<PAGE>
Page 1 of 19
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 NOVEMBER 30, 1998 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 NOVEMBER 30, 1998 THERE WERE 11,404,077 SHARES OF COMMON STOCK OF ELECTRO
SCIENTIFIC INDUSTRIES, INC. OUTSTANDING.
<PAGE>
Page 2 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
EXHIBIT INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Part I. Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets 3-4
November 30, 1998 and May 31, 1998*
Consolidated Statements of Income 5
Three Months and Six Months ended
November 30, 1998 and November 30, 1997
Consolidated Statements of Cash Flows 6-7
Six Months ended
November 30, 1998 and November 30, 1997
Notes to Consolidated Financial Statements 8-12
Item 2. Management's Discussion and Analysis of Financial 13-17
Condition and Results of Operations
Part II. Other Information
Item 1. Legal Proceedings 18
Signature 19
*Audited
</TABLE>
<PAGE>
Page 3 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
ASSETS November 30, May 31,
1998* 1998
------------ --------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 6,382 $ 9,803
Securities available for sale 26,803 29,113
-------- --------
Total cash and securities 33,185 38,916
Trade receivables, net 70,762 61,890
Inventories 50,600 49,805
Deferred income taxes 4,788 4,788
Other current assets 4,733 3,558
-------- --------
Total current assets 164,068 158,957
-------- --------
PROPERTY AND EQUIPMENT, AT COST 62,054 57,550
Less - Accumulated depreciation (31,733) (29,912)
-------- --------
Net property and equipment 30,321 27,638
-------- --------
DEFERRED INCOME TAXES 2,692 2,692
OTHER ASSETS 9,934 10,156
-------- --------
$207,015 $199,443
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these statements.
* Unaudited
<PAGE>
Page 4 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
LIABILITIES AND
SHAREHOLDERS' EQUITY November 30, May 31,
1998* 1998
------------ --------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 5,255 $ 5,184
Accrued liabilities:
Payroll related 5,683 5,138
Commissions 5,448 4,025
Warranty 1,752 1,948
Other 1,201 578
-------- --------
Total accrued liabilities 14,084 11,689
Deferred revenue 352 289
-------- --------
Total current liabilities 19,691 17,162
-------- --------
SHAREHOLDERS' EQUITY:
Common stock,without par value; Authorized:
40,000 shares; Outstanding:
11,404, and 11,368 respectively 102,399 101,831
Retained earnings 84,925 80,450
-------- --------
Total shareholders' equity 187,324 182,281
-------- --------
$207,015 $199,443
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these statements.
* Unaudited
<PAGE>
Page 5 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share)
<TABLE>
<CAPTION>
Three Months Six Months
Ended Nov. 30* Ended Nov. 30*
---------------------- --------------------
1998 1997 1998 1997
------- ------- ------- --------
<S> <C> <C> <C> <C>
Net sales $45,349 $59,872 $90,541 $116,991
Cost of sales 22,811 27,266 45,603 52,150
------- ------- ------- --------
Gross margin 22,538 32,606 44,938 64,841
Operating expenses:
Selling, service and administrative 13,306 14,703 26,771 28,272
Research, development and engineering 6,743 7,032 14,217 13,818
Acquiredin-process research and development
And merger related expenses -- -- -- 11,124
------- ------- ------- --------
Total operating expenses 20,049 21,735 40,988 53,214
------- ------- ------- --------
Operating income 2,489 10,871 3,950 11,627
Interest income 273 420 641 910
Other income, net 47 267 91 324
------- ------- ------- --------
Income before income taxes 2,809 11,558 4,682 12,861
Provision for income taxes 960 3,583 1,592 6,804
------- ------- ------- --------
Net income $ 1,849 $ 7,975 $ 3,090 $ 6,057
------- ------- ------- --------
------- ------- ------- --------
Net income per share:
Basic $ 0.16 $ 0.72 $ 0.27 $ 0.55
Diluted $ 0.16 $ 0.70 $ 0.27 $ 0.53
------- ------- ------- --------
------- ------- ------- --------
Weighted average number of shares:
Basic 11,400 11,075 11,392 11,022
Diluted 11,584 11,417 11,619 11,363
</TABLE>
The accompanying notes are an integral part of these statements.
