Electro Scientific Industries, Inc.
ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 11/09/2016 06:02:16)
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 October 1, 2016
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 November 4, 2016 was 32,464,117 shares.
 


Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
2017 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)
October 1, 2016
 
April 2, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
52,685

 
$
42,413

Short-term investments
3,500

 
15,252

Trade receivables, net of allowances of $879 and $1,039
29,744

 
42,770

Inventories, net
61,895

 
60,470

Shipped systems pending acceptance
3,893

 
1,181

Other current assets
5,547

 
5,340

Total current assets
157,264

 
167,426

Non-current assets:
 
 
 
Property, plant and equipment, net of accumulated depreciation of $110,437 and $107,910, (PP&E)
24,581

 
24,543

Non-current deferred income taxes, net
884

 
914

12,652

 
7,445

Acquired intangible assets, net of accumulated amortization of $21,702 and $21,146
6,589

 
7,146

Other assets
15,448

 
12,626

Total assets
$
217,418

 
$
220,100

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
13,611

 
$
16,061

Accrued liabilities
17,170

 
18,334

Deferred revenue
10,951

 
6,373

Total current liabilities
41,732

 
40,768

Non-current liabilities:
 
 
 
Income taxes payable
1,360

 
1,266

Deferred income tax liability, net
226

 
234

Other liabilities
6,529

 
7,801

Total liabilities
49,847

 
50,069

Commitments and contingencies (See Note 13 "Commitments & Contingencies" )


 


Shareholders’ equity:
 
 
 
Preferred stock, without par value; 1,000 shares authorized; no shares issued

 

Common stock, without par value; 100,000 shares authorized; 32,966 and 31,613 issued and outstanding
202,493

 
195,024

Accumulated deficit
(33,792
)
 
(23,998
)
Accumulated other comprehensive loss
(1,130
)
 
(995
)
Total shareholders’ equity
167,571

 
170,031

Total liabilities and shareholders’ equity
$
217,418

 
$
220,100

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


3

Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share amounts)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Net sales:
 
 
 
 
 
 
 
Systems
$
21,442

 
$
35,570

 
$
59,642

 
$
67,632

Services
8,216

 
10,902

 
17,684

 
21,931

Total net sales
29,658

 
46,472

 
77,326

 
89,563

Cost of sales:
 
 
 
 
 
 
 
Systems
14,146

 
22,345

 
36,568

 
43,630

Services
4,532

 
5,706

 
8,970

 
12,135

Total cost of sales
18,678

 
28,051

 
45,538

 
55,765

Gross profit
10,980

 
18,421

 
31,788

 
33,798

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
12,766

 
12,534

 
25,637

 
25,151

Research, development and engineering
7,760

 
8,283

 
15,390

 
16,928

Acquisition and integration costs
335

 
40

 
335

 
194

Restructuring costs

 
591

 

 
653

Net operating expenses
20,861

 
21,448

 
41,362

 
42,926

Operating loss
(9,881
)
 
(3,027
)
 
(9,574
)
 
(9,128
)
Non-operating income:
 
 
 
 
 
 
 
Interest and other income, net
206

 
6

 
128

 
1

Total non-operating income
206

 
6

 
128

 
1

Loss before income taxes
(9,675
)
 
(3,021
)
 
(9,446
)
 
(9,127
)
Provision for income taxes

 
239

 
347

 
497

Net loss
$
(9,675
)
 
$
(3,260
)
 
$
(9,793
)
 
$
(9,624
)
Net loss per share - basic
$
(0.30
)
 
$
(0.10
)
 
$
(0.30
)
 
$
(0.31
)
Net loss per share - diluted
$
(0.30
)
 
$
(0.10
)
 
$
(0.30
)
 
$
(0.31
)
Weighted average number of shares - basic
32,396

 
31,384

 
32,109

 
31,280

Weighted average number of shares - diluted
32,396

 
31,384

 
32,109

 
31,280

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 COMPREHENSIVE LOSS
(Unaudited)

 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Net loss
$
(9,675
)
 
$
(3,260
)
 
$
(9,793
)
 
$
(9,624
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $0, $17, $0 and $0
47

 
(756
)
 
(139
)
 
(725
)
Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $2, $(2), $(2) and $(4)
5

 
4

 
9

 
8

Net unrealized loss on available-for-sale securities, net of taxes of $0, $0, $0 and $0
(1
)
 
(1
)
 
(4
)
 
(1
)
Other comprehensive income (loss):
51

 
$
(753
)
 
$
(134
)
 
$
(718
)
Comprehensive loss
$
(9,624
)
 
$
(4,013
)
 
$
(9,927
)
 
$
(10,342
)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

5

Table of Contents

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(9,793
)
 
$
(9,624
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
3,592

 
3,803

Amortization of acquired intangible assets
554

 
725

Share-based compensation expense
3,136

 
2,626

Loss on disposition of property and equipment, net
40

 
6

(Benefit from) provision for doubtful accounts
(235
)
 
127

Charges for write-off of damaged product
1,170

 

Decrease in deferred income taxes
87

 
106

Changes in operating accounts, net of acquisitions:

 

Decrease (increase) in trade receivables, net
13,373

 
(3,953
)
Increase in inventories
(3,669
)
 
(2,668
)
(Increase) decrease in shipped systems pending acceptance
(2,712
)
 
17

(Increase) decrease in other current assets
(43
)
 
2,736

(Decrease) increase in accounts payable and accrued liabilities
(6,100
)
 
10,308

Increase in deferred revenue
4,577

 
286

Net cash provided by operating activities
3,977

 
4,495

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(228,921
)
 
(261,978
)
Proceeds from sales and maturities of investments
240,209

 
251,982

Purchase of property, plant and equipment
(2,710
)
 
(2,185
)
Proceeds from sale of property, plant and equipment
7

 

Cash paid for business acquisitions, net of cash acquired
(2,010
)
 

(Increase) decrease in other assets
(71
)
 
386

Net cash provided by (used in) investing activities
6,504

 
(11,795
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Payment of withholding taxes on stock-based compensation
(793
)
 
(603
)
Proceeds from issuance of common stock
654

 
737

Net cash (used in) provided by financing activities
(139
)
 
134

Effect of exchange rate changes on cash
(70
)
 
(186
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
10,272

 
(7,352
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
42,413

 
50,994

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
52,685

 
$
43,642

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for interest
$
(25
)
 
$
(57
)
Cash paid for income taxes
(251
)
 
