upon the laws of the United States and foreign countries where we develop, manufacture or sell our products to protect our proprietary rights. We may not be successful in protecting these proprietary rights, these rights may not provide the competitive advantages that we expect, or other parties may challenge, invalidate or circumvent these rights.
Protection of Proprietary Rights – Foreign Jurisdictions
Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. Many United States companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins.
Intellectual Property Infringement Claims
Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. While we attempt in our designs to avoid patent infringement, from time to time we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. Competitors or others have in the past and may in the future assert infringement claims against our customers or us with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.
If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.
Tax Audits and Changes in Tax Law
We are periodically under audit by United States and foreign tax authorities and may have exposure to additional tax liabilities as a result. Significant judgment is required in determining our provision for income and other tax liabilities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and the impact of changes in tax laws or the