<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 1999 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
13900 N.W. SCIENCE PARK DRIVE, PORTLAND, OREGON
97229
(503) 641-4141
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
AS OF FEBRUARY 28, 1999 THERE WERE 12,991,237 SHARES OF COMMON STOCK OF ELECTRO
SCIENTIFIC INDUSTRIES, INC. OUTSTANDING.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
EXHIBIT INDEX
Part I. Financial Information
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets 3-4
February 28, 1999 and May 31, 1998
Consolidated Statements of Income 5
Three Months and Nine Months ended
February 28, 1999 and February 28, 1998
Consolidated Statements of Cash Flows 6-7
Nine Months ended February 28, 1999 and
February 28, 1998
Notes to Consolidated Financial Statements 8-13
Item 2. Management's Discussion and Analysis of Financial 14-18
Condition and Results of Operations
Part II. Other Information
Item 1. Legal Proceedings 19
Signature 20
</TABLE>
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
ASSETS February 28, 1999 May 31, 1998
- ------ ----------------- ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,856 $ 10,034
Securities available for sale 26,698 29,113
------ ------
Total cash and securities 29,554 39,147
Trade receivables, net 79,413 65,605
Inventories 55,484 52,721
Deferred income taxes 4,788 4,788
Other current assets 2,305 3,616
----- -------
Total current assets 171,544 165,877
------- -------
PROPERTY AND EQUIPMENT, AT COST 67,988 62,735
Less - Accumulated depreciation (35,516) (32,362)
-------- --------
Net property and equipment 32,472 30,373
------ ------
DEFERRED INCOME TAXES 2,692 2,692
OTHER ASSETS 9,656 10,189
----- ------
Total Assets $216,364 $209,131
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
LIABILITIES AND
SHAREHOLDERS' EQUITY February 28, 1999 May 31, 1998
- -------------------- ------------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 6,952 $ 5,857
Accrued liabilities:
Payroll related 4,763 6,595
Commissions 5,673 4,289
Warranty 2,199 2,010
Other 487 1,939
-------- --------
Total accrued liabilities 13,122 14,833
Deferred revenue 334 347
-------- --------
Total current liabilities 20,408 21,037
------ ------
SHAREHOLDERS' EQUITY:
Common stock, without par value; Authorized:
40,000 shares; Outstanding:
12,991, and 12,848 respectively 104,750 101,838
Retained earnings 91,206 86,256
------ ------
Total shareholders' equity 195,956 188,094
------- -------
Total liabilities and shareholders' equity $216,364 $209,131
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
Feb. 28, 1999 Feb. 28, 1998 Feb. 28, 1999 Feb. 28, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net Sales $ 51,506 $ 68,152 $148,965 $197,805
Cost of sales 25,415 29,765 74,118 86,289
------ ------ ------ ------
Gross margin 26,091 38,387 74,847 111,516
Operating expenses:
Selling, service and administrative 14,331 15,910 42,964 47,297
Research, development and engineering 7,340 9,039 22,908 26,510
Merger related expenses 2,773 3,510 2,773 14,634
------ ----- ----- ------
Total operating expenses 24,444 28,459 68,645 88,441
------ ------ ------ ------
Operating income 1,647 9,928 6,202 23,075
Interest income 304 365 907 1,155
Other income, net 84 298 190 610
--------- --------- --------- -------
Income before income taxes 2,035 10,591 7,299 24,840
Provision for income taxes 1,115 3,165 2,707 9,969
----- ----- ----- -----
Net income $ 920 $ 7,426 $ 4,592 $ 14,871
-------- ------- ------- --------
-------- ------- ------- --------
Net income per share:
Basic $ 0.07 $ 0.60 $ 0.36 $ 1.19
-------- ------- ------- --------
-------- ------- ------- --------
Diluted $ 0.07 $ 0.58 $ 0.35 $ 1.16
-------- ------- ------- --------
-------- ------- ------- --------
Weighted average number of shares:
Basic 12,943 12,452 12,895 12,485
Diluted 13,344 12,798 13,180 12,826
