Electro Scientific Industries, Inc.
ELECTRO SCIENTIFIC INDUSTRIES INC (Form: 10-Q, Received: 02/08/2017 06:03:16)
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 December 31, 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 February 3, 2017 was 32,670,422 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)
December 31, 2016
 
April 2, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
44,891

 
$
42,413

Short-term investments
6,301

 
15,252

Trade receivables, net of allowances of $685 and $1,039
27,644

 
42,770

Inventories, net
58,830

 
60,470

Shipped systems pending acceptance
3,983

 
1,181

Other current assets
5,903

 
5,340

Total current assets
147,552

 
167,426

Non-current assets:
 
 
 
Property, plant and equipment, net of accumulated depreciation of $111,811 and $107,910, (PP&E)
23,660

 
24,543

Non-current deferred income taxes, net
836

 
914

Goodwill
9,352

 
7,445

Acquired intangible assets, net of accumulated amortization of $21,979 and $21,146
9,611

 
7,146

Other assets
17,025

 
12,626

Total assets
$
208,036

 
$
220,100

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
14,345

 
$
16,061

Accrued liabilities
16,015

 
18,334

Deferred revenue
10,822

 
6,373

Total current liabilities
41,182

 
40,768

Non-current liabilities:
 
 
 
Income taxes payable
1,048

 
1,266

Deferred income tax liability, net
218

 
234

Other liabilities
6,085

 
7,801

Total liabilities
48,533

 
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; 33,151 and 31,613 issued and outstanding
204,859

 
195,024

Accumulated deficit
(43,485
)
 
(23,998
)
Accumulated other comprehensive loss
(1,871
)
 
(995
)
Total shareholders’ equity
159,503

 
170,031

Total liabilities and shareholders’ equity
$
208,036

 
$
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
 
Three fiscal quarters ended
(In thousands, except per share amounts)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Net sales:
 
 
 
 
 
 
 
Systems
$
25,427

 
$
31,282

 
$
85,069

 
$
98,914

Services
8,352

 
12,060

 
26,036

 
33,991

Total net sales
33,779

 
43,342

 
111,105

 
132,905

Cost of sales:
 
 
 
 
 
 
 
Systems
17,283

 
20,292

 
53,851

 
63,922

Services
5,048

 
5,329

 
14,018

 
17,464

Total cost of sales
22,331

 
25,621

 
67,869

 
81,386

Gross profit
11,448

 
17,721

 
43,236

 
51,519

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
13,280

 
12,468

 
38,917

 
37,619

Research, development and engineering
7,868

 
7,778

 
23,258

 
24,706

Acquisition and integration costs
31

 

 
366

 
194

Restructuring costs
321

 
1,944

 
321

 
2,597

Net operating expenses
21,500

 
22,190

 
62,862

 
65,116

Operating loss
(10,052
)
 
(4,469
)
 
(19,626
)
 
(13,597
)
Non-operating income:
 
 
 
 
 
 
 
Interest and other income, net
34

 
67

 
162

 
68

Total non-operating income
34

 
67

 
162

 
68

Loss before income taxes
(10,018
)
 
(4,402
)
 
(19,464
)
 
(13,529
)
(Benefit from) provision for income taxes
(325
)
 
184

 
22

 
681

Net loss
$
(9,693
)
 
$
(4,586
)
 
$
(19,486
)
 
$
(14,210
)
Net loss per share - basic
$
(0.29
)
 
$
(0.15
)
 
$
(0.60
)
 
$
(0.45
)
Net loss per share - diluted
$
(0.29
)
 
$
(0.15
)
 
$
(0.60
)
 
$
(0.45
)
Weighted average number of shares - basic
32,919

 
31,495

 
32,379

 
31,355

Weighted average number of shares - diluted
32,919

 
31,495

 
32,379

 
31,355

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
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Net loss
$
(9,693
)
 
$
(4,586
)
 
$
(19,486
)
 
$
(14,210
)
Other comprehensive loss:
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of taxes of $0, $0, $0 and $0
(745
)
 
(68
)
 
(884
)
 
(793
)
Accumulated other comprehensive income related to benefit plan obligation, net of taxes of $(5), $(2), $(7) and $(7)
5

 
4

 
14

 
12

Net unrealized loss on available-for-sale securities, net of taxes of $0, $0, $0 and $0
(2
)
 
2

 
(6
)
 
1

Other comprehensive loss:
(742
)
 
(62
)
 
(876
)
 
(780
)
Comprehensive loss
$
(10,435
)
 
