Edgar Filing: ELECTRO SCIENTIFIC INDUSTRIES INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 29, 2007

¨	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: (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 x No ¨

Indicate by check mark whether the registrant is large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares outstanding of the Registrant’s Common Stock at January 24, 2008 was 27,887,825 shares.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

TABLE OF CONTENTS



		Page
PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Condensed Balance Sheets – December 29, 2007 and June 2, 2007	2

	Consolidated Condensed Statements of Operations – Three Months and Six Months Ended December 29, 2007 and December 2, 2006	3

	Consolidated Condensed Statements of Cash Flows – Six Months Ended December 29, 2007 and December 2, 2006, and Seven Months Ended December 29, 2007	4

	Notes to Consolidated Condensed Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

Item 4.	Controls and Procedures	31

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	32

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41

Item 4.	Submission of Matters to a Vote of Security Holders	42

Item 6.	Exhibits	43

Signatures		44

PART I - FINANCIAL INFORMATION

Item 1.

Financial Statements

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands)

(Unaudited)


	December 29, 2007		June 2, 2007
Assets
Current assets:
Cash and cash equivalents	$	152,997	$	100,462
Marketable securities		7,584		124,607

Total cash and securities		160,581		225,069
Trade receivables, net of allowances of $760 and $626		59,986		55,722
Inventories		88,934		80,981
Shipped systems pending acceptance		10,368		1,817
Deferred income tax asset, net		10,179		9,504
Prepaid and other current assets		8,722		5,776

Total current assets		338,770		378,869
Long-term marketable securities		21,727		3,622
Property, plant and equipment, net of accumulated depreciation of $66,017 and $58,701		45,792		43,859
Deferred income tax asset, net		8,373		11,246
Goodwill		11,541		1,442
Acquired intangible assets, net of accumulated amortization of $1,310 and $0		11,001		—
Other assets		35,938		26,630

Total assets	$	473,142	$	465,668

Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable	$	12,215	$	13,826
Accrued liabilities		26,307		25,465
Deferred revenue		24,751		12,290

Total current liabilities		63,273		51,581
Income tax liability		7,598		5,757
Commitments and contingencies
Shareholders' equity:
Preferred stock, without par value; 1,000 shares authorized; no shares issued		—		—
Common stock, without par value; 100,000 shares authorized; 27,837 and 28,766 shares issued and outstanding		142,612		162,719
Retained earnings		259,156		245,546
Accumulated other comprehensive income		503		65

Total shareholders' equity		402,271		408,330

Total liabilities and shareholders' equity	$	473,142	$	465,668

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS

(In thousands, except per share data)

(Unaudited)


	For the three months ended					For the six months ended
	December 29, 2007		December 2, 2006			December 29, 2007		December 2, 2006
Net sales	$	77,286	$	59,301		$	159,604	$	119,669
Cost of sales		41,602		35,027			87,111		69,130

Gross profit		35,684		24,274			72,493		50,539
Operating expenses:
Selling, service and administration		15,978		12,023			31,358		24,074
Research, development and engineering		11,508		9,617			22,601		18,921
Write-off of acquired in-process research & development		—		—			2,800		—
Insurance recoveries		—		(1,000	)		—		(2,287	)

		27,486		20,640			56,759		40,708

Operating income		8,198		3,634			15,734		9,831
Interest and other income, net		1,856		2,278			3,916		5,090

Income before income taxes		10,054		5,912			19,650		14,921
Provision for income taxes		3,392		2,123			7,458		4,930

Net income	$	6,662	$	3,789		$	12,192	$	9,991

Net income per share - basic	$	0.24	$	0.13		$	0.44	$	0.34

Net income per share - fully diluted	$	0.24	$	0.13		$	0.43	$	0.34

Weighted average number of shares - basic		27,817		29,128			27,989		29,102

Weighted average number of shares - fully diluted		28,238		29,522			28,452		29,303

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW

(In thousands)

(Unaudited)


	For the six months ended						For the seven months ended
	December 29, 2007			December 2, 2006			December 29, 2007
Cash flows from operating activities:
Net income	$	12,192		$	9,991		$	13,610
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation		4,944			4,093			5,625
Amortization of intangible assets		1,310			15			1,310
Write-off of in-process research & development		2,800			—			2,800
Insurance recovery on damaged equipment		—			(1,287	)		—
Stock-based compensation expense		2,182			1,488			2,377
Provision for doubtful accounts		—			104			—
Loss on disposal of property and equipment		34			—			35
Deferred income taxes		(54	)		2,947			(54	)
Changes in operating accounts, net of assets acquired:
(Increase) decrease in trade receivables, net		(2,673	)		(5,350	)		2,237
Decrease in inventories		(52	)		(11,740	)		(4,797	)
(Increase) decrease in shipped systems pending acceptance		(8,242	)		749			(8,551	)
(Increase) decrease in prepaid and other current assets		1,178			(2,843	)		857
Increase (decrease) in accounts payable and other liabilities		(10,136	)		2,470			(8,105	)
Increase (decrease) in deferred revenue		10,604			(77	)		10,858

Net cash provided by operating activities		14,087			560			18,202
Cash flows from investing activities:
Purchase of property, plant and equipment		(3,284	)		(5,718	)		(3,850	)
Purchase of securities		(277,309	)		(281,840	)		(310,750	)
Proceeds from sales of securities and maturing securities		353,526			303,512			409,580
Cash paid for acquisition of NWR, net of cash acquired		(36,159	)		—			(36,159	)
Minority equity investment		—			(11,000	)		—
Insurance recovery on damaged equipment		—			1,287			—
(Increase) decrease in other assets		1,022			1,099			(1,178	)

Net cash provided by investing activities		37,796			7,340			57,643
Cash flows from financing activities:
Proceeds from exercise of stock options and stock plans		3,373			1,370			3,520
Share repurchases		(21,552	)		—			(27,540	)
Excess tax benefits realized from stock options exercised		710			40			710

Net cash provided by (used in) financing activities		(17,469	)		1,410			(23,310	)

Net increase in cash and cash equivalents		34,414			9,310			52,535
Cash and cash equivalents:
Beginning of period		118,583			79,961			100,462

End of period	$	152,997		$	89,271		$	152,997

Supplemental cash flow information:
Income tax refunds received	$	133		$	331		$	133
Cash paid for income taxes		(7,940	)		(939	)		(7,940	)

The accompanying notes are an integral part of these statements.

ELECTRO SCIENTIFIC INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

These unaudited interim consolidated condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in these interim statements. Accordingly, these 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. These consolidated condensed 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.

Results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. With the exception of the adoption of Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as discussed in Note 16, the Company’s significant accounting policies remain unchanged from those presented in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K filed for the fiscal year ended June 2, 2007.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. Management believes that the estimates used are reasonable. Significant estimates made by management include: inventory write-downs; allowances for uncollectible trade accounts receivables; valuation of minority equity investments; long-lived assets valuations; product warranty reserves; loss contingency reserves; revenue recognition; purchase accounting; stock compensation valuation and income tax benefits, expenses and deferred taxes.

On July 3, 2007, the Company’s Board of Directors approved a change in the Company’s reporting periods that results in a fiscal year end on the Saturday nearest March 31. Accordingly, the Company’s fiscal year 2008 will consist of approximately a ten month period containing 43 weeks ending on March 29, 2008. The Company has elected to file its interim financial statements in Quarterly Reports on Form 10-Q based on the reporting periods in its new fiscal year ending March 29, 2008. In order to conform to the prospective reporting periods in our new fiscal year, we refer to the three months ended December 29, 2007 as the third quarter of fiscal 2008. The current year financial statements are presented for the three months and six months ended December 29, 2007. Due to the implementation of its enterprise resource system in the fourth quarter of fiscal 2006, the Company performed full close and reporting procedures on a fiscal quarter basis only during fiscal 2007 and comparative data for the three months and six months ended December 30, 2006 are not available and are not cost beneficial to prepare. As such, comparative data has been provided for the prior year using the three-month and six-month results for the financial reporting period ending on the date nearest to December 29, which is the second quarter of fiscal 2007 ended December 2, 2006. The Company believes that the second quarter of fiscal 2007 and related six-month results provide a meaningful comparison to the three-month and six-months period ending December 29, 2007. The Company does not believe that there are any meaningful factors, seasonal or otherwise, that would impact the comparability of information or trends, if results for the three months and six months ended December 30, 2006 were presented in lieu of results for the second quarter of fiscal 2007 and the six months ended December 2, 2006.