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Feb. 28
1999 1998
---- ----
<S> <C> <C>
Cash Flows From Operating Activities:
Net income $ 4,592 $ 14,871
Adjustment to align AISI with the period ended February 28, 1998 -- (565)
Adjustments to reconcile net income to cash provided by (used in) operating
activities:
Merger-related expenses (1) 2,773 14,634
Depreciation and amortization 4,907 4,440
Changes in operating accounts:
Increase in trade receivables (12,806) (10,230)
Increase in inventories (1,610) (12,114)
Increase (decrease) in other current assets 1,313 (2,089)
Decrease in current liabilities (3,890) (5,224)
----- -------
Net cash provided by (used in) operating activities (4,721) 3,723
------- -----
Cash Flows From Investing Activities:
Purchases of property and equipment (5,998) (9,001)
Purchase of securities (16,330) (18,659)
Proceeds from sales of securities and maturing securities 18,745 17,415
(Increase) decrease in other assets (1,213) (773)
------- ---------
Net cash used in investing activities: (4,796) (11,018)
------- --------
Cash Flows From Financing Activities:
Repayment of Dynamotion subsidiary debt (2) -- (6,979)
Distributions to shareholders (573) (849)
Repurchase of shares -- (625)
Proceeds from exercise of stock options and stock plans 2,912 4,182
------ -------
Net cash (used in) provided by financing activities: 2,339 (4,271)
------ --------
Net Change in Cash and Cash Equivalents (7,178) (11,566)
Cash and Cash Equivalents at Beginning of Period 10,034 20,412
------ ------
Cash and Cash Equivalents at End of Period $ 2,856 $ 8,846
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(Unaudited)
Cash payments for interest were not significant for the nine months ended
February 28, 1999 and February 28, 1998. Cash payments for income taxes were
$2,839 and $9,270 for the nine months ended February 28, 1999 and February 28,
1998, respectively.
Notes:
(1) See Note 5 in Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
(2) Acquisition of Dynamotion subsidiary:
<S> <C>
Assets less liabilities acquired, net of cash $(11,950)
Issuance of common stock and common stock options 11,950
------
Net cash used to acquire Dynamotion: $ 0
</TABLE>
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except share data)
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, 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 generally accepted accounting principles have been condensed or
omitted in these interim statements. Management believes that the interim
statements include all adjustments (consisting of only normal recurring
accruals) necessary for a fair presentation of results for the interim periods.
It is suggested that these condensed consolidated financial statements be read
in conjunction with the financial statements and notes thereto included in the
Company's 1998 Annual Report filed on Form 10-K.
Results of operations for interim periods are not necessarily indicative of the
results to be expected for the full year.
NOTE 2 - ACCOUNTS RECEIVABLE
Accounts receivable are net of an allowance for doubtful accounts of $667 at
February 28, 1999 and $519 at May 31, 1998.
NOTE 3 - INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
February 28, 1999 May 31, 1998
----------------- ------------
<S> <C> <C>
Raw materials and purchased parts $ 24,626 $33,519
Work-in-process 17,692 9,193
Finished goods 13,166 10,009
------ --------
Total inventories $55,484 $52,721
------- -------
------- -------
</TABLE>
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands except share data)
(Unaudited)
NOTE 4 - NET INCOME PER SHARE
The Company adopted the Financial Accounting Standards Board's Statement 128,
"Earnings Per Share" (SFAS 128), in the third fiscal quarter of 1998. All
earnings per share amounts in the following table are presented and, where
necessary, restated to conform to the SFAS 128 requirements.