$
(4,648
)
 
$
(20,362
)
 
$
(14,990
)
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)
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net loss
$
(19,486
)
 
$
(14,210
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,424

 
5,659

Amortization of acquired intangible assets
832

 
1,047

Share-based compensation expense
5,118

 
3,939

Loss on disposition of property, plant and equipment, net
52

 
788

(Benefit from) provision for doubtful accounts
(341
)
 
127

Charges for write-off of damaged product
946

 

Decrease (increase) in deferred income taxes
37

 
(71
)
Changes in operating accounts, net of acquisitions:

 

Decrease in trade receivables, net
15,258

 
8,593

Increase in inventories
(3,259
)
 
(7,046
)
(Increase) decrease in shipped systems pending acceptance
(2,802
)
 
1,342

(Increase) decrease in other current assets
(738
)
 
1,967

(Decrease) increase in accounts payable and accrued liabilities
(5,189
)
 
10,531

Increase (decrease) in deferred revenue
4,449

 
(4,668
)
Net cash provided by operating activities
301

 
7,998

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Purchase of investments
(331,343
)
 
(320,581
)
Proceeds from sales and maturities of investments
339,691

 
306,423

Purchase of property, plant and equipment
(3,408
)
 
(2,740
)
Proceeds from sale of property, plant and equipment
7

 
2

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

Increase in other assets
(120
)
 
(133
)
Net cash provided by (used in) investing activities
2,817

 
(17,029
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Payment of withholding taxes on stock-based compensation
(801
)
 
(645
)
Proceeds from issuance of common stock
1,043

 
1,056

Net cash provided by financing activities
242

 
411

Effect of exchange rate changes on cash
(882
)
 
(303
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
2,478

 
(8,923
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
42,413

 
50,994

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
44,891

 
$
42,071

SUPPLEMENTAL CASH FLOW INFORMATION
 
 
 
Cash paid for interest
$
(30
)
 
$
(57
)
Cash paid for income taxes
(504
)
 
(799
)
Income tax refunds received
45

 
140

Net increase in PP&E and other assets related to transfers from inventory
5,414

 
2,988

Non-cash additions to PP&E
205

 
160

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; acquisition 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 quarter ended December 31, 2016 consisted of a 13-week period while the fiscal quarter ended January 2, 2016 consisted of a 14-week period. Similarly, the three fiscal quarters ended December 31, 2016 consisted of a 39-week period compared to a 40-week period for the three fiscal quarters ended January 2, 2016 .
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.  

7


2. Recent Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment in order to simplify the accounting for goodwill impairment where step 2 was required in the past. In place of step 2, companies will recognize an impairment loss equal to the amount by which the carrying value exceeds the value; not to exceed the total amount of goodwill allocated to the reporting unit. ASU 2017-04 is effective, for SEC filers, for annual periods beginning after December 15, 2019, and interim periods within those annual periods, which would be the Company's fiscal year ending March 27, 2021; early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. While the Company does not expect the adoption of ASU 2017-04 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2017-04 may have on its financial position, results of operations or cash flows.
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, making the new guidance effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted no earlier than the original effective date. The FASB has continued to issue ASU topics to further clarify ASU 2014-09. These have included ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2016-20. The effective date and transition requirements of these ASU topics are the same as the effective date and transition requirements of ASU 2015-14. The Company has not yet selected a transition method and is currently evaluating the effect that the updated standards will have on the consolidated financial statements and related disclosures. The new standards are effective for the Company's fiscal year ending March 30, 2019.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash (a consensus of the FASB Emerging Issues Task Force), which provides specific guidance for classifying and presenting changes in restricted cash and restricted cash equivalents on the statement of cash flows due to transfers or transactions in order to reduce the diversity in practice. ASU 2016-18 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods, which would be the Company's fiscal year ending March 30, 2019. While the Company does not expect the adoption of ASU 2016-18 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2016-18 may have on its financial position, results of operations or cash flows.
In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control, which amends guidance on related parties under common control and the consideration of indirect interests held by related parties under common control by the single decision maker. ASU 2016-17 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods, which would be the Company's fiscal year ending March 30, 2019. While the Company does not expect the adoption of ASU 2016-17 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2016-17 may have on its financial position, results of operations or cash flows.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, to improve and simplify the accounting for the income tax consequences of intra-entity transfers of assets other than inventory, requiring companies to recognize income tax consequences upon the transfer of the asset to a third party. ASU 2016-16 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods, which would be the Company's fiscal year ending March 30, 2019. While the Company does not expect the adoption of ASU 2016-16 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2016-16 may have on its financial position, results of operations or cash flows.
In August 2016, the FASB issued 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. The Company elected to early adopt ASU 2016-15 and it did not have any effect on the Company's cash flows.