(478
)
Income tax refunds received
6

 
110

Net increase in PP&E and other assets related to transfers from inventory
3,128

 
622

Non-cash additions to property, plant and equipment
270

 
227

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

6

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 United States generally accepted accounting principles ("U.S. GAAP") have been condensed or omitted in these interim statements. Accordingly, these condensed consolidated financial statements are to be read in conjunction with the financial statements and notes included in the Company's Annual Report on Form 10-K for its fiscal year ended April 2, 2016 . 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 U.S. GAAP 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; purchase price accounting; valuation of long-lived assets; valuation of goodwill; and valuation of acquired technology.
Except for the added policy below, there have been no significant changes to the Company's significant accounting policies from those presented in Note 2 “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company's Annual Report on Form 10-K for its fiscal year ended April 2, 2016 . All references to years or quarters relate to fiscal years or fiscal quarters unless otherwise noted. The fiscal quarters ended October 1, 2016 and September 26, 2015 consisted of 13-week periods while the two fiscal quarters ended October 1, 2016 and September 26, 2015 consisted of 26-week periods.
Acquisition Accounting
The fair value of the consideration exchanged in an acquisition is allocated to tangible assets and identifiable intangible assets acquired and liabilities assumed at acquisition date fair value. Goodwill is measured as the excess of the consideration transferred over the net fair value of identifiable assets acquired and liabilities assumed. The accounting for an acquisition involves a considerable amount of judgment and estimation. Cost, income, market or a combination of approaches may be used to establish the fair value of consideration exchanged, assets acquired and liabilities assumed, depending on the nature of those items. The valuation approach is determined in accordance with generally accepted valuation methods or other generally accepted methods. Key areas of estimation and judgment may include projections of future performance, cost of capital, market characteristics, cost structure, impacts of synergies, and estimates of terminal value, among others.
While the Company uses best estimates and assumptions as part of the purchase price allocation process to estimate the value of assets acquired and liabilities assumed, estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with a corresponding offset to goodwill, to the extent that adjustments are identified to the preliminary purchase price allocation. Upon conclusion of the measurement period, or final determination of the value of the assets acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to results from operations. Refer to Note 5, “Business Acquisitions” of Notes to Condensed Consolidated Financial Statements for further discussion of purchase accounting, valuation methodology and assumptions.  
2. Recent Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments, which will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. We elected to early adopt ASU 2016-15 and it did not have any effect on our cash flows.

7


In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date for implementation of ASU 2014-09 by one year and are now effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted but not earlier than the original effective date. In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08), which clarifies the implementation guidance of principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing (ASU 2016-10), which clarifies the identification of performance obligations and licensing implementation guidance. In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients (ASU 2016-12), to improve guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. The effective date and transition requirements in ASU 2016-08, ASU 2016-10, and ASU 2016-12 are the same as the effective date and transition requirements of ASU 2015-14. We have not yet selected a transition method and we are currently evaluating the effect that the updated standards will have on our consolidated financial statements and related disclosures. The new standards are effective for the Company's fiscal year ending March 30, 2019.
In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation – Improvements to Employee Share-Based Payment Accounting.” ASU 2016-09 simplifies the accounting for several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, which would be the Company's fiscal year ending March 31, 2018. While we do not expect the adoption of ASU 2016-09 to have a material effect on our business, we are still evaluating any potential impact that adoption of ASU 2016-09 may have on our financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases.” ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018 and interim periods within those annual periods, which would be the Company's fiscal year ending March 29, 2020. While we do not expect the adoption of ASU 2016-02 to have a material effect on our business, we are still evaluating any potential impact that adoption of ASU 2016-02 may have on our financial position, results of operations or cash flows.
3. Share-Based Compensation
The Company's share-based compensation consists of stock-settled stock appreciation rights (SARs), restricted stock unit awards with a service condition (time-based RSUs), restricted stock unit awards with a performance condition (performance-based RSUs), restricted stock unit awards with a market condition (market-based RSUs) and an employee stock purchase plan.
The Company recognizes expense related to the fair value of SARs and employee stock purchase plan using the Black-Scholes model to estimate the fair value of awards on the date of grant. 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 fair value of time-based RSUs and performance-based RSUs are measured on the grant date based on the market value of our common stock. The market-based RSUs must achieve the total shareholder return (TSR) measures in order for the awards to vest, and the grant date fair value of the awards is calculated using a Monte Carlo simulation model.
The Company recognizes compensation expense for all share-based compensation awards, net of estimated forfeitures, on a straight-line basis over the requisite service period of the award. Expense for performance-based RSUs is recognized based on the probability of achievement of the performance criteria. The compensation cost for market-based RSUs that reference a TSR measure is recognized over the related service period, even if the market condition is never satisfied.
The Company granted a total of 709,000 time-based RSUs, 195,000 market-based RSUs and 90,000 performance-based RSUs during the first two quarters of 2017 , but did not grant any SARs. Grants for the second quarter of 2017 included 152,000 time-based RSUs and 90,000 performance-based RSUs granted to the employees of the Company who were hired as a part of the Visicon acquisition.

8


Share-based compensation expense under the stock incentive plans is included in the Company’s Condensed Consolidated Statements of Operations as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Cost of sales
$
136

 
$
114

 
$
256

 
$
243

Selling, general and administrative
1,205

 
746

 
2,182

 
1,461

Research, development and engineering
177

 
206

 
371

 
425

Total share-based compensation expense
$
1,518

 
$
1,066

 
$
2,809

 
$
2,129

The Company does not capitalize share-based compensation costs. As of October 1, 2016 , the Company had $9.7 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 and Liabilities 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 for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of October 1, 2016 and April 2, 2016 was as follows (in thousands):
October 1, 2016
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
3,638

 
$

 
$

 
$
3,638

Commercial paper

 
23,388

 

 
23,388

Total cash equivalents
$
3,638

 
$
23,388

 
$

 
$
27,026

Short term investments - available for sale:
 
 
 
 
 
 
 
U.S. treasury fund
$
1,003

 
$

 
$

 
$
1,003

Commercial paper
$

 
$
1,495

 
$

 
$
1,495

Government agencies
$

 
$
1,002

 
$

 
$
1,002

Total short-term investments - available for sale
$
1,003

 
$
2,497

 
$

 
$
3,500

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen
$

 
$
(21
)
 
$

 
$
(21
)
New Taiwan Dollar

 
(2
)
 

 
(2
)
Korean Won

 
(2
)
 