<TABLE>
<CAPTION>
Three Months Ended Feb. 28 Nine Months Ended Feb. 28
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $920 $7,426 $4,592 $14,871
Weighted average number of shares
of common stock and common stock
equivalents outstanding:
Weighted average number of
shares outstanding for computing
basic net income per share 12,943 12,452 12,895 12,485
Dilutive effect of employee stock options
after application of the treasury stock
method 401 346 285 341
--- --- --- ---
Weighted average number of
shares outstanding for computing
diluted net income per share 13,344 12,798 13,180 12,826
------ ------ ------ ------
------ ------ ------ ------
Net income per share - basic $ 0.07 $ 0.60 $ 0.36 $ 1.19
------ ------ ------ ------
------ ------ ------ ------
Net income per share - diluted $ 0.07 $ 0.58 $ 0.35 $ 1.16
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands except share data)
(Unaudited)
NOTE 4 - CONT.
For purposes of computing diluted earnings per share, weighted average common
share equivalents do not include the following stock options because inclusion
would have an anti-dilutive effect on the earnings per share calculation.
<TABLE>
<CAPTION>
Three Months Ended February 28 Nine Months Ended February 28
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Number of Employee
Stock Options 126 3 262 10
</TABLE>
NOTE 5 - ACQUISITIONS
MICROVISION, INC.
On January 29, 1999, the Company completed the acquisition of MicroVision, a
provider of integrated, vision-based inspection and automation solutions for use
in semiconductor front-end and back-end applications, located in Chanhassen,
Minnesota. The acquisition consideration consisted of 1,018,500 shares of
ESI stock, of which 979,025 shares were issued and outstanding, and 39,475
shares were reserved for stock options. The transaction has been accounted for
as a pooling-of-interests and, accordingly, all data included in the
Consolidated Financial Statements has been restated.
TESTEC, INC.
On December 21, 1998, the Company completed the acquisition of Testec, a
provider of electrical test systems for the passive component marketplace,
located in Phoenix, Arizona. The acquisition consideration consisted of 500,000
shares of ESI common stock. The transaction has been accounted for as a
pooling-of-interests and, accordingly, all data included in the Consolidated
Financial Statements has been restated.
APPLIED INTELLIGENT SYSTEMS, INC. (AISI)
On December 1, 1997, the Company completed the acquisition of AISI, a provider
of machine vision solutions for the semiconductor and electronics industries,
located in Ann Arbor, Michigan. The acquisition consideration consisted of
1,399,515 shares of ESI common stock. The transaction has been accounted for as
a pooling-of-interests and, accordingly, all data included in the Consolidated
Financial Statements has been restated.
CHIP STAR, INC.
On June 26, 1997, the Company completed the acquisition of Chip Star Inc., a
provider of ceramic capacitor termination systems located in San Marcos,
California, through the issuance of 700,000 shares of ESI stock. The
transaction has been accounted for as a pooling of interests, and
accordingly, all data included in the consolidated financial statements has
been restated.
Disclosure of ESI and Chip Star's revenue and net income, on an individual
company basis from June 1 to June 25, 1997 is not deemed to be significant.
DYNAMOTION, INC.
On June 9, 1997, the Company acquired all of the outstanding stock of Dynamotion
Corp., a producer of high performance mechanical drilling and routing systems
based in Santa Ana, California. The purchase consideration consisted of
347,200 shares of ESI stock. The transaction was accounted for as a purchase.
In connection with the purchase price allocation, the Company obtained an
appraisal of the intangible assets that indicated that substantially all of the
acquired intangible assets consisted of research and development projects in
process. At that time, the development of these projects had not reached
technological feasibility and the technology was believed to have no alternative
future use. In accordance with generally accepted accounting principles, the
acquired in-process research and development was charged to merger related
expense during the quarter ended August 31, 1997 and is reflected in the
accompanying Consolidated Statements of Operations.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands except share data)
(Unaudited)
NOTE 5 - CONT.