8


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 the Company does not expect the adoption of ASU 2016-09 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2016-09 may have on its 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 28, 2020. While the Company does not expect the adoption of ASU 2016-02 to have a material effect on its business, the Company is still evaluating any potential impact that adoption of ASU 2016-02 may have on its 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 the Company's 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 is recognized over the related service period, even if the market condition is never satisfied.
The Company granted a total of 943,445 time-based RSUs, 443,565 market-based RSUs and 90,000 performance-based RSUs during the first three quarters of 2017 , but did not grant any SARs. Grants for the third quarter of 2017 included 248,565 market-based RSUs and 229,445 time-based RSUs granted to the Company's newly appointed President and CEO.
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
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Cost of sales
$
142

 
$
103

 
$
398

 
$
347

Selling, general and administrative
1,391

 
832

 
3,573

 
2,291

Research, development and engineering
285

 
188

 
656

 
613

Total share-based compensation expense
$
1,818

 
$
1,123

 
$
4,627

 
$
3,251

The Company does not capitalize share-based compensation costs. As of December 31, 2016 , the Company had $10.6 million of total unrecognized share-based compensation costs, net of estimated forfeitures, which are expected to be recognized over a weighted average period of 1.8 years.

9


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 December 31, 2016 and April 2, 2016 was as follows (in thousands):
December 31, 2016
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents:
 
 
 
 
 
 
 
Money market securities
$
3,370

 
$

 
$

 
$
3,370

Commercial paper

 
11,196

 

 
11,196

Total cash equivalents
$
3,370

 
$
11,196

 
$

 
$
14,566

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

 
$

 
$

 
$
1,003

Commercial paper

 
4,295

 

 
4,295

Government agencies

 
1,003

 

 
1,003

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

 
$
5,298

 
$

 
$
6,301

 
 
 
 
 
 
 
 
Forward purchase or (sale) contracts:
 
 
 
 
 
 
 
Japanese Yen
$

 
$
(2
)
 
$

 
$
(2
)
New Taiwan Dollar

 
(12
)
 

 
(12
)
Korean Won

 
48

 

 
48

Euro

 
158

 

 
158

British Pound

 
(33
)
 

 
(33
)
Chinese Renminbi

 
(1
)
 

 
(1
)
Singapore Dollar

 
1

 

 
1

Total forward contracts
$

 
$
159

 
$

 
$
159

 
 
 
 
 
 
 
 
Deferred compensation plan assets:*
 
 
 
 
 
 
 
Mutual funds and exchange traded funds
$
2,316

 
$

 
$

 
$
2,316

Money market securities
785

 

 

 
785

Total deferred compensation plan assets
$
3,101

 
$

 
$

 
$
3,101


10


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 December 31, 2016 and April 2, 2016 were utilized to calculate fair values.
During the first three quarters of 2017 and 2016 , there were no transfers between Level 1, 2 or 3 assets.

11


Investments
The Company’s investments at December 31, 2016 and April 2, 2016 were as follows (in thousands):  
 
 
 
Unrealized
 
 
December 31, 2016
Cost
 
Gain
 
Loss
 
Fair Value
Available-for-sale securities (current):
 
 
 
 
 
 
 
Government agencies
$
1,003

 
$

 
$

 
$
1,003

Commercial paper
15,491

 

 

 
15,491

Total investments (current)
$
16,494

 
$

 
$

 
$
16,494

Available-for-sale securities (non-current):
 
 
 
 
 
 
 
Mutual funds, exchange traded funds and money market securities*
$
3,046

 
$
55

 
$

 
$
3,101

Total investments (non-current)
$
3,046

 
$
55

 
$

 
$
3,101

 
 
 
 
 
 
 
 
 
 
 
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 December 31, 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, the Company 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, adjusted for working capital changes, 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 .

12


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 may be revised once the fair value of the associated assets acquired and liabilities assumed is finalized. 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
3,300

Goodwill
1,907

Other assets
26

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

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 sales process and customer base.
The value of goodwill has not been finalized as the valuation of assets acquired and liabilities assumed is not yet complete. None of the goodwill is expected to be deductible for tax purposes. The acquired intangible assets consisted primarily of approximately $2 million of developed technology and identified intangible assets are expected to be amortized over their useful lives of one to six years.
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 through the third 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.