 
(2
)
Euro

 
(82
)
 

 
(82
)
British Pound

 
(12
)
 

 
(12
)
Chinese Renminbi

 

 

 

Singapore Dollar

 
(1
)
 

 
(1
)
Total forward contracts
$

 
$
(120
)
 
$

 
$
(120
)
 
 
 
 
 
 
 
 
Deferred compensation plan assets:*
 
 
 
 
 
 
 
Mutual funds and exchange traded funds
$
2,176

 
$

 
$

 
$
2,176

Money market securities
787

 

 

 
787

Total deferred compensation plan assets
$
2,963

 
$

 
$

 
$
2,963


9


April 2, 2016
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
4,643

 
$

 
$

 
$
4,643

Commercial paper

 
12,140

 

 
12,140

Total cash equivalents
$
4,643

 
$
12,140

 
$

 
$
16,783

Short term investments - available for sale:
 
 
 
 
 
 
 
U.S. treasury fund
$
1,003

 
$

 
$

 
$
1,003

Commercial paper
$

 
$
997

 
$

 
$
997

Government agencies

 
13,252

 

 
13,252

Total short-term investments - available for sale
$
1,003

 
$
14,249

 
$

 
$
15,252

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen
$

 
$
(31
)
 
$

 
$
(31
)
New Taiwan Dollar

 
5

 

 
5

Korean Won

 
129

 

 
129

Euro

 
(367
)
 

 
(367
)
Chinese Renminbi

 
(1
)
 

 
(1
)
Singapore Dollar

 
20

 

 
20

Total forward contracts
$

 
$
(245
)
 
$

 
$
(245
)
 
 
 
 
 
 
 
 
Deferred compensation plan assets:*
 
 
 
 
 
 
 
Mutual funds and exchange traded funds
$
1,916

 
$

 
$

 
$
1,916

Money market securities
588

 

 

 
588

Total deferred compensation plan assets
$
2,504

 
$

 
$

 
$
2,504

*These investments represent assets held in trust for the deferred compensation plan
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 October 1, 2016 and April 2, 2016 were utilized to calculate fair values.
During the first two quarters of 2017 and 2016 , there were no transfers between Level 1, 2 or 3 assets.

10


Investments
The Company’s investments at October 1, 2016 and April 2, 2016 were as follows (in thousands):  
 
 
 
Unrealized
 
 
October 1, 2016
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Government agencies
1,001

 
1

 

 
1,002

Commercial paper
24,883

 

 

 
24,883

Total investments (current)
$
25,884

 
$
1

 
$

 
$
25,885

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Mutual funds, exchange traded funds and money market securities*
2,874

 
89

 

 
2,963

Total investments (non-current)
$
2,874

 
$
89

 
$

 
$
2,963

 
 
 
 
 
 
 
 
 
 
 
Unrealized
 
 
April 2, 2016
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Commercial paper
$
13,137

 
$

 
$

 
$
13,137

Government agencies
13,247

 
5

 

 
13,252

Total investments (current)
$
26,384

 
$
5

 
$

 
$
26,389

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Mutual funds, exchange traded funds and money market securities*
$
2,507

 
$

 
$
(3
)
 
$
2,504

Total investments (non-current)
$
2,507

 
$

 
$
(3
)
 
$
2,504

*These investments represent assets held in trust for the deferred compensation plan
For purposes of determining gross realized gains and losses and reclassification out of accumulated other comprehensive income (loss), the cost of securities sold is based on specific identification. Net unrealized holding gains and losses on current available-for-sale securities included in accumulated other comprehensive income (loss) were insignificant as of October 1, 2016 and April 2, 2016 .
5. Business Acquisitions
Fiscal 2017
On August 1, 2016, the Company acquired all of the outstanding shares of Visicon Technologies, Inc. (Visicon), a leading supplier of high-accuracy and high-throughput measurement and defect detection systems based in Napa, California. The consideration under the merger agreement is subject to adjustment for indebtedness, seller's transaction expenses, working capital and other items.
Based on estimated closing working capital and other adjustments, ESI paid $2.0 million in cash and expects to issue 637,082 shares of ESI common stock, valued at approximately $4.5 million . The value of the common stock is based on the closing price of stock on August 1, 2016. Of the expected shares to be issued in connection with the agreement, 33,143 shares are expected to be reserved in escrow to serve as a source of payment for any purchase price adjustments or indemnity claims by the Company. The sellers have contractually agreed to limitations on the sale of the shares of common stock they receive in connection with the sale of Visicon; specifically, no shares can be sold for six months following closing, after which point twenty five percent of the shares each stockholder receives can be sold in each of the following four three-month periods. The shares issued as a part of this merger represent a non-cash investing activity of $4.5 million .

11


As of the reporting date, the Company has not completed the valuation of assets acquired and liabilities assumed. The amounts presented below represent provisional amounts based on best estimates utilizing information available to-date. In the absence of better information, amounts presented represent the carrying value of the item as of the acquisition date. These provisional amounts will be revised when the value of the associated assets and liabilities is determined. The total estimated purchase price of $6.5 million , net of cash acquired, was allocated to the underlying assets acquired and liabilities assumed based on estimated fair value, as shown in the following table:
(In thousands)
 
Accounts receivable
$
391

Inventory
2,056

Prepaid expense and other current assets
116

Property, plant and equipment
642

Acquired intangibles and goodwill*
5,207

Other assets
26

Accounts payable and other accrued liabilities
(1,952
)
Total purchase price, net of cash acquired
$
6,486