The consolidated condensed statement of operations in this report for the six months ended December 29, 2007 does not present amounts included in fiscal 2008 year-to-date results of operations for the four weeks ending June 30, 2007, which are detailed as follows (in thousands):


Net sales	$	16,961
Cost of sales		8,886

Gross profit		8,075
Selling, service and administration		3,745
Research, development and engineering		2,886

Operating income		1,444
Interest and other income, net		816

Income before income taxes		2,260
Provision for income taxes		842

Net income	$	1,418

Net income per share - basic and diluted	$	0.05

Certain reclassifications have been made in the accompanying consolidated condensed financial statements for prior periods to conform to the current presentation.

During the third quarter of fiscal 2007, the Company revised its results of operations for the first quarter of fiscal 2007 for certain immaterial corrections and the amounts presented for the six months ended December 2, 2006 in the consolidated condensed financial statements and related notes are the revised amounts, as shown in the table below:


	Six months ended December 2, 2006
(in thousands, except per share amounts)	As Reported			Adjustment			As Revised
Consolidated Condensed Statement of Operations:
Net sales	$	119,465		$	204		$	119,669
Cost of sales		67,910			1,220			69,130

Gross profit		51,555			(1,016	)		50,539
Selling, service and administration		24,181			(107	)		24,074
Research, development and engineering		18,921			—			18,921
Insurance recovery		(2,287	)		—			(2,287	)

Operating income		10,740			(909	)		9,831
Interest and other income, net		5,188			(98	)		5,090

Income before income taxes		15,928			(1,007	)		14,921
Provision for income taxes		5,367			(437	)		4,930

Net income	$	10,561		$	(570	)	$	9,991

Net income per share - basic and diluted	$	0.36		$	(0.02	)	$	0.34

As shown in the table above, the revisions to the first quarter of fiscal year 2007 include the following:

•

Increase in net sales of $0.2 million related to deferral of the fair value of certain undelivered elements and the timing of recording credit memos issued to certain customers;

•

Increase in cost of sales of $1.2 million primarily related to inaccurate inventory transactions recorded within the new enterprise resource planning (ERP) system and, to a lesser degree, late freight and duty invoices received from an offshore service provider;

•

Decrease in variable expenses included in selling, service and administration of $0.1 million resulting from the above adjustments;

•

Decrease in other income of $0.1 million due to revised net foreign exchange loss; and

•

Net decrease in tax expense of $0.4 million resulting from the above revisions.

Based on the above adjustments, the net cash used in operating activities presented in the consolidated condensed statement of cash flows for the six months ended December 2, 2006 decreased by $0.7 million and net cash provided by investing activities increased by $0.7 million.

Note 2 – Acquisition of New Wave Research, Incorporated

On July 20, 2007, the Company acquired New Wave Research, Incorporated (“NWR”), a privately held company headquartered in Fremont, California. NWR is a global leader in the development of high-end lasers and laser-based systems and its products are used in the semiconductor market for sapphire wafer scribing, flat-panel display repair and semiconductor failure analysis, among other applications. The acquisition was an investment aimed at leveraging the companies’ combined core competencies into adjacent markets and driving revenue growth and shareholder value, which supports the premium paid over the fair market value of individual assets.

The Company acquired 100% of NWR’s outstanding common stock for approximately $36.2 million, comprised of $34.9 million in cash and merger-related transaction costs of $1.3 million. The contractual purchase price of $36.0 million was reduced by $1.1 million related to certain net working capital adjustments and indemnity payments agreed to prior to closing. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their fair values. Analysis supporting the purchase price allocation includes a valuation of assets and liabilities as of the closing date, a valuation specialist’s report on intangible assets and a detailed review of the opening balance sheet to determine other significant adjustments required to recognize assets and liabilities at fair value. The purchase price allocation is subject to further changes, including the finalization of purchase price adjustments for payments to former NWR shareholders relating to the amount of NWR’s net working capital on the date of acquisition, the resolution of various tax-related matters and liabilities and additional merger-related transaction costs. In the third quarter of fiscal 2008, the Company reduced its acquired value-added tax liability and its deferred tax valuation allowance required for net operating losses, resulting in the reduction in goodwill of approximately $1.3 million.

The following table presents the preliminary allocation of the purchase price of $36.2 million to the assets acquired and liabilities assumed based on their fair values (in thousands):


Accounts receivable	$	5,437
Inventory		6,110
Prepaid expense and other current assets		3,457
Property, plant and equipment		2,579
Intangible assets		12,311
In-process research & development		2,800
Goodwill		10,099
Other long-term assets		1,129
Accounts payable and accrued liabilities		(11,100	)
Deferred revenue ⁽¹⁾		(1,603	)

Net assets acquired		31,219
Escrow deposits pending disbursement ⁽²⁾		4,940

Total purchase price, net of cash acquired	$	36,159

(1)	The amount recorded for deferred revenue represents the fair value of the remaining obligation assumed related to custom acceptance criteria and remaining revenue on extended warranties.

(2)	The final disbursement of escrow deposits will increase the goodwill recorded in the acquisition by the amount of the disbursement. This amount is included in other long-term assets at December 29, 2007.

The following table presents the details of the intangible assets purchased in the NWR acquisition as of July 20, 2007 and accumulated amortization to date at December 29, 2007 (in thousands):


	Useful life	Estimated Fair Value at Acquisition		Accumulated Amortization			Recorded value at December 29, 2007
Developed technology	7 years	$	8,100	$	(511	)	$	7,589
Customer relationships	6 years		2,700		(341	)		2,359
Customer backlog	1 year		700		(309	)		391
Trade name and trademarks	3 years		400		(59	)		341
Change of control agreements	1 year		100		(44	)		56
Fair value of below-market lease (non-current portion)	3.8 years		311		(46	)		265

Subtotal – long term			12,311		(1,310	)		11,001
Fair value of below-market lease (current portion)			110		—			110

Total acquired intangible assets		$	12,421	$	(1,310	)	$	11,111

Amortization expense for intangible assets purchased in the NWR acquisition was approximately $0.7 and $1.3 million for the three-month and six-month periods ended December 29, 2007, respectively, and has been recorded in the consolidated condensed statement of operations as follows (in thousands):


	Three months ended December 29, 2007		Six months ended December 29, 2007
Cost of sales	$	289	$	511
Selling, service and administration		454		799

	$	743	$	1,310

The estimated amortization expense of intangible assets purchased in the NWR acquisition for the current fiscal year, including amounts amortized to date, and in future years is as follows (in thousands):


Fiscal Year	Amortization
2008	$	2,052
2009		2,330
2010		1,954
2011		1,734
2012		1,472
2013		1,325
2014		1,197
2015		357

	$	12,421

At the acquisition date, NWR had in-process research and development valued at $2.8 million and the immediate write-off of this amount has been included in operating expenses for the six-month period ended December 29, 2007. The in-process research and development related to three programs consisting of development on a diode-pumped solid-state LED wafer-scribing system, a next-generation Advanced Beam Delivery System and a next-generation laser product. The value of the in-process research and development was based on the excess earnings method of the income approach, which measures the value of an asset by calculating the present value of related future economic benefits, such as cash earnings. In determining the value of in-process research and development, the assumed commercialization date for these products was April 2008. The current estimated commercialization dates for these products ranges from May 2008 to November 2008. The modeled cash flow was discounted back to the net present value and was based on estimates of revenues and operating profits related to the project. Significant assumptions used in the valuation of in-process research and development included: stage of development of the project, future revenues, the estimated life of the product’s underlying technology, future operating expenses, and a discount rate of 18% to reflect present value.

Purchase accounting adjustments were made to record inventory at fair value on the date of acquisition. These adjustments resulted in $0.2 million in additional purchase accounting charges to cost of sales in the third quarter of fiscal 2008 and $1.1 in the six months ended December 29, 2007.