13


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 third 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.
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 third quarter of fiscal 2017 , the Company has recognized $1.4 million in share-based compensation expense related to this agreement. From acquisition through the third 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 three quarters of 2017 the Company did not incur any Topwin acquisition-related costs while it incurred approximately $194 thousand in the first three 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.

14


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.
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:

15


(In thousands)
December 31, 2016
 
April 2, 2016
Raw materials and purchased parts
$
40,405

 
$
38,957

Work-in-process
14,196

 
14,270

Finished goods
4,229

 
7,243

 
$
58,830

 
$
60,470

7. Trade Accounts Receivable
Trade accounts receivable consisted of the following:
(In thousands)
December 31, 2016
 
April 2, 2016
Current trade accounts receivable, net
$
27,644

 
$
42,770

Non-current trade accounts receivable
90

 
320

 
$
27,734

 
$
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)
December 31, 2016
 
April 2, 2016
Prepaid expenses
$
3,411

 
$
2,747

Value added tax receivable
1,538

 
1,353

Other
954

 
1,240

 
$
5,903

 
$
5,340

Included in "Other" Other current assets are non-trade receivables and other similar items.
9. Other Assets
Other assets consisted of the following:
(In thousands)
December 31, 2016
 
April 2, 2016
Consignment and demo equipment, net
$
11,130

 
$
7,242

Long term deposits
2,627

 
2,543

Non-current trade accounts receivable, net
90

 
320

Other non-current assets
3,178

 
2,521

 
$
17,025

 
$
12,626

Depreciation expense for demo and leased equipment totaled $0.1 million in the third quarter of 2017 and $0.2 million in the third quarter of 2016 . For the three fiscal quarters ended December 31, 2016 depreciation expense for demo and leased equipment totaled $0.3 million compared to $0.4 million for the three fiscal quarters ended January 2, 2016 .
Included in "Other" Other assets are long-term investments and other similar items.

16


10. Accrued Liabilities (Current) & Other Liabilities (Non-current)
Accrued liabilities (current) consisted of the following:
(In thousands)
December 31, 2016
 
April 2, 2016
Payroll-related liabilities
$
4,860

 
$
5,717

Product warranty accrual
4,136

 
3,666

Customer deposits
2,364

 
1,731

Purchase order commitments and receipts
1,256

 
2,588

Professional fees payable
914

 
1,052

Restructuring costs payable
620

 
757

Other current liabilities
1,865

 
2,823

 
$
16,015

 
$
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)
December 31, 2016
 
April 2, 2016
Deferred compensation
$
3,101

 
$
2,504

Product warranty accrual
775

 
2,068

Other non-current liabilities
2,209

 
3,229

 
$
6,085

 
$
7,801

Other non-current liabilities include long-term deferred revenue, income taxes payable, 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
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Product warranty accrual, beginning
$
5,521

 
$
4,451

 
$
5,734

 
$
3,342

Warranty charges incurred, net
(1,674
)
 
(2,057
)
 
(4,988
)
 
(5,604
)
Provision for warranty charges
1,064

 
2,292

 
4,165

 
6,948

Product warranty accrual, ending
$
4,911

 
$
4,686

 
$
4,911

 
$
4,686

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 $4.9 million in product warranty accrual at December 31, 2016 , $0.8 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.

17


The following is a reconciliation of the changes in deferred revenue:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Deferred revenue, beginning
$
11,583

 
$
12,662

 
$
7,685

 
$
12,376

Revenue deferred
9,075

 
13,868

 
28,547

 
47,459

Revenue recognized
(9,440
)
 
(18,822
)
 
(25,014
)
 
(52,127
)
Deferred revenue, ending
$
11,218

 
$
7,708

 
$
11,218

 
$
7,708

Of the total of $11.2 million in deferred revenue at December 31, 2016 , $0.4 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 December 31, 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. In the fourth quarter of 2017, the Company amended and extended by one year this credit agreement. As amended, the credit agreement allows for a greater level of EBITDA losses over the next 12 months, but reduces the level of permitted acquisitions and purchases of capital equipment. Please see Note 18 "Subsequent Events" .
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
 
Three fiscal quarters ended
(In thousands, except per share data)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Net loss
$
(9,693
)
 
$
(4,586
)
 
$
(19,486
)
 
$
(14,210
)
Weighted average shares used for basic earnings per share
32,919

 
31,495

 
32,379

 
31,355

Weighted average shares used for diluted earnings per share
32,919

 
31,495

 
32,379

 
31,355

Net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.29
)
 
$
(0.15
)
 
$
(0.60
)
 
$
(0.45
)
Diluted
$
(0.29
)
 
$
(0.15
)
 
$
(0.60
)
 
$
(0.45
)
Awards of options, SARs and RSUs representing an additional 2.8 million and 2.9 million shares of stock for the third quarter of 2017 and 2016 , respectively, and 2.5 million and 2.6 million shares of stock for the three 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.