* Unaudited
<PAGE>
Page 6 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months
Ended Nov. 30
-------------------
1998* 1997*
------- --------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income $ 3,090 $ 6,057
Adjustment to align AISI with the period ended November 30, 1997
Adjustments to reconcile net income to cash provided by -- (565)
(used in) operating activities:
Acquired in-process research and development and
Merger-related expenses (1) -- 11,124
Depreciation and amortization 2,670 2,803
Changes in operating accounts:
(Increase) decrease in trade receivables (7,473) (640)
Decrease (increase) in inventories 461 (5,453)
(Increase) decrease in other current assets (1,175) (1,348)
Increase (decrease) in current liabilities 2,156 (4,661)
------- --------
Net cash (used in) provided by operating activities: (271) 7,317
------- --------
Cash Flows From Investing Activities:
Purchases of property and equipment (5,456) (6,766)
Purchase of securities (8,740) (12,871)
Proceeds from sales of securities and maturing securities 11,050 11,500
Increase in other assets (572) (37)
------- --------
Net cash used in investing activities: (3,718) (8,174)
------- --------
Cash Flows From Financing Activities:
Repayment of Dynamotion subsidiary debt (2) -- (6,979)
Net repayment of AISI subsidiary debt -- (74)
Proceeds from exercise of stock options and stock plans 568 3,280
------- --------
Net cash, provided by (used in) financing activities: 568 (3,773)
------- --------
Net Change in Cash and Cash Equivalents (3,421) (4,630)
Cash and Cash Equivalents at Beginning of Period 9,803 20,315
------- --------
Cash and Cash Equivalents at End of Period $ 6,382 $ 15,685
------- --------
------- --------
</TABLE>
The accompanying notes are an integral part of these statements.
*Unaudited
<PAGE>
Page 7 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(Unaudited)
Cash payments for interest were not significant for the six months ended
November 30, 1998 and November 30, 1997. Cash payments for income taxes were $
1,117 and $9,014 for the six months ended November 30, 1998 and November 30,
1997, respectively.
Notes:
(1) See Note 5 in Notes to Consolidated Financial Statements.
<TABLE>
<S> <C>
(2) Acquisition of Dynamotion subsidiary:
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>
Page 8 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(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 $288 at
November 30, 1998 and $419 at May 31, 1998*.
NOTE 3 - INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
November 30, 1998 May 31, 1998*
----------------- -------------
<S> <C> <C>
Raw materials and purchased parts $33,165 $31,491
Work-in-process 7,338 8,975
Finished goods 10,097 9,339
------- -------
$50,600 $49,805
------- -------
------- -------
</TABLE>
*Audited
<PAGE>
Page 9 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(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 Six Months
Ended Nov. 30 Ended Nov. 30
----------------- -----------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $ 1,849 $ 7,975 $ 3,090 $ 6,057
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 11,400 11,075 11,392 11,022
Dilutive effect of employee stock
options after application of the
treasury stock method 184 342 227 341
------- ------- ------- -------
Weighted average number of shares
outstanding for computing diluted net
income per share 11,584 11,417 11,619 11,363
------- ------- ------- -------
------- ------- ------- -------
Net income per share - basic $0.16 $0.72 $0.27 $0.55
------- ------- ------- -------
------- ------- ------- -------
Net income per share - diluted $0.16 $0.70 $0.27 $0.53
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
<PAGE>
Page 10 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
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. The
following shares have not been recalculated using the treasury stock method.
<TABLE>
<CAPTION>
Three Months Six Months
Ended November 30 Ended November 30
----------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Number of Employee Stock Options 171 -- 329 --
</TABLE>
NOTE 5 - ACQUISITIONS
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
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 expense during the
quarter ended August 31, 1997 and is reflected in the accompanying Consolidated
Statements of Operations.
The statement of operations data for the three months and six months ended
November 30, 1997 was prepared as if the acquisition had occurred at the
beginning of the period. The pro forma effect of Dynamotion's revenue and net
income for the period from June 1 to June 9, 1997 is not significant.
<PAGE>
Page 11 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
NOTE 5 - CONT.
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 shares of ESI stock. The transaction
has been accounted for as a pooling of interests.
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.
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
1,400 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.
A reconciliation of amounts previously reported to amounts included in the
financial statements is as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended Nov. 30 Ended Nov. 30
------------- -------------
1997 1997
------- --------
<S> <C> <C>
Revenue:
ESI $51,390 $ 99,746
AISI 8,482 17,245
------- --------
As Restated $59,872 $116,991
Net Income:
ESI $ 6,170 $ 2,309
AISI 1,805 3,748
------- --------
As Restated $ 7,975 $ 6,057
</TABLE>
<PAGE>
Page 12 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
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.
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.
<PAGE>
Page 13 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS
Results of Operations
Revenue of $45.3 million for the quarter ended November 30, 1998 was $14.5
million or 24% lower than in the second quarter of fiscal 1998, and was $0.1
million higher than for the quarter ended August 31, 1998. Memory yield
equipment represented the largest percentage of sales for the quarter at 33% of
total revenues versus 28% in the second quarter of the prior year. Overall,
memory yield improvement, electronic component and machine vision equipment
sales were down over the same quarter in the prior year, partially offset by
increased sales in circuit fine tuning and advanced packaging equipment.