*Acquired intangibles and goodwill are combined above and are both included in Goodwill on the Condensed Consolidated Balance Sheets as the Company has not yet completed its estimation of fair value of intangibles acquired. Upon completion of the valuation process, these amounts will be presented separately.
The acquisition is expected to provide the Company with a portfolio of standalone defect detection systems for the medical device and consumer electronics markets. In addition to a standalone product portfolio and associated value streams, the Company believes the acquisition will provide complementary technology for integrated verification of laser machining, expand its presence into the medical device market, present an opportunity for enhanced vertical integration and result in synergies with the Company's current consumer electronics customer base. Products acquired in the Visicon acquisition are included in the Micromachining segment due to the complementary nature of the sale process and customer base. The value of goodwill acquired has not been finalized as the valuation of assets acquired and liabilities assumed is not complete, as noted above. None of the goodwill is expected to be deductible for tax purposes.
In connection with the acquisition of Visicon, the Company is consolidating Visicon operations with ESI operations, and streamlining manufacturing and development activities between Napa and existing ESI locations. The Company expects to incur total costs approximating $1.2 million in connection with these integration activities. Approximately $0.5 million in integration costs were incurred in the second quarter of 2017 . These costs are included in Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations, and include transaction fees, travel costs, employee severance and other related costs.
The operating results of the acquired entity 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 Visicon as it is not material to the Company’s operations and financial position.
Fiscal 2015
On January 15, 2015, the Company acquired all of the outstanding shares of Wuhan Topwin Optoelectronics Technology Co., Ltd. (Topwin), a Chinese manufacturer of laser-based systems for $7.6 million in cash and 748,944 shares of ESI common stock issuable over a three year period, valued at approximately $2.9 million as of the acquisition date. Out of the $2.9 million in equity, one-half, or 374,472 shares, is contingent-based consideration and one-half, or 374,472 shares, is non-contingent and will be issued over a three year period beginning June 30, 2015. The contingent consideration is based on future performance of Topwin, as evaluated against targets for net income for each year over a three year period. One-third of the contingent shares will be issued after each year if the target is met for that year. However, failing to meet stated targets will result in none of the contingent shares being issued for that year. As of the acquisition date, the fair value of 374,472 shares of contingent consideration was estimated to be $0.4 million and the fair value of 374,472 shares of non-contingent consideration was estimated to be $2.5 million . The fair value of the non-contingent and contingent shares to be issued over the three year period was determined based on the estimated share price as of the issuance date derived through Monte Carlo simulation, discounted back to the acquisition date. The value of the contingent shares included an estimate of the probability of attainment of the net income targets. 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. Through the second quarter of 2017 , zero and 212,217 shares of ESI common stock have been issued in connection with contingent and non-contingent consideration under the purchase agreement, respectively.

12


Additionally, the Company agreed to issue, on the same terms described above, up to approximately 513,328 shares valued at $2.0 million , which, together with cash amounts of $0.2 million , is treated as compensation to an employee in the Company who was also a former shareholder of Topwin. The compensation expense was to be recognized over a three year period. From acquisition through the second quarter of fiscal 2017 , the Company has recognized $1.2 million in share-based compensation expense related to this agreement. From acquisition through the second quarter of fiscal 2017 , zero and 145,427 shares of ESI common stock have been issued in connection with contingent and non-contingent components of compensation expense, respectively.
The total purchase price of approximately $10.5 million , net of cash acquired, was allocated to the underlying assets acquired and liabilities assumed based on their fair values, as shown in the following table:
(In thousands)
 
Accounts receivable, net of allowances of $268
$
454

Inventory
544

Prepaid expense and other current assets
295

Property, plant and equipment
23

Acquired intangibles
3,618

Goodwill
7,445

Accounts payable and other accrued liabilities
(1,859
)
Total purchase price, net of cash acquired
$
10,520

The acquisition is expected to enable the Company to gain entry into the low total-cost-of-ownership solutions market in China and the goodwill of approximately $7.4 million recognized as a result of the acquisition was assigned to the Topwin reporting unit. The premium paid over the fair value of the individual assets acquired and liabilities assumed reflects the Company’s view that this acquisition was the result of a competitive bid process and has provided the Company with innovative design and manufacturing capabilities for laser-based manufacturing solutions across a variety of complementary applications, together with direct access to local China market, supply chain and opto-electronics knowledge center. None of the goodwill is expected to be deductible for tax purposes.
As a result of the acquisition, the Company recorded approximately $4.9 million of identifiable assets, including $3.6 million of identifiable intangible assets and $1.9 million of identifiable liabilities. The acquired intangible assets consisted primarily of $3.5 million of developed technology to be amortized over their useful lives, which range from one to ten years.
In the first two quarters of 2017 the Company did not incur any Topwin acquisition-related costs while it incurred approximately $194 thousand in the first two quarters of 2016 ; these costs are included in Selling, general and administrative 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 Topwin as it is not material to the Company’s operations and overall financial position.
In the first quarter of 2017, the Company entered into an agreement with former Topwin shareholders to settle claims against withheld shares. Pursuant to the purchase agreement and the subsequent settlement agreement, the Company’s obligation to issue shares with a future issuance date, which served as a source of indemnification, was terminated, representing the effective recovery of 63,114 shares. At the date of recovery the shares had a closing price of $6.30 per share and an original fair value of $446 thousand . As a result, the withheld shares which were initially accounted for as stock compensation were deemed to have forfeited in the first quarter of 2017 and those shares representing contingent consideration and included as a component of purchase price were accounted for within equity. This subsequent recovery of shares issuable under the agreement represented a non-cash investing and financing activity.
In the second quarter of 2017, as a result of this same settlement agreement, all cash amounts held in escrow were released to the Company, representing the recovery of $430 thousand , slightly less than the original cash escrow of $450 thousand due to exchange rate losses. As a result of this recovery, amounts previously recognized as compensation costs were reversed in the current period and those amounts included as a component of purchase price were recognized as a non-operating gain in the second quarter of 2017, and classified accordingly on the statement of cash flows. The purchase price of Topwin was not adjusted for either the stock or cash escrow recoveries as the measurement period for purchase price accounting related to this acquisition had lapsed prior to the recovery of these amounts.

13



6. Inventories
Inventories are principally valued at standard cost, which approximates the lower of cost or market on a first-in, first-out basis. Components of inventories were as follows:
(In thousands)
October 1, 2016
 
April 2, 2016
Raw materials and purchased parts
$
42,186

 
$
38,957

Work-in-process
13,303

 
14,270

Finished goods
6,406

 
7,243

 
$
61,895

 
$
60,470

7. Trade Accounts Receivable
Trade accounts receivable consisted of the following:
(In thousands)
October 1, 2016
 
April 2, 2016
Current trade accounts receivable, net
$
29,744

 
$
42,770

Non-current trade accounts receivable
134

 
320

 
$
29,878

 
$
43,090

Non-current trade accounts receivable are included in Other assets in the Condensed Consolidated Balance Sheets.
8. Other Current Assets
Other current assets consisted of the following:
(In thousands)
October 1, 2016
 
April 2, 2016
Prepaid expenses
$
3,072

 
$
2,747

Value added tax receivable
1,485

 
1,353

Other
990

 
1,240

 
$
5,547

 
$
5,340

Included in "Other" Other current assets are non-trade receivables, income tax refund receivable and other similar items.
9. Other Assets
Other assets consisted of the following:
(In thousands)
October 1, 2016
 
April 2, 2016
Consignment and demo equipment, net
$
9,510

 
$
7,242

Long term deposits
2,734

 
2,543

Non-current trade accounts receivable, net
134

 
320

Other non-current assets
3,070

 
2,521

 
$
15,448

 
$
12,626

Depreciation expense for demo and leased equipment totaled $0.1 million in the second quarters of 2017 and 2016 and $0.2 million for the two fiscal quarters ended October 1, 2016 and September 26, 2015 .
Included in "Other" Other assets are long-term investments and other similar items.