18


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 currently 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 sales 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 segment management is 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 and because this level of information is not used by the CODM, 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, the Company revised the method it uses to determine segment gross margin amounts used by the CODM. Previously the profit on lasers (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 consistent with the information used by the CODM, 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.
Net sales by segment were as follows:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Component Processing
$
28,084

 
$
37,511

 
$
96,952

 
$
108,549

Micromachining
5,695

 
5,831

 
14,153

 
24,356

 
$
33,779

 
$
43,342

 
$
111,105

 
$
132,905

Gross profits by segment were as follows:
 
Fiscal quarter ended
 
Three fiscal quarters ended
(In thousands)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Component Processing
$
11,234

 
$
17,969

 
$
45,004

 
$
45,466

Micromachining
415

 
1,482

 
262

 
8,617

Corporate and other
(201
)
 
(1,730
)
 
(2,030
)
 
(2,564
)
 
$
11,448

 
$
17,721

 
$
43,236

 
$
51,519

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)
December 31, 2016
 
January 2, 2016
 
December 31, 2016
 
January 2, 2016
Asia
$
26,015

 
$
33,278

 
$
92,184

 
$
103,843

Americas
6,210

 
7,589

 
11,464

 
20,750

Europe
1,554

 
2,475

 
7,457

 
8,312

 
$
33,779

 
$
43,342

 
$
111,105

 
$
132,905


19


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 three quarters of 2017 . Since the inception of the plan, $5.8 million in restructuring costs have been recognized. 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 December 31, 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 December 31, 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 three quarters of 2017 or 2016 . There is no fixed completion date for the repurchase program.
18. Subsequent Events
Facility Mortgage Agreement
On January 9, 2017, ESI Leasing, LLC (“ESI Leasing”), a wholly owned subsidiary of the Company, entered into a loan agreement (the “Loan Agreement”) with First Technology Federal Credit Union (the “Lender”). The Loan Agreement provides for a term loan from the Lender to ESI Leasing in the principal amount of $14 million (the “Loan”). The interest rate of the Loan is fixed at 4.75% per annum, except that it may be increased if certain covenants under the Loan Agreement are not satisfied and after and during the continuation of an “Event of Default” as defined in the Loan Agreement. The Loan amortizes over a period of approximately 20 years, but the maturity date of the loan is January 1, 2027 , meaning that, if ESI Leasing does not prepay or refinance the Loan, a significant portion of the principal of the Loan will become due on January 1, 2027. ESI Leasing will pay monthly principal and interest payments on the Loan totaling annual amounts of $1.1 million .
Loan and Security Agreement with Silicon Valley Bank
In the fourth quarter of 2017, the Company amended and extended by one year this credit agreement. As amended, the credit agreement allows for a greater level of EBITDA losses over the next 12 months, but reduces the level of permitted acquisitions and purchases of capital equipment.

20


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 third quarter of 2017 ended December 31, 2016 and the second quarter of 2017 ended October 1, 2016 were both 13-week periods while the third quarter of 2016 ended January 2, 2016 was a 14-week period. Similarly, the three quarters ended December 31, 2016 consisted of a 39-week period compared to a 40-week period for the three quarters ended January 2, 2016 .
Summary of Sequential Quarterly Results
Third Quarter 2017 Ended December 31, 2016 Compared to Second Quarter 2017 Ended October 1, 2016 .
The financial results for the third quarter of 2017 reflected a sequential improvement in our order volume with total orders of $44.1 million , compared to $28.0 million in the second quarter of 2017. By segment, orders for Component Processing (CP) increased significantly due to orders for flex via drilling products and Allegro TM component test product systems. Micromachining (MM) segment orders increased modestly due to additional orders for defect detection products from our Visicon acquisition.
Total net sales increased from $29.7 million in the second quarter of 2017 to $33.8 million in the third quarter of 2017. CP segment net sales increased by $2.3 million from $25.7 million in the second quarter of 2017 to $28.1 million in the third quarter of 2017 , primarily due to increased revenues for Interconnect (IC) products for both flex circuit and IC package via drilling systems. Sales for the third quarter included the first CornerStone TM system sale, where customer acceptance was received during the quarter. These increases were offset by lower Semiconductor Product sales of wafer mark and wafer trim products. MM segment net sales increased by $1.8 million from $3.9 million in the second quarter of 2017 to $5.7 million in the third quarter of 2017 , primarily due to increased Visicon defect detection system sales, higher sales of laser ablation systems and laser products, partially offset by lower service sales due to continued decline in service base.
Gross profit was $11.4 million , with gross margins of 33.9% , in the third quarter of 2017 compared to gross profit of $11.0 million , with gross margin of 37.0% , in the second quarter of 2017 . Gross profit remained fairly consistent on increased net sales. Gross margins were impacted negatively by increases in other cost of sales charges, which included inventory expense, timing of laser repair charges and material cost variances.