A reconciliation of amounts prior to these acquisitions to amounts included in
the financial statements is as follows:
<TABLE>
<CAPTION>
Three Months Ended Feb. 28 Nine Months Ended Feb. 28
-------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
ESI $ 48,917 $ 57,594 $ 139,458 $ 157,340
AISI - - - 17,245
Testec 817 2,501 2,587 5,466
MicroVision 1,772 8,057 6,920 17,754
----- ----- ----- ------
As Restated $ 51,506 $ 68,152 $ 148,965 $197,805
Net Income:
ESI $ 827 $ 4,534 $ 3,917 $ 6,843
AISI - - - 3,748
Testec 215 639 340 1,447
MicroVision (122) 2,253 335 2,833
---- ----- --- -----
As Restated $ 920 $ 7,426 $ 4,592 $ 14,871
</TABLE>
NOTE 6 - INCOME TAXES
The effective income tax rate for the interim period is based on estimates of
annual amounts of taxable income, tax credits and other factors.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands except share data)
(Unaudited)
NOTE 7 - NEW ACCOUNTING PRONOUNCEMENTS
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130). The Company has adopted SFAS 130 in the first fiscal quarter of
1999. The statement establishes presentation and disclosure requirements for
reporting comprehensive income. Comprehensive income includes charges or credits
to equity that are not the result of transactions with shareholders. Components
of the Company's comprehensive income consist of cumulative foreign currency
translation adjustments and unrealized gains/losses of securities available for
sale, none of which are material to the Company's consolidated financial
position or results of operations.
HEDGING ACTIVITIES
The Financial Accounting Standards Board issued "Accounting for Derivative
Instruments and Hedging Activities"(SFAS 133), in June 1998. SFAS 133 will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If the derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of the derivatives will either be offset against the
change in fair value of the hedged assets, liabilities, or firm commitments
through earnings, or recognized in other comprehensive income until the hedged
item is recognized in earnings. The change in the derivative's fair value
related to the ineffective portion of a hedge, if any, will be immediately
recognized in earnings. The Company expects to adopt this Standard as of the
beginning of its fiscal year 2001. The effect of adopting this standard is
currently being evaluated, but is not expected to have a material effect on the
Company's financial position or its results of operations.
NOTE 8 - SUBSEQUENT EVENTS
On April 8, 1999 a federal court jury awarded ESI a $13.1 million damage
judgment in its patent infringement suit against General Scanning, Inc. ESI
initiated litigation against General Scanning in December 1996 in the U.S.
District Court for the Northern District of California. On April 2, 1999 the
same federal court jury issued a verdict upholding the validity of ESI's
semiconductor link blowing patent - U.S. patent 5,265,114 entitled "System
and Method for Selectively Laser Processing a Target Structure of One or More
Materials of a Multimaterial Multilayer Device". The jury also concluded
that General Scanning's infringement was willful and gives the court the
authority to increase the damages up to three times. General Scanning has
announced that it intends to appeal the verdict.
<PAGE>
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ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS
Results of Operations
Revenue of $51.5 million for the quarter ended February 28, 1999 was $16.7
million or 24.5% lower than in the third quarter of fiscal 1998, and $2.5
million or 5.1% higher than in the quarter ended November 30, 1998. Revenue
of $149.0 million for the year to date ended February 28, 1999 was $48.8
million or 24.7% lower as compared to the year to date ended February 28,
1998. Demand for electronic component test and termination equipment and
vision products was down from prior year levels, but was up as compared to
the prior quarter. Sales of memory yield improvement systems increased, and
again, represented the largest percentage of sales for the quarter at 33% of
total revenues. Advanced Packaging and Circuit Fine Tuning equipment sales
were both down slightly from both prior quarter and prior year levels.
Gross margin for the three months ended February 28, 1999 decreased to 50.7%
from 56.3% for the third quarter of the prior fiscal year. Gross margin was
up about 0.2% compared to the quarter ended November 30, 1998. Gross margin
for the year to date ended February 28, 1999 decreased to 50.2% from 56.3%
for the year to date ended February 28, 1998. The decrease in margin from the
prior fiscal year is driven by changes in product mix, a slight decrease in
average selling prices, and lower levels of overhead absorption due to lower
unit volumes.