The NWR results of operations are included in our consolidated financial statements from the date of acquisition forward. The NWR acquisition was not significant, as defined in Regulation S-X of the Securities and Exchange Commission, compared to our overall financial position. Accordingly, pro forma financial statements of the combined entities are not presented.

Note 3 – Marketable Securities

As of December 29, 2007, the Company had a total of $19.6 million invested in auction rate securities. These securities historically provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 to 35 days. This mechanism allows existing investors to either retain or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. In the second quarter of fiscal 2008, the Company determined that these securities should be reclassified to long-term marketable securities on the consolidated condensed balance sheet. The Company has the intent and ability to hold these securities until they reach maturity or are redeemed by the issuers and accrued interest income continues to be received when due. As such, the Company has determined that there has been no permanent impairment of the value of these securities and that their par value approximates fair value. Thus, no unrealized gain or loss has been recorded in other comprehensive income or in the condensed consolidated statement of operations.

Note 4 – Inventories

Inventories are principally valued at standard costs, which approximate the lower of cost (on a first-in, first-out basis) or market. Components of inventories were as follows (in thousands):


	December 29, 2007		June 2, 2007
Raw materials and purchased parts	$	54,152	$	50,021
Work-in-process		19,816		19,170
Finished goods		14,966		11,790

	$	88,934	$	80,981

Note 5 – Other Assets

Other assets consisted of the following (in thousands):


	December 29, 2007		June 2, 2007
Patents, net	$	153	$	188
Consignment and demo equipment, net		9,866		7,516
Minority equity investment		11,000		11,000
All-Ring patent suit court bond		9,084		6,901
Acquisition escrow deposit		4,940		—
Other		895		1,025

	$	35,938	$	26,630

As discussed in Note 15, in June 2007, the Company paid an additional $2.1 million to increase its Taiwan dollar security bond posted with the Kaohsiung Court in Taiwan related to the filing of a patent infringement suit against All Ring Tech Co., Ltd. in that jurisdiction.

As discussed in Note 2, escrow deposits totaling $4.9 million related to the NWR acquisition are included in other assets pending final disbursement.

Note 6 – Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):


	December 29, 2007		June 2, 2007
Payroll-related	$	9,947	$	11,391
Product warranty		3,876		3,893
Income taxes payable		2,268		2,961
Value-added taxes payable		2,243		648
Other		7,973		6,572

	$	26,307	$	25,465

See Note 7 for a discussion of the accrual for product warranty.

Note 7 – Product Warranty

The Company evaluates obligations related to product warranties quarterly. A standard one-year warranty is provided on products. Warranty charges are comprised of costs to service the warranty, including labor to repair the system and replacement parts for defective items, as well as other costs incidental to the repairs. Warranty charges are recorded net of any cost recoveries resulting from either successful repair of damaged parts or from warranties offered by the Company’s suppliers for defective components. Using historical data, the Company estimates average warranty cost per system or part type and records the provision for such charges as an element of cost of goods sold upon recognition of the related revenue. Additionally, the overall warranty accrual balance is separately analyzed using the remaining warranty periods outstanding on systems and items under warranty, and any resulting changes in estimates are recorded as an adjustment to cost of sales. If circumstances change, or if a material change in warranty-related incidents occurs, the estimate of the warranty accrual could change significantly. Accrued product warranty is included on the consolidated condensed balance sheets as a component of accrued liabilities.

Following is a reconciliation of the change in the aggregate accrual for product warranty for the three months ended December 29, 2007 and December 2, 2006 (in thousands):


	Three months ended
	December 29, 2007			December 2, 2006
Product warranty accrual, beginning	$	4,424		$	3,766
Warranty charges incurred, net		(2.448	)		(1,196	)
Provision for warranty charges		1,900			1,125

Product warranty accrual, ending	$	3,876		$	3,695

Following is a reconciliation of the change in the aggregate accrual for product warranty for the six months ended December 29, 2007 and December 2, 2006 and the seven months ended December 29, 2007 (in thousands):


	Six months ended						Seven months ended December 29, 2007
	December 29, 2007			December 2, 2006			Seven months ended December 29, 2007
Product warranty accrual, beginning	$	3,630		$	3,716		$	3,893
NWR warranty reserve acquired		774			—			774
Warranty charges incurred		(2,895	)		(2,573	)		(3,746	)
Provision for warranty charges		2,367			2,552			2,955

Product warranty accrual, ending	$	3,876		$	3,695		$	3,876

Note 8 – Deferred Revenue

Revenue is deferred pending title transfer and fulfillment of acceptance criteria, which frequently occur at the time of delivery to a common carrier. Shipments for which title transfer has not occurred and/or acceptance criteria cannot be demonstrated at the Company’s factory include sales to Japanese end-user customers and shipments of substantially new products. In sales involving multiple element arrangements, the fair value of any undelivered elements, including installation services, is deferred until the elements are delivered and acceptance criteria are met. Revenue related to maintenance and service contracts is deferred and recognized ratably over the duration of the contracts.

The following is a reconciliation of the changes in deferred revenue for the three months ended December 29, 2007 and December 2, 2006 (in thousands):


	Three months ended
	December 29, 2007			December 2, 2006
Deferred revenue, beginning	$	19,365		$	12,159
Revenue deferred		16,574			7,952
Revenue recognized		(11,188	)		(6,867	)

Deferred revenue, ending	$	24,751		$	13,244

The following is a reconciliation of the changes in deferred revenue for the six months ended December 29, 2007 and December 2, 2006 and the seven months ended December 29, 2007 (in thousands):


	Six months ended						Seven months ended December 29, 2007
	December 29, 2007			December 2, 2006			Seven months ended December 29, 2007
Deferred revenue, beginning	$	12,544		$	13,321		$	12,290
NWR deferred revenue acquired		1,603			—			1,603
Revenue deferred		30,579			13,484			32,577
Revenue recognized		(19,975	)		(13,561	)		(21,719	)

Deferred revenue, ending	$	24,751		$	13,244		$	24,751

Note 9 – Earnings Per Share

The following is a reconciliation of weighted-average shares outstanding used in the calculation of basic and diluted earnings per share (EPS) for the three months ended December 29, 2007 and December 2, 2006 (in thousands):


	Three months ended December 29, 2007			Three months ended December 2, 2006
	Net Income		Shares	Net Income		Shares
Net income available to common shareholders – basic	$	6,662	27,817	$	3,789	29,128
Effect of dilutive shares		—	421		—	394

Net income available to common shareholders – diluted	$	6,662	28,238	$	3,789	29,522

The following is a reconciliation of weighted-average shares outstanding used in the calculation of basic and diluted earnings per share (EPS) for the six months ended December 29, 2007 and December 2, 2006 (in thousands):


	Six months ended December 29, 2007			Six months ended December 2, 2006
	Net Income		Shares	Net Income		Shares
Net income available to common shareholders – basic	$	12,192	27,989	$	9,991	29,102
Effect of dilutive shares		—	463		—	201

Net income available to common shareholders – diluted	$	12,192	28,452	$	9,991	29,303

In the diluted EPS calculations for the three months ended December 29, 2007 and December 2, 2006, employee stock options representing approximately 2,561,000 and 2,748,000 common stock equivalent shares, respectively, were excluded because inclusion would have had an antidilutive effect. In the diluted EPS calculation, approximately 2,538,000 and 2,720,000 antidilutive shares, respectively, were excluded for the six months ended December 29, 2007 and December 2, 2006.