14


10. Accrued Liabilities (Current) & Other Liabilities (Non-current)
Accrued liabilities (current) consisted of the following:
(In thousands)
October 1, 2016
 
April 2, 2016
Payroll-related liabilities
$
5,064

 
$
5,717

Product warranty accrual
4,551

 
3,666

Customer deposits
2,284

 
1,731

Purchase order commitments and receipts
1,279

 
2,588

Professional fees payable
953

 
1,052

Restructuring costs payable
675

 
757

Other current liabilities
2,364

 
2,823

 
$
17,170

 
$
18,334

Included in other current liabilities above are accrued amounts for value-added taxes, income taxes, freight, and other similar items.
Other liabilities (non-current) consisted of the following:
(In thousands)
October 1, 2016
 
April 2, 2016
Deferred compensation
$
2,963

 
$
2,504

Product warranty accrual
970

 
2,068

Other non-current liabilities
2,596

 
3,229

 
$
6,529

 
$
7,801

Other non-current liabilities include long-term deferred revenue, long-term deposits and other similar items.
11. Product Warranty
The following is a reconciliation of the changes in the aggregate product warranty accrual:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Product warranty accrual, beginning
$
5,947

 
$
4,021

 
$
5,734

 
$
3,342

Warranty charges incurred, net
(1,263
)
 
(2,063
)
 
(3,314
)
 
(3,547
)
Provision for warranty charges
837

 
2,493

 
3,101

 
4,656

Product warranty accrual, ending
$
5,521

 
$
4,451

 
$
5,521

 
$
4,451

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. Of the total of $5.5 million in product warranty accrual at October 1, 2016 , $1.0 million is non-current and is included in Other liabilities on the Condensed Consolidated Balance Sheets.
12. Deferred Revenue

Generally, revenue is recognized upon fulfillment of acceptance criteria at the Company's factory and transfer of risk and title. Revenue is deferred whenever title transfer is pending, risk has not transferred, and/or acceptance criteria have not yet been fulfilled. Deferred revenue arises from, among other factors, sales to Japanese customers, shipments of substantially new products and shipments with custom specifications and acceptance criteria where the Company cannot demonstrate a track record of acceptance. For sales involving multiple element arrangements, the relative selling price of any undelivered elements, including installation services and similar items, 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.

15


The following is a reconciliation of the changes in deferred revenue:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Deferred revenue, beginning
$
9,757

 
$
14,961

 
$
7,685

 
$
12,376

Revenue deferred
9,119

 
17,871

 
19,472

 
33,591

Revenue recognized
(7,293
)
 
(20,170
)
 
(15,574
)
 
(33,305
)
Deferred revenue, ending
$
11,583

 
$
12,662

 
$
11,583

 
$
12,662

Of the total of $11.6 million in deferred revenue at October 1, 2016 , $0.6 million is non-current and is included in Other liabilities on the Condensed Consolidated Balance Sheets.
13. Commitments & Contingencies
The Company is party to a loan and security agreement ("Loan Agreement") with Silicon Valley Bank, which was initially entered into on March 20, 2015 and amended on July 12, 2016. The Loan Agreement provides for a senior secured asset-based revolving credit facility (the “Credit Facility”) with up to $30 million available on a revolving basis, including a $15 million sublimit for letters of credit. The credit agreement expires March 20, 2018. At October 1, 2016 , the Company had no revolving loans or letters of credit outstanding under the Credit Facility, was in compliance with all covenants, and was not in default under the Loan Agreement. The commitment fee on the amount of unused credit was 0.3 percent.
The Company mitigates credit risk by transacting with highly rated counterparties for foreign exchange contracts, letters of credit and other transactions where counterparty risk is a factor. The Company has evaluated the non-performance risks associated with the Company's lenders and other parties and believe them to be insignificant.
From time to time the Company may be party to litigation arising in the normal course of business. Currently, the Company is not party to any litigation it believes would have a material adverse effect on the Company's financial position, results of operations or cash flows.
14. Earnings (Loss) Per Share
The following is a reconciliation of weighted average shares outstanding used in the calculation of basic and diluted earnings (loss) per share:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands, except per share data)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Net loss
$
(9,675
)
 
$
(3,260
)
 
$
(9,793
)
 
$
(9,624
)
Weighted average shares used for basic earnings per share
32,396

 
31,384

 
32,109

 
31,280

Weighted average shares used for diluted earnings per share
32,396

 
31,384

 
32,109

 
31,280

Net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.30
)
 
$
(0.10
)
 
$
(0.30
)
 
$
(0.31
)
Diluted
$
(0.30
)
 
$
(0.10
)
 
$
(0.30
)
 
$
(0.31
)
Awards of options, SARs and RSUs representing an additional 2.7 million and 3.7 million shares of stock for the second quarter of 2017 and 201 6 , respectively, and 2.4 million and 3.6 million shares of stock for the two fiscal quarters of 2017 and 2016, respectively, were not included in the calculation of diluted net earnings per share because their effect would have been antidilutive.
15. Segment and Geographic Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The chief operating decision maker ("CODM") is the Company's Chief Executive Officer. The Company operates in two segments, Component Processing and Micromachining. Included within Component Processing are interconnect products, semiconductor products and component test products. The interconnect, semiconductor and component test products are sold primarily to manufacturers of electronic components and are used to drill, cut, trim, ablate, test and mark features that improve the yield or functionality of the component. Micromachining products are sold primarily to manufacturers of end devices across multiple industries and are used primarily to drill, cut or mark features on a variety of materials, generally on the casing or external surface of the end device. In addition, micromachining products tend to serve markets that require fewer features, less stringent design requirements, and lower cost. Products acquired in the Visicon acquisition are included in the Micromachining segment due to the complementary nature of the sale process and customer base. The Company uses U.S. GAAP for segment reporting, consistent with the accounting policies of the consolidated entity.
Segment disclosures are presented to the gross profit level as this is the primary performance measure for which the segment management are responsible. Corporate and other charges include amortization of acquired intangible assets, stock-based compensation, restructuring and other costs. Selling, general and administrative and other operating expenses are managed at the functional and corporate levels, and because allocation to the market segments would be arbitrary, have not been allocated to the market segments. See the consolidated statements of operations for reconciliations from gross profit to income before taxes. These reconciling items are not included in the measure of profit and loss for each reportable segment.
In the quarter ended July 2, 2016, we revised the method we use to determine segment gross margin amounts used by the CODM. Previously the profit on the laser (or more specifically, the difference between an estimated third-party purchase price of a similar laser and the cost for the Company to produce these lasers) was associated with only a single segment where the internal lasers were primarily employed or expected to be employed. However, with recent introduction of new products, certain of the Company's internal lasers are now used in both the Component Processing and Micromachining segments. The change in method was made to refine the allocation of profit to the segments given this new dynamic, and to ensure that the margin associated with the use of internal lasers is reflected in the profit of the segment generating the third-party sale. No revisions to segment gross margins were made retrospectively as the changes were deemed immaterial.