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Operating expenses of $21.5 million in the third quarter of 2017 represent an increase of $0.6 million from $20.9 million in the second quarter of 2017 . Selling, general and administrative (SG&A) expenses increased $0.5 million to $13.3 million , primarily due to increased share-based compensation expense due to higher number of grants compared to the second quarter of 2017 and having a full quarter of expenses related to the Visicon acquisition. Research, development and engineering (RD&E) expenses increased $0.1 million , primarily related to a full quarter of Visicon expenses.
The Company had an operating loss of $10.1 million in the third quarter of 2017 compared to an operating loss of $9.9 million in the second quarter of 2017 .
The benefit from income taxes was $0.3 million in the third quarter of 2017 compared to no impact from income taxes in the second quarter of 2017 . The change in income taxes was due primarily to a credit related the expiration of statute of limitations on an uncertain tax position. In October 2016, the Company obtained a waiver from the Singapore tax authority, confirming the retention of benefits enjoyed through June 2016. The Company has applied for a 5-year extension through June 2021 of its Singapore Pioneer incentive, which is conditioned upon meeting certain business conditions. The Company believes it is likely that this extension will be granted and it will continue to receive the associated tax incentives.
Net loss was $9.7 million in both the third quarter of 2017 and the second quarter of 2017 .
Third Quarter 2017 Ended December 31, 2016 Compared to Third Quarter 2016 Ended January 2, 2016
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Fiscal quarter ended
 
December 31, 2016
 
January 2, 2016
Net sales
100.0
 %
 
100.0
 %
Cost of sales
66.1

 
59.1

Gross profit
33.9

 
40.9

Selling, general and administrative
39.3

 
28.8

Research, development and engineering
23.3

 
17.9

Acquisition and integration costs
0.1

 

Restructuring costs
1.0

 
4.5

Operating loss
(29.8
)
 
(10.3
)
Interest and other income, net
0.1

 
0.1

Total non-operating income
0.1

 
0.1

Loss before income taxes
(29.7
)
 
(10.2
)
(Benefit from) provision for income taxes
(1.0
)
 
0.4

Net loss
(28.7
)%
 
(10.6
)%
Net Sales
The following table presents net sales information by product group:
 
Fiscal quarter ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
15,987

 
47.3
%
 
$
22,824

 
52.6
%
Semiconductor Products (SP)
6,690

 
19.8

 
11,384

 
26.3

Component Test Products (CTP)
5,407

 
16.0

 
3,303

 
7.6

 
$
28,084

 
83.1
%
 
$
37,511

 
86.5
%
Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
5,695

 
16.9
%
 
$
5,831

 
13.5
%
Net Sales
$
33,779

 
100.0
%
 
$
43,342

 
100.0
%

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Table of Contents

Net sales for the third quarter of 2017 decreased $9.6 million or 22.1% from net sales for the third quarter of 2016 . By segment, net sales in CP decreased by 25.1% and MM decreased by 2.3% .
CP segment net sales for the third quarter of 2017 decreased $9.4 million compared to the third quarter of 2016 . The decrease in CP net sales was driven by lower sales of our flex via drilling systems, a $3.8 million decrease due to one-time sales of legacy memory repair systems in the third quarter of 2016 which did not repeat, and a $2.4 million decrease in service sales. Flex via drilling sales fell due to low order levels during the second quarter of 2017, which caused backlog to be very low entering into the third quarter of 2017. These decreases were partially offset by a $2.4 million increase in sales of MLCC testing systems.
MM segment net sales for the third quarter of 2017 decreased $0.1 million compared to the third quarter of 2016 . The decrease was primarily due to lower follow on demand for our micromachining systems and lower service sales. These decreases were almost offset by increased sales of Visicon systems and sales of laser products.
The following table presents net sales information by geographic region:
 