Note 10 – Comprehensive Income

The components of comprehensive income, net of tax, for the three months and six months ended December 29, 2007 and December 2, 2006 are as follows (in thousands):


	Three months ended
	December 29, 2007		December 2, 2006
Net income	$	6,662	$	3,789
Other comprehensive income		4		(6	)
Foreign currency translation adjustment		49		406
Net unrealized gain on securities classified as available for sale		1		231

	$	6,716	$	4,420

The components of comprehensive income, net of tax, for the six months ended December 29, 2007 and December 2, 2006 are as follows (in thousands):


	Six months ended
	December 29, 2007			December 2, 2006
Net income	$	12,192		$	9,991
Other comprehensive income		9			(11	)
Foreign currency translation adjustment		382			222
Net unrealized gain (loss) on securities classified as available for sale		(134	)		494

	$	12,449		$	10,696

Note 11 - Share Repurchase Program

On March 9, 2007, the Company’s Board of Directors authorized the repurchase of up to $50 million in shares of the Company’s outstanding common stock beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. During the three months ended December 29, 2007, approximately 72,000 shares were repurchased at a total purchase price of $1.8 million. Approximately 897,000 shares were purchased in the six months ended December 29, 2007 at a total purchase price of $20.6 million. Cash used to settle the repurchase transactions in the six months ended December 29, 2007 totaled $21.6 million, including $1.0 million for amounts owed on the unsettled repurchase transactions at June 30, 2007. On October 9, 2007, the Company suspended purchase transactions under its share repurchase program. In total, the Company repurchased approximately 1.7 million shares for $37.3 million under this share repurchase program at an average price per share of $21.96.

On January 22, 2008, the Company’s Board of Directors voted to resume the previous $50 million share repurchase program. Accordingly, the Board of Directors has authorized the repurchase of up to $12.7 million in shares of the Company’s outstanding common stock over a six-month period beginning January 29, 2008 through transactions in the open market or in negotiated transactions with brokers or shareholders.

Note 12 – Stock Based Compensation Plans

The Company uses the Black-Scholes model to estimate the fair value of all stock-based compensation awards on the date of grant, except for unvested stock awards which are valued at the fair market value on the date of award. The Company generally recognizes compensation expense for options and unvested stock awards on a straight-line basis over the requisite service period of each award.

Stock-based compensation was included in our consolidated statements of operations as follows (in thousands):


	Three months ended
	December 29, 2007			December 2, 2006
Cost of sales	$	169		$	172
Selling, service, and administration		685			506
Research, development, and engineering		284			233
Stock-based compensation expense before income taxes		1,138			911
Income tax benefit		(360	)		(74	)

Total stock-based compensation expense after income taxes	$	778		$	837


	Six months ended
	December 29, 2007			December 2, 2006
Cost of sales	$	299		$	280
Selling, service, and administration		1,387			850
Research, development, and engineering		496			358

Stock-based compensation expense before income taxes		2,182			1,488
Income tax benefit		(643	)		(174	)

Total stock-based compensation expense after income taxes	$	1,539		$	1,314

The total amount of cash received from the exercise of stock options and stock plans for the three and six months ended December 29, 2007 was $1.3 million and $3.4 million, respectively. For the six months ended December 29, 2007, there was $0.7 million in excess tax benefit realized from the exercise of stock options and ESPP purchases. There was no material excess tax benefit realized in the three months ended December 29, 2007. Upon exercise of stock options, the Company issues new shares of common stock from its authorized shares.

As of December 29, 2007, no stock-based compensation costs were capitalized and the Company had $12.3 million of total unamortized stock-based compensation costs, net of estimated forfeitures, to be recognized over a weighted-average period of 2.9 years.

At December 29, 2007, the Company had 9,668,442 shares of its common stock reserved for issuance under all of its plans combined. Of those shares, 4,527,155 are subject to issuance under currently outstanding stock options and stock awards and 5,141,287 shares are available for future grants. The weighted-average fair-value of stock-based compensation awards, including stock option awards granted and vested during the period, unvested stock awards granted during the period and the intrinsic value of stock options exercised during the period were (in thousands, except per share data):


	Three months ended
	December 29, 2007		December 2, 2006
Stock Option Awards:
Grant date fair value per share	$	—	$	9.40
Total fair value of options granted		—		940
Total fair value of options vested		66		530
Total intrinsic value of options exercised		65		80
Unvested Stock Awards:
Grant date fair value per share	$	22.73	$	20.49
Total fair value of awards granted		1,023		201
Employee Stock Purchase Plan:
Grant date fair value per share	$	6.80	$	6.63
Total grant date fair value		415		1,455


	Six months ended
	December 29, 2007		December 2, 2006
Stock Option Awards:
Grant date fair value per share	$	10.82	$	9.40
Total fair value of options granted		1,780		940
Total fair value of options vested		765		980
Total intrinsic value of options exercised		580		103
Unvested Stock Awards:
Grant date fair value per share	$	22.73	$	18.81
Total fair value of awards granted		9,442		1,947
Employee Stock Purchase Plan:
Grant date fair value per share	$	6.76	$	6.36
Total grant date fair value		479		1,842

Information with respect to stock option activity for the seven months ended December 29, 2007 is as follows:


	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value (in thousands)
Outstanding as of June 2, 2007	4,292,422		$	25.03
Granted	164,499		$	20.06
Exercised	(151,431	)	$	19.12
Expired or forfeited	(340,982	)	$	22.34

Outstanding as of December 29, 2007	3,964,508		$	25.28	5.96 years	$	2,392

Vested and expected to vest as of December 29, 2007	3,933,310		$	25.31	5.93 years	$	2,372

Exercisable as of December 29, 2007	3,699,567		$	25.61	5.74 years	$	2,177

Information with respect to unvested stock awards activity for the seven months ended December 29, 2007 is as follows:


	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Weighted Average Grant Date Fair Value (in thousands)
Outstanding as of June 2, 2007	223,194		$	20.01
Granted	416,841		$	22.73
Vested	(57,938	)	$	24.32
Expired or forfeited	(19,450	)	$	22.78

Outstanding as of December 29, 2007	562,647		$	21.81	2.56 years	$	11,253

Note 13 – Geographic and Product Information

Net sales by product type for the three months ended December 29, 2007 and December 2, 2006 were as follows (in thousands):


	Three months ended
	December 29, 2007		December 2, 2006
Semiconductor Group	$	39,691	$	29,440
Passive Component Group		18,767		15,892
Interconnect Micro-Machining Group		18,828		13,969

	$	77,286	$	59,301

Net sales by product type for the six months ended December 29, 2007 and December 2, 2006 were as follows (in thousands):


	Six months ended
	December 29, 2007		December 2, 2006
Semiconductor Group	$	77,867	$	61,324
Passive Component Group		42,558		34,553
Interconnect Micro-Machining Group		39,179		23,792

	$	159,604	$	119,669

Net sales by geographic area, based on the location of the end user, for the three months ended December 29, 2007 and December 2, 2006 were as follows (in thousands):


	Three months ended
	December 29, 2007		December 2, 2006
Asia	$	54,614	$	43,165
Americas		14,937		11,727
Europe		7,735		4,409

	$	77,286	$	59,301

Net sales by geographic area, based on the location of the end user, for the six months ended December 29, 2007 and December 2, 2006 were as follows (in thousands):


	Six months ended
	December 29, 2007		December 2, 2006
Asia	$	118,201	$	86,818
Americas		27,866		24,732
Europe		13,537		8,119

	$	159,604	$	119,669

Note 14 – Insurance Recoveries

In November 2006, the Company settled litigation related to insurance coverage for the shareholder and derivative lawsuits related to the restatement of financial results announced in 2003 and recorded a gain of $1.0 million in the second quarter of fiscal 2007. All related costs were expensed as incurred in prior periods.

In June 2006, the Company received $1.3 million in insurance proceeds for demonstration systems that were destroyed in a fire at a customer’s plant. As the book value of these assets had previously been written off, the Company recorded a gain on the recovery which is included as an offset to operating expenses in the consolidated condensed statement of operations.

Note 15 – Legal Proceeding

All Ring Patent Infringement Prosecution

In August 2005, the Company commenced a proceeding in the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. The Company alleged that All Ring’s Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes ESI’s Taiwan Patent No. 207469, entitled “Circuit Component Handler” (the 207469 patent). This patent corresponds to ESI’s U.S. Patent No. 5,842,579. The patented technology is used in the Model 3340 Multifunction MLCC Tester. The Court issued a Provisional Attachment Order (PAO) in August 2005 and All Ring filed a bond with the Court to obtain relief from the attachment of its assets. In July 2007, pursuant to the Company’s application, the Court issued a second PAO and approximately US$6.0 million was restricted in All Ring’s accounts. All Ring appealed the second PAO to the High Court in August 2007 and the High Court revoked the second PAO in September 2007. The Company appealed the High Court’s decision to the Supreme Court. The Supreme Court granted the Company’s appeal in January 2008 and revoked the High Court’s decision. The second PAO remains in effect and cannot be revoked.