16


Net sales by segment were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Component Processing
$
25,739

 
$
32,754

 
$
68,868

 
$
71,038

Micromachining
3,919

 
13,718

 
8,458

 
18,525

 
$
29,658

 
$
46,472

 
$
77,326

 
$
89,563

Gross profits by segment were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Component Processing
$
11,512

 
$
13,387

 
$
33,770

 
$
27,497

Micromachining
(168
)
 
5,473

 
(153
)
 
7,135

Corporate and other
(364
)
 
(439
)
 
(1,829
)
 
(834
)
 
$
10,980

 
$
18,421

 
$
31,788

 
$
33,798

Net sales by geographic area, based on the location of the end user, were as follows:
 
Fiscal quarter ended
 
Two fiscal quarters ended
(In thousands)
October 1, 2016
 
September 26, 2015
 
October 1, 2016
 
September 26, 2015
Asia
$
25,721

 
$
37,029

 
$
66,169

 
$
70,565

Americas
2,236

 
6,805

 
5,254

 
13,161

Europe
1,701

 
2,638

 
5,903

 
5,837

 
$
29,658

 
$
46,472

 
$
77,326

 
$
89,563

16. Restructuring and Cost Management Plans
Chelmsford
In March 2015, as a part of the plan to streamline manufacturing and development activities, the Company initiated a restructuring plan that included the closure of the assembly plant and development center located in Chelmsford, Massachusetts, which was part of the Component Processing segment. The original estimated completion date of the plan was the end of fiscal 2016 at a total estimated pre-tax cost of $ 5.5 million .
There were $297 thousand of restructuring payments related to the above mentioned restructuring plan in the first two quarters of 2017 . Since the inception of the plan, $5.8 million have been recognized in restructuring costs. The plan was effectively complete as of the end of the fourth quarter of 2016. Included in these costs were write-offs of leasehold improvements associated with the abandoned manufacturing facility, employee severance and related payments, and other wind-down costs. The Company expects to pay the remaining costs and accrued expenses related to the leased facility by December 2019, which is the end of the lease term.
At October 1, 2016 and April 2, 2016 , the amount of unpaid restructuring costs included in accrued liabilities for all plans was $0.5 million and $0.8 million , respectively.
The following table presents the amounts related to restructuring costs payable (in thousands):
Restructuring & cost management amounts payable as of April 2, 2016
$
757

Employee severance and related benefits:
 
Cash payments
(297
)
Restructuring & cost management amounts payable as of October 1, 2016
$
460

17. Shareholders’ Equity
Share Repurchase Program
In December 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 during the first two quarters of 2017 or 2016 . There is no fixed completion date for the repurchase program.

17


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”, “projects”, "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 micro-manufacturing solutions for industries reliant on microtechnologies. ESI's integrated solutions allow industrial designers and process engineers to control the power of laser light to transform materials in ways that differentiate their consumer electronics, wearable devices, semiconductor circuits and high-precision components for market advantage. Founded in 1944, ESI is headquartered in Portland, Oregon, with global operations and subsidiaries in Asia, Europe and North America.
Laser microfabrication is comprised of 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 are utilized in the production of consumer electronics, flexible and rigid printed circuit boards, semiconductor devices, advanced semiconductor packaging, electronic sensors, touch-panel glass, flat panel liquid crystal displays (LCDs) and other high value components and devices to enable functionality, increase performance and improve production yields.
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.
In the second quarter of 2017, ESI acquired Visicon Technologies, Inc. (Visicon), which brings a portfolio of standalone defect detection systems for the medical device and consumer electronics markets to ESI’s current product solutions.
The second quarter of 2017 ended October 1, 2016 , the first quarter of 2017 ended July 2, 2016 , and the second quarter of 2016 ended September 26, 2015 were all 13-week periods while the two quarters ended October 1, 2016 and the two quarters ended September 26, 2015 were each 26-week periods.
Summary of Sequential Quarterly Results
Second Quarter 2017 Ended October 1, 2016 Compared to First Quarter 2017 Ended July 2, 2016 .
The financial results for the second quarter of 2017 reflected a continued decline in our order volume with total orders of $28.0 million , compared to $30.4 million in the first quarter of 2017. By segment, orders for Component Processing (CP) decreased approximately 20% primarily due to lower service contracts following strong contract activity in Q1. The decrease in CP was partially offset by an increase in orders for our Micromachining (MM) segment products, primarily driven by increased system orders for our laser ablation products and application wins for our new Garnet TM platform systems.
Total net sales declined from $47.7 million in the first quarter of 2017 to $29.7 million in the second quarter of 2017. CP segment net sales decreased to $25.7 million in the second quarter of 2017 compared to $43.1 million in the first quarter of 2017 , a decrease of $17.4 million, primarily due to lower revenues for our flex interconnect drilling systems. The lower revenues were primarily the result of overcapacity in the flex via drilling market after several quarters of strong technology and capacity buys. Other factors included lower sales of our semiconductor memory repair products offset by increased sales of our wafer trim products and Allegro TM component test products. MM segment net sales decreased to $3.9 million in the second quarter of 2017 from $4.5 million in the first quarter of 2017 due to changes in backlog.
Gross profit was $11.0 million , with gross margins of 37.0% , in the second quarter of 2017 compared to gross profit of $20.8 million , with gross margin of 43.7% , in the first quarter of 2017 . The decline in gross profit and gross margin was driven by lower production volumes and less favorable product mix. These declines were partially offset by lower inventory charges as a result of flood damage in our Wuhan manufacturing facility in the first quarter of 2017.