Fiscal quarter ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
26,015

 
77.0
%
 
$
33,278

 
76.8
%
Americas
6,210

 
18.4

 
7,589

 
17.5

Europe
1,554

 
4.6

 
2,475

 
5.7

Net Sales
$
33,779

 
100.0
%
 
$
43,342

 
100.0
%
Net sales to Asia decreased by 21.8% or $7.3 million primarily due to decreased service sales and lower flex via drilling product sales. Net sales to Americas and Europe were impacted by lower flex via drilling product sales.
Gross Profit
 
Fiscal quarter ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
11,234

 
40.0
 %
 
$
17,969

 
47.9
 %
Micromachining
415

 
7.3

 
1,482

 
25.4

Corporate and other
(201
)
 
(0.6
)
 
(1,730
)
 
(4.0
)
Gross Profit
$
11,448

 
33.9
 %
 
$
17,721

 
40.9
 %
Gross profit was $11.4 million for the third quarter of 2017 , a decrease of $6.3 million compared to $17.7 million in the third quarter of 2016 . The gross profit decrease was primarily driven by lower net sales and production volumes and increased service costs due to higher contract material usage, partially offset by lower warranty charges.
Gross margin for the CP segment decreased from 47.9% to 40.0% primarily due to less favorable absorption of fixed costs on lower systems production and lower sales of legacy memory repair systems. These were partially offset by decrease in warranty charges. MM segment gross margins decreased from 25.4% to 7.3% primarily due to less favorable absorption of fixed costs on lower systems production and higher contract material usage in the third quarter of 2017 associated with service sales.
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. Third quarter of 2016 charges included a $1.4 million write-off of inventory associated with a discontinued large-format glass cutting product.

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Table of Contents

Operating Expenses
 
Fiscal quarter ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
13,280

 
39.3
%
 
$
12,468

 
28.8
%
Research, development and engineering
7,868

 
23.3

 
7,778

 
17.9

Acquisition and integration costs
31

 
0.1

 

 

Restructuring costs
321

 
1.0

 
1,944

 
4.5

Operating Expenses
$
21,500

 
63.6
%
 
$
22,190

 
51.2
%
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 third quarter of 2017 increased $0.8 million compared to the third quarter of 2016 . The increase is comprised of $1.0 million in share-based compensation expense due to higher grant date fair value in 2017 compared to 2016, higher overall grants in 2017 and due to Visicon operating expenses incurred during the third quarter of 2017. Partially offsetting these was a $0.4 million decrease in professional fees, employee variable pay and lower overall expenses due to not having an additional week of expenses in the third quarter of 2017 compared to 2016.
Research, Development and Engineering
Research, development and engineering (RD&E) expenses primarily comprise 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 third quarter of 2017 increased $0.1 million compared to the third quarter of 2016 , primarily due to Visicon operating expenses incurred in the third quarter of 2017.
Acquisition and Integration Costs
Acquisition and integration costs of $31 thousand in 2017 consisted mainly of legal and travel expenses associated with the acquisition and integration of Visicon, which was acquired during the second quarter of 2017 (see Note 5 "Business Acquisitions" ).
Restructuring and cost management plans
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 $1.9 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.
Non-operating Income and Expense
 
Fiscal quarter ended
   
December 31, 2016
 
January 2, 2016
(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
$
34

 
0.1
%
 
$
67

 
0.1
%
Total non-operating income
$
34

 
0.1
%
 
$
67

 
0.1
%
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 $34 thousand in the third quarter of 2017 and $67 thousand in the third quarter of 2016 .

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Table of Contents

Income Taxes
 
Fiscal quarter ended
 
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Income Tax Benefit
 
Effective
Tax Rate
 
Income Tax Provision
 
Effective
Tax Rate
(Benefit from) provision for income taxes
$
(325
)
 
3.2
%
 
$
184

 
(4.2
)%
The income tax benefit for the third quarter of 2017 was $325 thousand on pretax loss of $10.0 million , an effective tax rate of 3.2% . For the third quarter of 2016 , the income tax provision was $184 thousand on pretax loss of $4.4 million , an effective rate of (4.2)% . The change in provision for taxes primarily relates to the release of $324 thousand in benefit on credits from the expiration of the statute on uncertain tax positions and the mix of income between foreign jurisdictions.
Three Quarters Ended December 31, 2016 Compared to Three Quarters Ended January 2, 2016
Results of Operations
The following table presents results of operations data as a percentage of net sales:
 