In October 2005, the Court executed a Preliminary Injunction Order that prohibits All Ring from manufacturing, selling, offering for sale or using the Capacitor Tester until final judgment is entered in the formal patent infringement action. In October 2007, All Ring filed an application to revoke the Preliminary Injunction Order. The Court dismissed All Ring’s application on January 18, 2008.

Pursuant to the Court’s orders, in October 2005 the Company was required to post a Taiwan dollar security bond with the Court. An additional bond amount of US$2.1 million was posted in June 2007 related to the second Provisional Attachment Order. The total security bond is valued at approximately US$9.1 million and is included in other assets on the Company’s consolidated condensed balance sheets at December 29, 2007.

In November 2007, All Ring filed with the Hsinchu District Court an application for a reverse Preliminary Injunction Order to allow All Ring to continue to manufacture, produce, sell, display, import, or export the Capacitor Tester, and the Company submitted a defense brief in December 2007. All Ring’s application has not yet been ruled upon.

In October 2005, the Company filed a formal patent infringement action against All Ring in the Court. In May 2006, after all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim of the 207469 patent. The Court-appointed expert subsequently concluded that All Ring’s RK-T2000 also infringes on every claim of the 207469 patent and that All Ring’s RK-L50 infringes on a number of the claims as well.

In November 2005, All Ring filed a cancellation action against ESI’s 207469 patent in the Taiwan Intellectual Property Office (the IPO). On July 5, 2007, the IPO issued a notice requiring the Company to cancel two of the claims in the 207469 patent. No other claims of the patent have been rejected. The Company filed a response canceling the two claims and amending the remaining claims accordingly in August 2007. An interview with the Examiner is set for January 28, 2008. The Company intends to vigorously pursue its patent infringement claims against All Ring and defend against the cancellation action.

Note 16 – Adoption of FIN 48

Effective June 3, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 specifies the way companies are to account for uncertainty in income tax reporting, and prescribes a methodology for recognizing, reversing, and measuring the tax benefits of a tax position taken, or expected to be taken, in a tax return. The Company has previously accounted for uncertain tax positions under SFAS 5 and SFAS 109. The adoption of FIN 48 has not resulted in any adjustments to existing reserves for income taxes as of the beginning of fiscal 2008.

As of June 3, 2007, the total gross amount of reserves for income taxes, which is reported as non-current income tax liabilities, was $5.8 million. Any future adjustments to reserves for income taxes will be recorded as an increase or decrease to provision for income taxes and would impact the effective tax rate. In addition, interest is accrued related to reserves for income taxes and penalties in the provision for income taxes. The gross amount of interest accrued as of the beginning of our 2008 fiscal year was $0.3 million.

As of December 29, 2007, the total gross amount of reserves for income taxes was $8.6 million with $7.6 million reported as non-current income tax liability and $1.0 million as income tax payable. The reserve for income taxes includes $0.4 million of accrued interest and $0.6 million in penalties. The increase in income tax reserves from June 2, 2007 is primarily due to the inclusion of the NWR tax reserves. Any future adjustments to the reserves related to the NWR acquisition would be reflected as an adjustment to goodwill and would not impact the effective tax rate. The Company anticipates no significant changes in unrecognized tax benefits in the next 12 months as the result of examinations or lapse of statutes of limitation.

The Company operates globally but considers its significant tax jurisdictions to include the United States, Taiwan, China, Korea, Japan, Singapore and the United Kingdom. As of June 3, 2007, the following tax years remained subject to examination by the major tax jurisdictions indicated:


Major Jurisdictions		Open Tax Years

China		2004 and forward

Japan		2003 and forward

Korea		2001 and forward

Singapore		2000 and forward

Taiwan		2001 and forward

United Kingdom		2000 and forward

United States		2003 and forward

Note 17 - New Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not impose fair value measurements on items not already accounted for at fair value; rather it applies, with certain exceptions, to other accounting pronouncements that either require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact, if any, of adopting SFAS 157 on its financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159),” which permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007 and is to be applied prospectively to business combinations with an acquisition date on or after the date of adoption. The Company has not yet determined the impact that the elective adoption of SFAS 159 may have on its financial position and results of operations.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements” (SFAS 160). SFAS 160 requires all entities to report non-controlling (minority) interests in subsidiaries as equity in the consolidated financial statements. SFAS 160 requires that transactions between an entity and non-controlling interests are treated as equity transactions. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company currently owns 100% of each of its subsidiaries and as such, adoption of SFAS 160 is not expected to have a significant impact on its financial position and results of operations.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ as a result of many factors, including the risks described in Part II, Item 1A. under the heading “Risk Factors.”

Overview

Electro Scientific Industries, Inc. and its subsidiaries (ESI) provide high-technology manufacturing equipment to the global electronics market, including advanced laser systems that are used to microengineer electronic device features in high-volume production environments. Our customers are primarily manufacturers of semiconductors, passive components and interconnect devices. Our equipment enables these manufacturers to achieve the yield and productivity gains in their manufacturing processes that can be critical to their profitability. The components and devices manufactured by our customers are used in a wide variety of end products in the computer, consumer electronics, communications and automotive industries.

We supply advanced laser microengineering systems that allow electronics manufacturers to physically alter select device features during high-volume production in order to heighten performance and boost production yields of semiconductor devices, passive components and circuitry, high-density interconnect (HDI) circuit boards, advanced semiconductor packaging and high-bright LEDs and flat panel LCD displays. Laser microengineering comprises a set of precise fine-tuning processes (laser micro-machining, link cutting and via drilling) that require application-specific laser systems able to meet semiconductor and microelectronics manufacturers’ exacting performance and productivity requirements.

Additionally, we produce high-speed test, inspection and termination equipment used in the high-volume production of multi-layer ceramic capacitors (MLCCs) and other passive components, as well as original equipment manufacturer machine vision products.

Acquisition of New Wave Research, Incorporated

On July 20, 2007, we acquired New Wave Research, Incorporated (“NWR”), a privately-held company headquartered in Fremont, California. NWR is a global leader in the development of high-end lasers and laser-based systems and its products are used in the semiconductor market for sapphire wafer scribing, flat-panel display repair and semiconductor failure analysis, among other applications. The acquisition was an investment aimed at leveraging our combined core competencies into adjacent markets and driving revenue growth and shareholder value.

We acquired 100% of NWR’s outstanding common stock for approximately $36.2 million, comprised of $34.9 million in cash and merger-related transaction costs of $1.3 million. The contractual purchase price of $36.0 million was reduced by $1.1 million related to certain net working capital adjustments and indemnity payments agreed upon prior to closing. The results for the second and third quarters include the results of our NWR division from the date of acquisition forward.

Purchase accounting charges for the three-month and six-month periods ended December 29, 2007 were as follows (in thousands):


	Three months ended December 29, 2007			Six months ended December 29, 2007
Cost of sales	$	515		$	1,625
Selling, service and administration		542			919
Research, development and engineering		(24	)		(24	)
Write-off of in-process research & development		—			2,800

	$	1,033		$	5,320

Purchase accounting charges recorded in cost of sales related to the fair value adjustments to acquired inventory and amortization of acquired intangibles. Purchase accounting charges included in operating expenses for the three-month and six-month periods ended December 29, 2007 were $0.5 million and $3.7 million, respectively, for the amortization of acquired intangibles, adjustments to the depreciable value of property, plant & equipment and the write-off of $2.8 million of in-process research & development. See further discussion of in-process research & development below in the discussion of expenses to compared to the prior year.