Capacity purchases of electronic component manufacturing equipment have been
delayed as our customers have focused on achieving higher utilization rates of
existing equipment in their facilities. Broad based declines in capital
expenditures have also negatively impacted our vision customers and, although we
have successfully expanded our customer base for vision products, our existing
customers have experienced significant declines in sales volumes as compared to
fiscal 1998 levels. Revenues from circuit fine tuning, advanced packaging, and
vision systems were down this quarter in comparison to last quarter, offset by
an increase in revenues from memory yield improvement systems and electronic
component equipment over last quarter.
Gross margin for the three months ended November 30, 1998 decreased to 49.7%
from 54.5% for the second quarter of the prior fiscal year. Lower margins were
the result of a shift in product mix, a slight decrease in average selling
prices, and underabsorption of overhead costs due to lower unit volumes. Gross
margin for the current period was up slightly from 49.6% for the prior quarter.
Selling, service and administrative expenses for the three months ended November
30, 1998 were $1.4 million lower than for the second quarter of fiscal 1998.
The decrease is due to lower professional fees and bonus accruals as well as
general reductions associated with the continued consolidation of administrative
functions for recent acquisitions (AISI and Chip Star). Expenses for sales,
services and administration were down $0.2 million from the prior quarter due to
the first full-quarter effect of expense reduction initiatives that began in the
first quarter of fiscal 1999.
Expenses associated with research, development and engineering decreased by
$0.3 million as compared to the quarter ended November 30, 1997. Research,
development and engineering expenses decreased by $0.7 million from the first
quarter of fiscal 1999. The decreases are attributable to lower contract
labor costs and project spending. Research, development and engineering
spending typically fluctuates from quarter to quarter as engineering projects
move through their life cycles.
Net income for the quarter ended November 30, 1998 was $1.8 million or $0.16 per
basic share. This represents a decrease of 76.8% over the second quarter of
fiscal 1998, when there were earnings of $8.0 million or $0.72 per basic share.
Ending backlog on November 30, 1998 was $16.4 million as compared to $12.9
million on August 31, 1998 as book to ship times increased.
<PAGE>
Page 14 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (cont.)
Liquidity, Capital Resources and Business Environment
The Company's principal sources of liquidity are existing cash and cash
equivalents and marketable debt securities of $33.2 million, accounts
receivable of $70.8 million, and a $7.0 million line of credit, none of which
was outstanding at November 30, 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. ESI has a current ratio of
8.3:1 and no long-term debt. Working capital increased to $144.4 million at
November 30, 1998 vs. $141.8 million at May 31, 1998. Inventory increased by
$0.8 million from May 31, 1998 to November 30, 1998. Increases in raw
materials and finished goods were partially offset by a decrease in
work-in-process inventory.
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 percentage 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.
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 ESI products within agreed upon terms. In addition,
substantially all Asian end customer receivables are secured by letter of
credit.
<PAGE>
Page 15 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (cont.)
There can be no assurance that difficulties in the Asian economy 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. These risks include 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 US 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 in yen,
and ESI hedges these sales transactions to mitigate currency risks. The
European and Asian subsidiaries' operating expenses are denominated in their
respective local currencies. These transactions represent approximately 10%
of total consolidated operating expenses, with 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.
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.
<PAGE>
Page 16 of 19
ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES
MANAGEMENT DISCUSSION AND ANALYSIS (cont.)
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 director level manager 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 17 of 19
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 18 of 19
Part II. Other Information
Item 1. Legal Proceedings
On September 30, 1998 the U.S. District Court for the Northern District of
California issued a series of orders regarding ESI's lawsuit against General
Scanning, Inc. for patent infringement. The lawsuit alleges General Scanning is
infringing certain claims of ESI's patents. The Court granted ESI's Motion for
Summary Judgment of Literal Infringement by General Scanning. The Court granted
ESI's Motion for Summary Judgment on the issue of no inequitable conduct by ESI
in the prosecution of ESI's patent. The Court denied General Scanning's Motion
for Summary Judgment of Invalidity of the asserted claims of ESI patents. ESI
initiated litigation against General Scanning in December 1996. The lawsuit is
still pending in the U.S. District Court for the Northern District of
California.
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. The lawsuit is still pending.
<PAGE>
Page 19 of 19
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: January 14, 1999 By /s/ Barry L. Harmon
---------------------------------
Barry L. Harmon, Senior Vice
President and Chief Financial
Officer
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