Selling, service and administrative expenses for the three months ended
February 28, 1999 were $1.6 million lower in the current quarter as compared
to the third quarter of fiscal 1998. Expenses for sales, services and
administration increased about $0.1 million compared to the quarter ended
November 30, 1998. Selling, service and administrative expenses for the year
to date ended February 28, 1999 were $4.3 million lower as compared to the
year to date ended February 28, 1998. The decrease is due mainly to general
spending reductions associated with the continued consolidation of selling
and administrative functions for the Chip Star and AISI acquisitions.
Expenses associated with research, development and engineering decreased by
$1.7 million as compared to the third quarter of fiscal l998. R&D expenses
decreased $0.1 million from the prior quarter level. Research, development
and engineering expenses for the year to date ended February 28, 1999
decreased $3.6 million as compared to the year to date ended February 28,
1998. The decrease is attributable to reduced R&D spending at MicroVision and
a general decrease in spending from prior year levels in conjunction with
lower levels of revenue in fiscal 1999. R&D spending typically fluctuates
from quarter to quarter as engineering projects move through their life
cycles.
Merger related expenses for fiscal 1999 and 1998 principally include one-time
transaction costs associated with the acquisitions referred to in Note 5 to
the financial statements. Such costs include investment banking, legal, and
accounting costs as well as certain one-time costs
<PAGE>
Page 14/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (Continued)
Results of Operations
incurred to consolidate the operations of these acquisition entities. Fiscal
1998 merger related expenses also include a $9.0 million charge for acquired
in-process research and development incurred in connection with the
Dynamotion Corporation acquisition.
Net income for the quarter ended February 28, 1999 was $0.9 million or $0.07
per basic share. Excluding $2.8 million of merger related expenses, net
income was $3.2 million or $0.25 per basic share. This represents a decrease
of $6.1 million or 65.6% from the third quarter of fiscal 1998, when
earnings, excluding merger related expenses, were $9.3 million or $0.75 per
basic share. Net income for the year to date ended February 28, 1999 was $4.6
million or $0.36 per basic share. Excluding $2.8 million of merger related
expenses, net income was $6.6 million or $0.52 per basic share. This
represents a decrease of $19.8 million or 75% from the year to date ended
February 28, 1998, when earnings, excluding merger related expenses, were
$26.4 million or $2.12 per basic share.
Ending backlog on February 28, 1999 was $24 million as compared to $18
million for November 30, 1998.
<PAGE>
Page 15/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (continued)
Liquidity, Capital Resources and Business Environment
The Company's principal sources of liquidity are existing cash and cash
equivalents and marketable debt securities of $29.6 million, accounts
receivable of $79.4 million, and a $7.0 million line of credit, none of which
was outstanding at February 28, 1999. ESI has a current ratio of 8.4:1 and
no long-term debt. Working capital increased to $151.1 million at February
28, 1999 versus $145.0 million at May 31, 1998. Accounts receivable was
significantly higher than on May 31, 1998, but the increase is a function of
increased flexibility with regard to customer payment terms, and does not
include a significant increase in past due receivables. Inventory increased
by $2.8 million over May 31, 1998 due mainly to this Company's investment in
finished goods in preparation for an increased level of business associated
with the acceptance of new products in the Company's markets.
The Company's business depends in large part upon the capital expenditures of
manufacturers of electronic devices, including miniature capacitors and
semiconductor memory devices, and circuits used in wireless telecommunications
equipment, such as pagers and cellular phones, automotive electronics and
computers. The markets for products manufactured by the Company's customers are
cyclical and have historically experienced periodic downturns, which often have
had a negative effect on the demand for capital equipment such as that sold by
the Company. Several large, multinational electronics companies constituted 41%
of the Company's fiscal 1998 sales and are expected to comprise a similar ratio
in fiscal 1999. The loss of any of these customers would have a significant
effect on the Company's financial statements.