18

Table of Contents

Operating expenses of $20.9 million in the second quarter of 2017 represent a slight increase from $20.5 million in the first quarter of 2017 . We acquired Visicon during the quarter, and incurred $0.5 million in acquisition related costs. Additionally, the acquisition resulted in approximately $0.8 million in accretive operating expenses during the quarter. Selling, general and administrative (SG&A) expenses increased approximately $0.1 million, primarily due to increases related to the Visicon acquisition, partially offset by a $0.5 million decrease in employee variable compensation and a $0.4 million decrease in commissions on lower sales volumes. Research, development and engineering (RD&E) expenses increased $0.1 million , primarily related to a $0.3 million increase related to Visicon. Other RD&E expenses decreased $0.2 million, primarily due to lower spending on project materials and consulting as NViant TM and CornerStone TM platforms moved to production.
The Company had an operating loss of $9.9 million in the second quarter of 2017 compared to operating income of $0.3 million in the first quarter of 2017 .
The provision for income taxes was zero in the second quarter of 2017 compared to a provision of $0.3 million in the first quarter of 2017 . The change in income taxes was due to a decrease in projected annual income and a corresponding change in mix of income from foreign jurisdictions. In October, 2016, the Company obtained a waiver from the Singapore tax authority, confirming the retention of benefits enjoyed through June 2016.
Net loss was $9.7 million in the second quarter of 2017 compared to net loss of $0.1 million in the first quarter of 2017 .
Second Quarter 2017 Ended October 1, 2016 Compared to Second Quarter 2017 Ended September 26, 2015
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
October 1, 2016
 
September 26, 2015
Net sales
100.0
 %
 
100.0
 %
Cost of sales
63.0

 
60.4

Gross profit
37.0

 
39.6

Selling, general and administrative
43.0

 
27.0

Research, development and engineering
26.2

 
17.8

Acquisition and integration costs
1.1

 
0.1

Restructuring costs

 
1.3

Operating loss
(33.3
)
 
(6.5
)
Interest and other income (expense), net
0.7

 

Total non-operating income (expense)
0.7

 

Loss before income taxes
(32.6
)
 
(6.5
)
Provision for income taxes

 
0.6

Net loss
(32.6
)%
 
(7.0
)%
Net Sales
The following table presents net sales information by product group:
 
Fiscal quarter ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
13,527

 
45.6
%
 
$
21,500

 
46.2
%
Semiconductor Products (SP)
7,222

 
24.4

 
6,763

 
14.6

Component Test Products (CTP)
4,990

 
16.8

 
4,491

 
9.7

 
$
25,739

 
86.8
%
 
$
32,754

 
70.5
%
Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
3,919

 
13.2
%
 
$
13,718

 
29.5
%
Net Sales
$
29,658

 
100.0
%
 
$
46,472

 
100.0
%

19

Table of Contents

Net sales for the second quarter of 2017 decreased $16.8 million or 36.2% from net sales for the second quarter of 2016 . By segment, net sales in CP decreased by 21.4% and MM decreased by 71.4% .
CP segment net sales for the second quarter of 2017 decreased $7.0 million compared to the second quarter of 2016 . The decrease in CP net sales was driven by lower sales of our flex via drilling systems primarily due to overcapacity in the market and a $1.7 million decrease in service sales. Partially offsetting these was an increase in sales of $1.5 million of our wafer trim products and $0.5 million of Component Test Products.
MM segment net sales for the second quarter of 2017 decreased $9.8 million compared to the second quarter of 2016 . The decrease was primarily due to lower follow-on demand for our micromachining systems.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
25,721

 
86.8
%
 
$
37,029

 
79.7
%
Americas
2,236

 
7.5

 
6,805

 
14.6

Europe
1,701

 
5.7

 
2,638

 
5.7

Net Sales
$
29,658

 
100.0
%
 
$
46,472

 
100.0
%
Net sales to Asia decreased by 30.5% or $11.3 million primarily due to decreased placements of flex via drilling products and low follow-on demand for our micromachining systems.
Gross Profit
 
Fiscal quarter ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
11,512

 
44.7
 %
 
$
13,387

 
40.9
 %
Micromachining
(168
)
 
(4.3
)
 
5,473

 
39.9

Corporate and other
(364
)
 
(1.2
)
 
(439
)
 
(0.9
)
Gross Profit
$
10,980

 
37.0
 %
 
$
18,421

 
39.6
 %
Gross profit was $11.0 million for the second quarter of 2017 , a decrease of $7.4 million compared to $18.4 million in the second quarter of 2016 . The gross profit decrease was primarily driven by lower net sales and production volumes, partially offset by decreases in service repair costs and improved warranty costs.
Gross margin for the CP segment increased from 40.9% to 44.7% primarily due to improved service margins due to lower contract material usage, lower warranty repair charges and decreased costs due to use of internal lasers. These were partially offset by the impact of lower volume on flex via drilling products. MM segment gross margins decreased from 39.9% to (4.3)% primarily due to lower production volumes driving unfavorable absorption of fixed costs.
Corporate and other cost of sales include expenses not allocated to our two operating segments, including stock compensation, amortization of intangibles, restructuring and other expense.
Operating Expenses
 
Fiscal quarter ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
12,766

 
43.0
%
 
$
12,534

 
27.0
%
Research, development and engineering
7,760

 
26.2

 
8,283

 
17.8

Acquisition and integration costs
335

 
1.1

 
40

 
0.1

Restructuring costs

 