Change in Fiscal Reporting Periods

On July 3, 2007, our Board of Directors approved a change in our reporting periods that results in a fiscal year end on the Saturday nearest March 31. Accordingly, our fiscal year 2008 will consist of approximately a ten-month period containing 43 weeks ending on March 29, 2008. We have elected to file our interim financial statements in Quarterly Reports on Form 10-Q based on the reporting periods of our new fiscal year ending March 29, 2008. In order to conform to the prospective reporting periods in our new fiscal year, we refer to the three months ended December 29, 2007 as the third quarter of fiscal 2008. Due to the implementation of our enterprise resource system in the fourth quarter of fiscal 2006, we performed full close and reporting procedures on a fiscal quarter basis only during fiscal 2007. Accordingly, comparative data for the three months and six months ended December 30, 2006 is not available and is not cost beneficial to prepare. We believe that the first two quarters of fiscal 2007, comprised of the three months and six months ended December 2, 2006, provides a meaningful comparison to the second and third quarters of fiscal 2008. We do not believe that there are any meaningful factors, seasonal or otherwise, that would impact the comparability of information or trends, if the results for the three and six months ended December 30, 2006 were presented in lieu of results for the first and second quarters of fiscal 2007.

Summary of Sequential Quarterly Results

The semiconductor industry has recently experienced falling prices that have limited the profitability of memory producers. This has resulted in a decrease in capital expenditures by the semiconductor industry. Despite this slowing within our semiconductor market, the third quarter of fiscal 2008 reflected strong demand driven by successful introduction of new products. Orders increased slightly to $74.6 million compared to $74.4 million in the prior quarter. A significant sequential increase in orders for our semiconductor group was substantially offset by decreases in our interconnect/micro-machining and passive component groups.

Orders for our semiconductor group products increased by 61% compared to the second quarter of fiscal 2008. A portion of the increase was due to the timing of orders, which were lower in the second quarter due to specific large orders received in the four weeks preceding that quarter. In addition, we experienced continued strength in demand for our semiconductor group products, driven by adoption of our ultra-violet (UV) memory repair systems and continued strength in demand for our dual-beam infra-red (IR) memory repair systems.

Passive component group orders decreased by 5% compared to the second quarter of fiscal 2008. Despite the sequential decrease, we received multiple orders for our new Model 3550 high capacitance testing system and for our 3300 series and 6650 test systems. We believe this activity reflects continued strength in the MLCC manufacturing market and our continued penetration into the Japanese MLCC market.

Due to increasing focus on tools designed for micro-machining applications, we have designated our electronic interconnect products as the interconnect/micro-machining group (IMG). Orders for our IMG products decreased by 60% due primarily to timing of orders for micro-machining applications.

Gross margins were 46.2% on net sales of $77.3 million in the third quarter of fiscal 2008, compared to 44.7% on net sales of $82.3 million in the second quarter of fiscal 2008. Included in cost of sales in the current quarter were $0.5 million in purchase accounting charges, compared to $1.1 million in the prior quarter, which resulted in a 0.8 percentage point increase in gross margin in the current quarter. The remaining sequential increase in gross margin was driven primarily by favorable product mix.

Operating expenses decreased by $1.8 million to $27.5 million in the third quarter of fiscal 2008, compared to $29.3 million in the second quarter of fiscal 2008. The current quarter included $0.5 million in purchase accounting charges. The second quarter of fiscal 2008 included $3.2 million in purchase accounting charges, primarily comprised of a $2.8 million write-off of in-process research & development. The $0.9 million increase, exclusive of the decrease in purchase accounting charges, is primarily due to increases in NWR operating expenses and integration expenses in the third quarter of fiscal 2008 compared to the prior quarter. A full 13 weeks of operating results for NWR are included in the current quarter, compared to approximately 10 weeks in the second quarter of fiscal 2008.

Operating income increased to $8.2 million in the third quarter of fiscal 2008, compared to $7.5 million in the second quarter of fiscal 2008. Non-operating income decreased to $1.9 million from $2.1 million, primarily due to lower interest income resulting from lower average invested assets resulting from funds used for the acquisition of NWR and share repurchases.

The income tax provision recorded for the third quarter of fiscal 2008 was $3.4 million with an associated effective rate of 34%. Comparatively, the income tax provision in the second quarter of fiscal 2008 was $4.1 million with an associated effective tax rate of 42%. The prior quarter effective tax rate was higher due to a $1.0 million tax provision adjustment related to the $2.8 million purchase accounting write-off of in-process research and development.

Net income for the current quarter was $6.7 million or $0.24 per basic and diluted share, compared to net income of $5.5 million or $0.20 per basic and $0.19 per diluted share in the second quarter of fiscal 2007.

We expect to see continued weakening in the overall semiconductor capital equipment market. As a result, in the fourth quarter of fiscal 2008 we expect shipments and net sales to be in the range of $65 million to $75 million. The gross margin percentage in the fourth quarter is expected to be approximately 44, reflecting less favorable product mix. We anticipate operating expenses for the fourth quarter of fiscal 2008 to be approximately flat compared to the third quarter. We expect the tax rate in the fourth quarter to be approximately 36% and diluted earnings per share to be in the range of $0.08 to $0.15.

Revision of Statement of Operations for the First Quarter of Fiscal 2007

During the third quarter of fiscal 2007, we revised our results of operations for the first quarter of fiscal 2007 for certain immaterial corrections. The amounts presented for the six months ended December 2, 2006 in the consolidated condensed financial statements and related management’s discussion and analysis include these adjustments, which are detailed in Note 1 to the consolidated condensed financial statements presented in Part I, Item 1 of this Report on Form 10-Q.

Results of Operations

The following table sets forth results of operations data as a percentage of net sales.


	Three months ended				Six months ended
	December 29, 2007		December 2, 2006		December 29, 2007		December 2, 2006
Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	53.8		59.1		54.6		57.8

Gross margin	46.2		40.9		45.4		42.2
Selling, service and administrative	20.7		20.3		19.6		20.1
Research, development and engineering	14.9		16.2		14.2		15.8
Write-off acquired in-process R&D	—		—		1.8		—
Insurance recovery	—		(1.7	)	—		(1.9	)

Operating income	10.6		6.1		9.9		8.2
Total other income, net	2.4		3.8		2.5		4.3

Income before taxes	13.0		10.0		12.3		12.5
Income tax provision	4.4		3.6		4.7		4.1

Net income	8.6	%	6.4	%	7.6	%	8.3	%

Net Sales

Net sales were $77.3 million for the quarter ended December 29, 2007, an increase of $18.0 million or 30.3% compared to net sales of $59.3 million for the quarter ended December 2, 2006. The overall increase was driven by increases in all three of our product groups, as well as the impact of NWR net sales totaling $7.4 million in the third quarter of fiscal 2008.

Information regarding our net sales by product group is as follows (net sales in thousands):


	Three months ended
	December 29, 2007				December 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Semiconductor (SG)	$	39,691	52	%	$	29,440	50	%
Passive Components (PCG)		18,767	24			15,892	27
Interconnect/micro-machining (IMG)		18,828	24			13,969	23

	$	77,286	100	%	$	59,301	100	%


	Six months ended
	December 29, 2007				December 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Semiconductor (SG)	$	77,867	49	%	$	61,324	51	%
Passive Components (PCG)		42,558	27			34,553	29
Interconnect/micro-machining (IMG)		39,179	24			23,792	20

	$	159,604	100	%	$	119,669	100	%

SG sales in the third quarter of fiscal 2008 increased $10.3 million or 35% compared to the second quarter of fiscal 2007, including an increase of $3.6 million resulting from the acquisition of NWR. The remaining net sales increase was primarily due to increased volume sales of our dual-beam UV-based Model 9850.

Third quarter PCG sales increased $2.9 million or 18% compared to sales in the second quarter of fiscal 2007. The rise in PCG net sales was driven by strong demand for our Model 3300 series electrical test and Model 6650A visual inspection systems, and increased penetration in the Asian market, as manufacturers seek to build production capacity for MLCC products. We believe end-market demand for MLCC products has increased for wireless handsets, dual core microprocessors, flat-panel displays and automotive electronics.

IMG sales were $18.8 million in the third quarter of fiscal 2008, an increase of $4.9 million or 35% compared to IMG sales of $14.0 million in the second quarter of fiscal 2007, including an increase of $3.8 million resulting from the acquisition of NWR. The remaining increase was led by sales volumes of our Model 5300 series UV laser micro-via drilling systems.