The market for the Company's products is characterized by rapidly changing
technology and evolving industry standards. The Company believes that its
future success will depend on its ability to develop and manufacture new
products and product enhancements, to introduce them successfully into the
market and to create and sustain intellectual property protection for these new
products. Failure to do so in a timely fashion could harm the Company's
competitive position. The announcements or introductions of new products by the
Company or its competitors may adversely affect the Company's operating results,
as these announcements may cause customers to defer or forego ordering products
from the Company's existing product lines.
<PAGE>
Page 16/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (continued)
Liquidity, Capital Resources and Business Environment
International shipments have accounted for 64% of year-to-date sales for fiscal
1999 as compared to 57% for the fiscal year 1998. About 39% of the company's
year-to-date product sales are to Asian customers versus 26% for fiscal year
1998. Several countries in this region, notably South Korea, Japan and Taiwan,
have experienced currency devaluation and/or difficulties in financing
short-term obligations. The Company's customers in these countries continued to
purchase and pay for products within agreed upon terms. In addition,
substantially all Asian end customer receivables are secured by letter of
credit.
There can be no assurance that difficulties in Asian economies will not
adversely affect the demand for the Company's products in that region or
elsewhere.
The Company expects that international shipments will continue to represent a
significant percentage of net sales in the future. As a result, a significant
portion of the Company's net sales will be subject to certain risks, including
changes in demand resulting from fluctuations in interest and currency exchange
rates, as well as factors such as government financed competition, changes in
trade policies, tariff regulations, difficulties in obtaining export licenses
and the difficulties of staffing and managing foreign operations.
Most of the Company's sales are transacted in dollars and the Company's
products are made in the United States. Many Japanese customers pay us in
yen, and the Company hedges these sales transactions to mitigate currency
risks. The European and Asian sales subsidiaries' operating expenses are
denominated in their respective local currencies. These transactions
represent approximately 9% of total consolidated operating expenses with
about 60% attributable to Europe and 40% to Asia. Changes in the value of
the local currency, as measured in US dollars, will commensurably increase or
decrease operating expenses.
The Company has a task force to prepare for Year 2000 (Y2K) issues. The Director
of Corporate Technology serves as the Y2K coordinator and has overall
responsibility for organizing and managing the Company's Y2K program. The
coordinator reports to the Chief Technical Officer and Vice President. The
Company has evaluated its technology and data used in the creation and delivery
of its products and services and in its internal operations, and has identified
Y2K issues related to its customers and suppliers.
<PAGE>
Page 17/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (CONT.)
Each of the Company's product lines have technical and communication resources
assigned for Y2K readiness. ESI uses Sematech Tests to determine equipment
product readiness. All of the Company's current standard products are now Y2K
ready. Past products have been evaluated and readiness upgrade kits are being
developed and offered where practical. The overall Y2K coordinator is working
with each product line group to develop and implement their product plans. Y2K
readiness is viewed as a necessary capability for doing business.
The Company has completed the inventory and evaluation of its business systems.
Assessment includes facilities, engineering, manufacturing, laboratory, banking,
accounting, procurement, product test, customer order, receiving, warehousing,
and communications. The Company is greater than 90% complete with ready
business systems. The Company's core business systems are now Y2K ready. A
number of non-critical business systems are not ready and remediation plans are
in place that include an upgrade of systems as well as orderly end of life. For
each deficiency identified, a responsible party has been identified to ensure
compliance. This activity is expected to be completed by June 30, 1999.
The Company has a corporate officer assigned the responsibility for ESI's
supplier Y2K readiness evaluation. The plan includes automatic assessment of
the top 80% of the suppliers and key supplier identification of the remaining
20%. Additionally, in each business area, engineering and purchasing teams
have been formed to identify material that meet certain criteria for
inclusion as strategic material. Vendors supplying this strategic material
will be subject to in depth assessment of their ability to continue to supply
to the Company. Remediation actions for at risk vendors include working with
the vendors to ensure continued delivery of material and inventory of some
materials within the Company. Contingency plans include switching from
suppliers that are not Y2K compliant, to vendors that are able to demonstrate
Y2K readiness. This activity is expected to be complete by June 30, 1999.