 
591

 
1.3

Operating Expenses
$
20,861

 
70.3
%
 
$
21,448

 
46.2
%

20

Table of Contents

Selling, general and administrative
Selling, general and administrative (SG&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. SG&A expenses for the second quarter of 2017 increased $0.2 million compared to the second quarter of 2016 . This increase is comprised of $0.5 million in Visicon operating expenses during the second quarter of 2017 and $0.4 million in share based compensation expense primarily due to higher grant date fair value in 2017 compared to 2016. These increases were partially offset by $0.6 million decrease in commission and other variable compensation expenses due to lower sales volume.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses are primarily comprised of labor and other employee-related expenses including share-based compensation expense, professional fees, project materials costs, equipment costs and facilities costs. RD&E expenses for the second quarter of 2017 decreased $0.5 million compared to the second quarter of 2016 . This decrease was primarily due to a $0.4 million decrease in project development costs as various new products moved to production.
Acquisition and Integration Costs
2017
Acquisition and integration costs consisted mainly of $0.5 million of consulting, legal and travel expenses associated with the acquisition and integration of Visicon, which was acquired on August 1, 2016 (see Note 5 "Business Acquisitions" ). The Visicon acquisition charges were partially offset by $0.2 million of Topwin escrow cash settlement received in the second quarter of 2017.
2016
Acquisition and integration costs consisted mainly of consulting, legal and travel expenses associated with the acquisition and integration of Wuhan Topwin Optoelectronics Technology Co., Ltd., which was acquired on January 15, 2015.
Restructuring Costs
During the fourth quarter of 2015, we initiated restructuring plans to consolidate and shift our manufacturing activities to Asia and other cost reduction actions. The $0.6 million of restructuring costs in 2016 relate primarily to the labor charges for the closure of the Chelmsford, Massachusetts manufacturing plant associated with these restructuring plans. We ceased our use of that facility in 2016, and no further restructuring charges were incurred in the second quarter of 2017.
Non-operating Income and Expense
 
Fiscal quarter ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Interest and Other (Expense) Income, net
 
% of Net Sales
 
Interest and Other (Expense) Income, net
 
% of Net Sales
Interest and other income, net
$
206

 
0.7
%
 
$
6

 
%
Total non-operating income
$
206

 
0.7
%
 
$
6

 
%
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 $206 thousand in the second quarter of 2017 and $6 thousand in the second quarter of 2016 . The change in non-operating income was primarily due to the recovery of escrow funds related to the Topwin Acquisition.
Income Taxes
 
Fiscal quarter ended
 
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Income Tax Provision
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
Provision for income taxes
$

 
%
 
$
239

 
(7.9
)%

21

Table of Contents

The income tax provision for the second quarter of 2017 was zero on pretax loss of $9.7 million , an effective tax rate of zero . For the second quarter of 2016 , the income tax provision was $239 thousand on pretax loss of $3.0 million , an effective rate of (7.9)% . The change in provision for taxes relates to the decrease in projected annual income in the second quarter of 2017 and the mix of income between foreign jurisdictions.
Two Quarters Ended October 1, 2016 Compared to Two Quarters Ended September 26, 2015
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Two fiscal quarters ended
 
October 1, 2016
 
September 26, 2015
Net sales
100.0
 %
 
100.0
 %
Cost of sales
58.9

 
62.3

Gross profit
41.1

 
37.7

Selling, general and administrative
33.2

 
28.1

Research, development and engineering
19.9

 
18.9

Acquisition and integration costs
0.4

 
0.2

Restructuring costs

 
0.7

Operating loss
(12.4
)
 
(10.2
)
Interest and other income (expense), net
0.2

 

Total non-operating income (expense)
0.2

 

Loss before income taxes
(12.2
)
 
(10.2
)
Provision for income taxes
0.5

 
0.5

Net loss
(12.7
)%
 
(10.7
)%
Net Sales
The following table presents net sales information by product group:
 
Two fiscal quarters ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
44,445

 
57.5
%
 
$
42,145

 
47.0
%
Semiconductor Products (SP)
14,831

 
19.2

 
17,904

 
20.0

Component Test Products (CTP)
9,592

 
12.4

 
10,989

 
12.3

 
$
68,868

 
89.1
%
 
$
71,038

 
79.3
%
Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
8,458

 
10.9
%
 
$
18,525

 
20.7
%
Net Sales
$
77,326

 
100.0
%
 
$
89,563

 
100.0
%
Net sales for the first two quarters of 2017 decreased $12.2 million or 13.7% from net sales for the first two quarters of 2016 . By segment, net sales in CP decreased by $2.2 million or 3.1% and net sales in MM decreased by $10.1 million or 54.3% .
CP segment net sales for the first two quarters of 2017 decreased primarily due to $4.5 million in lower semiconductor service and scribing system sales. These decreases were partially offset by a $2.9 million increase in sales of our flex via drilling products, primarily the new GemStone TM product and sales of memory repair systems.
The decrease in MM net sales for the first two quarters of 2017 compared to the first two quarters of 2016 was primarily due to lower follow-on demand for our micromachining systems as compared to strong demand in the first two quarters of 2016.

22

Table of Contents

The following table presents net sales information by geographic region:
 
Two fiscal quarters ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
66,169

 
85.6
%
 
$
70,565

 
78.8
%
Americas
5,254

 
6.8

 
13,161

 
14.7

Europe
5,903

 
7.6

 
5,837

 
6.5

Net Sales
$
77,326

 
100.0
%
 
$
89,563

 
100.0
%
Net sales in Americas decreased to $5.3 million in the first two quarters of 2017 , a decrease of $7.9 million compared to $13.2 million in the first two quarters of 2017 . This was primarily due to lower flex via drilling system sales and lower service sales. Asia net sales decreased to $66.2 million in the first two quarters of 2017 , a decrease of $4.4 million compared to $70.6 million in the first two quarters of 2017 due lower service sales.
Gross Profit
 
Two fiscal quarters ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
33,770

 
49.0
 %
 
$
27,497

 
38.7
 %
Micromachining
(153
)
 
(1.8
)
 
7,135

 
38.5

Corporate and other
(1,829
)
 
(2.4
)
 
(834
)
 
(0.9
)
Gross Profit
$
31,788

 
41.1
 %
 
$
33,798

 
37.7
 %
Gross profit was $31.8 million for the first two quarters of 2017 , a decrease of $2.0 million compared to the first two quarters of 2016 . Gross profit decreased primarily due to lower net sales and production volumes. Gross margin was 41.1% and 37.7% for the first two quarters of 2017 and 2016 , respectively. The improvement in gross margin was driven by decreases in warranty and service repair expenses, and improved mix in CP due to higher net sales of flex via drilling products. These were partially offset by unfavorable absorption on fixed costs due to lower production volumes in the first two quarters of 2017.
Operating Expenses
 
Two fiscal quarters ended
   
October 1, 2016
 
September 26, 2015
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
25,637

 
33.2
%
 
$
25,151

 
28.1
%
Research, development and engineering
15,390

 
19.9

 
16,928

 
18.9

Acquisition and integration costs
335

 
0.4

 
194

 
0.2

Restructuring costs

 

 
653

 
0.7

Operating Expenses
$
41,362