Net sales were $159.6 million for the six months ended December 29, 2007, an increase of $39.9 million or 33% compared to $119.7 million for the six months ended December 2, 2006. The increase in net sales for the six months ended December 29, 2007 compared to the first six months of fiscal 2007 are attributable to the inclusion of NWR net sales of $12.6 million, volume sales increases for our dual-beam UV-based Model 9850, strong demand for our Model 3300 series electrical test and Model 6650A visual inspection systems, increased penetration in the Asian market for our PCG products, and a volume sales increase for our Model 5300 series UV laser micro-via drilling systems.

Net sales by geographic region were as follows (net sales in thousands):


	Three months ended
	December 29, 2007				December 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Asia	$	54,614	71	%	$	43,165	73	%
United States		14,937	19			11,727	20
Europe		7,735	10			4,409	7

	$	77,286	100	%	$	59,301	100	%

	Six months ended
	December 29, 2007				December 2, 2006
	Net Sales		% of Net Sales		Net Sales		% of Net Sales
Asia	$	118,200	74	%	$	86,818	72	%
United States		27,867	18			24,732	21
Europe		13,537	8			8,119	7

	$	159,604	100	%	$	119,669	100	%

Compared to the second quarter of fiscal 2007, the percentage of net sales to Asia in the current quarter of fiscal 2008 decreased by two percentage points. The net $11.5 million increase in net sales to Asia was driven primarily by volume increases in net sales of SG products and IMG products in China and in volume increases in net sales of IMG and ECS products in Japan. Those increases were offset by lower volume sales of SG products in Korea. Partially offsetting these increases, the impact of NWR net sales by region reduced our percentage of total net sales to Asia by approximately two percentage points, as NWR net sales were not as concentrated in Asia. Net sales to Europe in the third quarter of fiscal 2008 increased by three percentage points compared to the second quarter of fiscal 2008, driven by higher sales volumes for SG products and NWR sales, which increased our European net sales as a percentage of total net sales by approximately two percentage points.

For the six months ended December 29, 2007, sales by region were weighted more strongly to Asia as the second quarter of fiscal 2008 included volume increases in net sales of SG products to China and Korea and increases in Japan due to higher net sales of PCG products, as compared to the prior year. Additionally, the impact of the NWR regional net sales distribution on the consolidated net sales distribution was reduced as they are included in our financial results only from the acquisition date beginning July 20, 2007.

Gross Profit

Gross profit was $35.7 million (46.2% of net sales) for the third quarter of fiscal 2008 compared to $24.3 million (40.9% of net sales) for the second quarter of fiscal 2007. Cost of sales in the current quarter included $0.5 million in purchase accounting charges, which reduced the gross margin by 0.6 percentage points. Gross profit was $72.5 million (45.4% of net sales) for the six months ended December 29, 2007 compared to $50.5 million (42.2% of net sales) for the first two quarters of fiscal 2007. Cost of sales in the six months ended December 29, 2007 included $1.6 million in purchase accounting charges, which reduced the gross margin by 1.0 percentage point. Despite the impact of purchase accounting, the increases in gross profit for the three and six months ended December 29, 2007 compared to the three and six months ended December 2, 2006 are due to favorable sales mix within our product groups and volume-based manufacturing efficiencies on increased shipments. Shipments increased by $21.3 million or 35% and $49.1 million or 41%, respectively, for the three months and six months ended December 29, 2007 compared to the three months and six months ended December 2, 2006. Included in that increase is $6.9 million and $13.0 million, respectively, in NWR shipments for the three and six months ended December 29, 2007. Additionally, gross margin was negatively impacted in the prior year comparative quarters by various incremental manufacturing expenses related to the timing of freight, duty and warranty charges.

Operating Expenses

Selling, Service and Administrative Expenses

The primary items included in selling, service and administrative expenses are labor and other employee-related expenses, travel expenses, professional fees and facilities costs. Selling, service and administrative expenses were $16.0 million (20.7% of net sales) in the third quarter of fiscal 2008, an increase of $4.0 million compared to $12.0 million (20.3% of net sales) in the second quarter of fiscal 2007. The increase was impacted by the inclusion of $3.1 million in NWR selling, service and administrative expenses. The remaining $0.9 million increase was primarily due to expenses to support higher volume sales and service activity as well as incremental costs related to the integration of NWR.

Selling, service and administrative expenses were $31.4 million (19.7% of net sales) in the six months ended December 29, 2007 compared to $24.1 million (20.2% of net sales) in the first six months of fiscal 2007. The increase of $7.3 million includes the impact of $5.7 million in NWR expenses, of which $0.9 primarily consisted of amortization of purchase accounting intangibles. The remaining $1.6 million increase in selling, service and administration expenses for the six months ended December 29, 2007 compared to the six months ended December 2, 2006 was primarily due to expenses to support higher volume sales and service activity as well as incremental costs related to the integration of NWR.

Research, Development and Engineering Expenses

Research, development and engineering expenses are primarily comprised of labor and other employee-related expenses, professional fees, project materials, equipment and facilities costs. Expenses associated with research, development and engineering totaled $11.5 million (14.9% of net sales) for the third quarter of fiscal 2008, representing a $1.9 million increase from $9.6 million (16.2% of net sales) for the second quarter of fiscal 2007, including an increase of $1.5 million related to the inclusion of NWR expenses. The remaining $0.4 million increase is primarily related to increased project materials and consulting costs to support the development of new products in existing and emerging markets.

Research, development and engineering expenses were $22.6 million (14.2% of net sales) in the six months ended December 29, 2007 compared to $18.9 million (15.9% of net sales) in the first six months of fiscal 2007. Excluding the impact of NWR expenses of $2.6 million, the remaining increase of $1.1 million is due primarily to increased project materials and consulting costs to support the development of new products.

Write-off of In-process Research & Development

At the acquisition date, NWR had in-process research and development valued at $2.8 million and the immediate write-off of this amount has been included in operating expenses for the six-month period ended December 29, 2007. The in-process research and development related to three programs consisting of development on a diode-pumped solid-state LED wafer-scribing system, a next-generation Advanced Beam Delivery System and a next-generation laser product. The value of the in-process research and development was based on the excess earnings method of the income approach, which measures the value of an asset by calculating the present value of related future economic benefits, such as cash earnings. In determining the value of in-process research and development, the assumed commercialization date for these products was April 2008. The current estimated commercialization dates for these products ranges from May 2008 to November 2008. The modeled cash flow was discounted back to the net present value and was based on estimates of revenues and operating profits related to the project. Significant assumptions used in the valuation of in-process research and development included: stage of development of the project, future revenues, estimated life of the product’s underlying technology, future operating expenses, and a discount rate of 18% to reflect present value.

Insurance Recoveries

In November 2006, we settled litigation related to insurance coverage for the shareholder and derivative lawsuits related to the restatement of financial results announced in 2003. As a result, we recorded a gain of $1.0 million in the second quarter of fiscal 2007 as an offset to operating expenses in the consolidated condensed statement of operations. All related costs had been expensed as incurred in prior periods.

In June 2006, we received $1.3 million in insurance proceeds for demonstration systems that were destroyed in a fire at a customer’s plant. As the book value of these assets had previously been written off, the Company recorded a gain on the recovery which was included as an offset to operating expenses in the consolidated condensed statement of operations.

Interest and Other Income, Net

Interest and other income was $1.9 million in the third quarter of fiscal 2008, a decrease of $0.4 million compared to $2.3 million in the second quarter of fiscal 2007. This decrease is primarily due to a lower volume of average invested assets as we used $36.2 million in cash to fund the purchase of NWR in July

2007 and $37.3 million for our share repurchase program conducted from late April 2007 to early October 2007. Cash and securities totaled $217.5 million at December 2, 2006 and decreased to $182.3 million at December 29, 2007. Yields on our invested assets have remained fairly stable over the past year.

Lower invested asset volumes also drove the $1.2 million reduction in interest and other income to $3.9 million for the six months ended December 29, 2007 compared to $5.1 million in the first six months of fiscal 2007.