The Company has incurred costs associated with assessing the Y2K issue and
implementing its Y2K plan. These costs have included consultants, software
upgrades, and security system upgrades. The Company estimates it has incurred
approximately two-thirds of its total expected Y2K costs. Total costs of
assessing and implementing the Company's Y2K plan are not expected to have a
material effect on the Company's consolidated financial position or the results
of its operations.
Consequences of not successfully implementing the Company's Y2K plan include
inability to ship product, delay or loss of sales, and delays in factory
operations. The Company believes that it will substantially complete the
implementation of its Y2K plan before the year 2000, and provided that third
parties mitigate their own risks successfully, the Company believes it will have
no material business risk from such Y2K issues. However, there can be no
assurances that third parties, over which the company has no control, will
successfully address their own Y2K issues.
<PAGE>
Page 18/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (CONT.)
Information in the Management Discussion and Analysis regarding expectations for
future product demand, customers, international shipments and future product
offerings and resources constitute forward-looking statements that involve a
number of risks and uncertainties. In addition, the Company may from time to
time issue other forward-looking statements. The following factors could cause
actual results to differ materially from the forward-looking statements: general
economic conditions, including their impact on capital expenditures; business
conditions in the electronics industry, including the cyclical nature of the
market for the Company's products; rapidly changing technology and evolving
industry standards; availability and continued validity of intellectual property
protection; competitive factors, including increased competition, new product
offerings by competitors and price pressures; availability of supplies from
third party suppliers on a timely basis and at reasonable prices; and
international business conditions, including fluctuations in interest and
currency exchange rates, government financed competition, changes in trade
policies, tariff regulations, and the difficulties of staffing and managing
foreign operations. The forward-looking statements should be considered in
light of these factors.
<PAGE>
Page 19/20
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (CONT.)
On April 8, 1999 a federal court jury awarded ESI a $13.1 million damage
judgment in its patent infringement suit against General Sanning, Inc. ESI
initiated litigation against General Scanning in December 1996 in the U.S.
District Court for the Northern District of California. On April 2, 1999 the
same federal court jury issued a verdict upholding the validity of ESI's
semiconductor link blowing patent-U.S. patent 5,265,144 entitled "System and
Method for Selectively Laser Processing a Target Structure of One or More
Materials or a Multimaterial, Multilayer Device". The jury also concluded
that General Scanning's infringement was willful and gives the court the
authority to increase the damages up to three times. General Scanning has
announced that it intends to appeal the verdict.
On October 20, 1998 the Company filed a second action against General
Scanning, Inc. in the United States District Court for the Northern District
of California for patent infringement. The complaint alleges General Scanning
is violating ESI's patents: 5,569,398 entitled "Laser System and Method for
Selectively Trimming Films" issued on October 29, 1996; 5,685,995 entitled
"Method for Laser Functional Trimming of Films and Devices" issued on
November 11,1997, and 5,808,272 entitled "Laser System for Functional
Trimming of Films and Devices issued on September 15, 1998. This Lawsuit is
still pending.
Numerous users of the Company's products have received notice of patent
infringement form the Lemelson Medical, Educational & Research Foundation
Limited Partnership ("Partnership") alleging that their use of the Company's
products infringes certain patents transferred to the Partnership by the late
Jerome H. Lemelson. Certain of these users have notified the Company that, in
the event it is subsequently determined that their use of the Company's
products infringes any of the Partnership's patents, they make seek
indemnification form the Company for damages or expenses resulting from this
matter.
<PAGE>
Page 20/20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
ELECTRO SCIENTIFIC INDUSTRIES, INC.
Dated: April 15, 1999 /s/ Donald R. VanLuvanee
-----------------------------------
Donald R. VanLuvanee, President and
Chief Executive Officer
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