Three fiscal quarters ended
 
December 31, 2016
 
January 2, 2016
Net sales
100.0
 %
 
100.0
 %
Cost of sales
61.1

 
61.2

Gross profit
38.9

 
38.8

Selling, general and administrative
35.0

 
28.3

Research, development and engineering
20.9

 
18.6

Acquisition and integration costs
0.3

 
0.1

Restructuring costs
0.3

 
2.0

Operating loss
(17.7
)
 
(10.2
)
Interest and other income, net
0.1

 
0.1

Total non-operating income
0.1

 
0.1

Loss before income taxes
(17.5
)
 
(10.2
)
Provision for income taxes
0.1

 
0.5

Net loss
(17.5
)%
 
(10.7
)%
Net Sales
The following table presents net sales information by product group:
 
Three fiscal quarters ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Component Processing
 
 
 
 
 
 
 
Interconnect Products (IP)
$
60,432

 
54.4
%
 
$
64,969

 
48.9
%
Semiconductor Products (SP)
21,521

 
19.4

 
29,288

 
22.0

Component Test Products (CTP)
14,999

 
13.5

 
14,292

 
10.8

 
$
96,952

 
87.3
%
 
$
108,549

 
81.7
%
Micromachining
 
 
 
 
 
 
 
Micromachining Products (MP)
$
14,153

 
12.7
%
 
$
24,356

 
18.3
%
Net Sales
$
111,105

 
100.0
%
 
$
132,905

 
100.0
%
Net sales for the first three quarters of 2017 decreased $21.8 million or 16.4% from net sales for the first three quarters of 2016 . By segment, net sales in CP decreased by $11.6 million or 10.7% and net sales in MM decreased by $10.2 million or 41.9% .
CP segment net sales for the first three quarters of 2017 decreased primarily due to $5.9 million in lower service sales due to smaller service base and a $5.7 million decrease in flex via drilling and memory repair system sales.

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Table of Contents

The decrease in MM net sales for the first three quarters of 2017 compared to the first three quarters of 2016 was primarily due to lower follow-on demand for our micromachining systems and related service, as compared to relatively strong demand in 2016. This was partially offset by an increase due to system sales related to our Visicon acquisition.
The following table presents net sales information by geographic region:
 
Three fiscal quarters ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Net Sales
 
% of Net Sales
 
Net Sales
 
% of Net Sales
Asia
$
92,184

 
83.0
%
 
$
103,843

 
78.1
%
Americas
11,464

 
10.3

 
20,750

 
15.6

Europe
7,457

 
6.7

 
8,312

 
6.3

Net Sales
$
111,105

 
100.0
%
 
$
132,905

 
100.0
%
Net sales in Asia decreased to $92.2 million in the first three quarters of 2017 , a decrease of $11.7 million compared to $103.8 million in the first three quarters of 2017 primarily due to lower service sales and lower flex via drilling and micromachining system sales. Americas decreased to $11.5 million in the first three quarters of 2017 , a decrease of $9.3 million compared to $20.8 million in the first three quarters of 2017 . This was primarily due to lower flex via drilling system sales, lower service sales and lower memory repair system sales.
Gross Profit
 
Three fiscal quarters ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Gross Profit
 
% of Net Sales
 
Gross Profit
 
% of Net Sales
Component Processing
$
45,004

 
46.4
 %
 
$
45,466

 
41.9
 %
Micromachining
262

 
1.9

 
8,617

 
35.4

Corporate and other
(2,030
)
 
(1.8
)
 
(2,564
)
 
(1.9
)
Gross Profit
$
43,236

 
38.9
 %
 
$
51,519

 
38.8
 %
Gross profit was $43.2 million for the first three quarters of 2017 , a decrease of $8.3 million compared to the first three quarters of 2016 . Gross profit decreased primarily due to lower net sales and production volumes. Gross margin was 38.9% and 38.8% for the first three quarters of 2017 and 2016 , respectively. Gross margins in 2017 were impacted by less favorable absorption of fixed costs on lower systems production and lower sales of legacy memory repair systems. Gross margins in 2016 were impacted negatively by a $1.4 million write-off of inventory associated with a discontinued large-format glass cutting product.
Operating Expenses
 
Three fiscal quarters ended
   
December 31, 2016
 
January 2, 2016
(In thousands, except percentages)
Expense
 
% of Net Sales
 
Expense
 
% of Net Sales
Selling, general and administrative
$
38,917

 
35.0
%
 
$
37,619

 
28.3
%