Income Taxes

The income tax provision recorded for the third quarter of fiscal 2008 was $3.4 million on pretax income of $10.1 million, an effective rate of 34%. Comparatively, the income tax provision was $2.1 million on pretax income of $5.9 million in the second quarter of fiscal 2007, an effective tax rate of 36%. The prior year effective tax rate was higher due to certain discrete adjustments related to the adoption of SFAS 123R, and to the expiration of a research and experimentation tax credit as of December 31, 2005 which was ultimately retroactively reinstated in the third quarter of fiscal 2007.

The provision for income taxes in the six months ended December 29, 2007 was $7.5 million on pretax income of $19.7 million, an effective tax rate of 38%, compared to an income tax provision of $4.9 million on pretax income of $14.9 million in the six months ended December 2, 2006, an effective tax rate of 33%. The increase in the effective tax rate in the six months ended December 29, 2007 compared to the first six months of fiscal 2007 is primarily due to discrete purchase accounting charges of $2.8 million associated with the write-off of in-process research and development, which is non-deductible for tax purposes.

Our effective tax rate is subject to fluctuation based upon the occurrence and timing of numerous discrete events, including, for example, changes in tax laws or their interpretations, extensions or expirations of research and experimentation credits, closure of tax years subject to examination and finalization of income tax returns. Based on currently available information, we are not aware of any further discrete events which are likely to occur that would have a materially adverse effect on our financial position, expected cash flows or results of operations. We anticipate no significant changes in unrecognized tax benefits in the next 12 months as the result of examinations or lapsed of statutes of limitation.

Net Income

Net income for the three and six months ended December 29, 2007 was $6.7 million (8.6% of net sales) or $0.24 per share on a basic and diluted basis and $12.2 million (7.6% of net sales) or $0.44 per basic and $0.43 per diluted share, respectively. For the three and six months ended December 2, 2006, we recorded net income of $3.8 million (6.4% of net sales) or $0.13 per basic and diluted share and $10.0 million (8.3% of net sales) or $0.34 per basic and fully diluted share, respectively.

Financial Condition and Liquidity

At December 29, 2007, our principal sources of liquidity consisted of cash, cash equivalents and short-term marketable securities of $160.6 million and accounts receivable of $60.0 million. At December 29, 2007, we had a current ratio of 5.4:1 and no long-term debt. Working capital decreased to $275.5 million at December 29, 2007 from $327.3 million at June 2, 2007, primarily due to the use of cash for the acquisition of NWR and the funding of our share repurchase program.

On July 20, 2007 we completed our cash acquisition of NWR for approximately $36.2 million including merger-related transaction fees and net of cash acquired.

On March 9, 2007, the Board of Directors authorized the repurchase of up to $50 million in shares of our outstanding common stock over a nine month period beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. We suspended purchase transactions under that share repurchase program effective October 9, 2007. In total, we repurchased a total of approximately 1.7 million shares for $37.3 million, with $27.5 million in cash used to settle purchases in the current fiscal year. On January 22, 2008, our Board of Directors voted to resume the previous $50 million share repurchase program. Accordingly, the Board of Directors has authorized the repurchase of up to $12.7 million in shares of our outstanding common stock over a six-month period beginning January 29, 2008 through transactions in the open market or in negotiated transactions with brokers or shareholders.

We believe that our existing cash, cash equivalents and marketable securities are adequate to fund our operations and our share repurchase program for at least the next twelve months.

As of December 29, 2007, we had a total of $19.6 million invested in auction rate securities. Historically, these securities provided liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 to 35 days. This mechanism allowed existing investors to either retain or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. We currently believe that these securities will ultimately be liquidated in orderly transactions in the future and we do not expect to need to sell these securities to fund our operations in the next twelve months. We have the intent and ability to hold these securities until they reach maturity or are redeemed by the issuers and accrued interest income continues to be received when due. As such, we have determined that there has been no permanent impairment of the value of these securities and that their par value approximates fair value. Thus, no unrealized gain or loss has been recorded in other comprehensive income or in the condensed consolidated statement of operations.

Cash flows provided by operating activities totaled $18.2 million in the period from June 3, 2007 through December 29, 2007. Cash totaling $25.7 million was provided by net income adjusted for non-cash items. Other significant factors impacting cash flows from operations included collections on trade receivables, purchases of inventories, decreases in current liabilities and increases in deferred revenue, net of the related deferred cost of sales.

Net trade receivables were $60.0 million at December 29, 2007, compared to $55.7 million at June 2, 2007. Receivables increased $4.3 million primarily due to the acquisition of NWR receivables of $5.4 million in July 2007. Days sales outstanding has remained stable at 71 days at both December 29, 2007 and June 2, 2007.

Net inventories increased $8.0 million from June 2, 2007 to $88.9 million at December 29, 2007. In July 2007, we acquired NWR inventories of $6.1 million. The remaining $1.9 million increase in inventories resulted from a production ramp relating to a specific customer shipment.

Operating cash flows from changes in deferred revenue, net of related changes in shipped systems pending acceptance, totaled $2.3 million.

Payables and other liabilities were $46.1 million at December 29, 2007 compared to $45.0 million at June 2, 2007, an increase of $1.1 million. In July 2007, we acquired $9.1 million in NWR current liabilities. Net cash used to settle other liabilities totaled $8.1 million, primarily used to fund the annual profit sharing payment for fiscal 2007 paid in August, settle income taxes payable and reduce outstanding accounts payable.

Cash flows provided by investing activities totaled $57.6 million for the seven months ended December 29, 2007. We generated $98.8 million, net, in cash and cash equivalents through the maturity and sale of investments in our portfolio of marketable securities. We invested approximately $36.2 million of those proceeds in the acquisition of NWR. Additionally, we invested $3.9 million in property, plant and equipment, primarily test equipment and computer hardware and software, and $1.2 million in loaned and demonstration system assets.

Net cash flows used in financing activities of $23.3 million were comprised of $27.5 million in cash used to settle repurchase transactions for approximately 1.2 million shares of our common stock pursuant to the share repurchase program discussed above, partially offset by $4.2 million in proceeds and tax benefits from the exercise of stock options and ESPP purchases for the seven months ended December 29, 2007.

Critical Accounting Policies and Estimates

Except as detailed below, we reaffirm the critical accounting policies and our use of estimates as reported in our annual report on Form 10-K for our fiscal year ended June 2, 2007 as filed with the Securities and Exchange Commission on August 15, 2007.

Goodwill and Intangible Assets

The Company accounts for goodwill and intangible assets pursuant to SFAS No. 141 “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill no longer be amortized, but instead be tested for impairment at least annually in accordance with the provision of SFAS No. 142. We will perform our annual impairment test in the fourth quarter of fiscal 2008. SFAS No. 142 requires purchased intangible assets, other than goodwill, to be amortized over their estimated useful lives, unless an asset has an indefinite life. Purchased intangible assets with definite useful lives are carried at cost less accumulated amortization. Amortization expense is recognized on either a straight-line or sum-of-the-years digits method over the estimated useful lives of the intangible assets, which range from one to seven years. The valuation of intangibles and their useful lives are subject to change as the purchase price allocations of NWR are still under review.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Except for the continued deterioration in the liquidity of auction rate securities as discussed, under the heading “Financial Condition and Liquidity” in Item 2 of Part I of this report, there have been no material changes in the market risk disclosure contained in our 2007 Annual Report on Form 10-K for our fiscal year ended on June 2, 2007.

Item 4.

Controls and Procedures

Attached to this quarterly report as exhibits 31.1 and 31.2 are the certifications of our President and Chief Executive Officer and our Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002 (the Section 302 Certifications). This portion of our quarterly report on Form 10-Q is our disclosure of the conclusions of our management, including our President and Chief Executive Officer and our Chief Financial Officer, regarding the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report based on management’s evaluation of those disclosure controls and procedures. You should read this disclosure in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our President and Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on that evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal controls over financial reporting during our fiscal quarter ended December 29, 2007 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

In August 2005, we commenced a proceeding in the Kaohsiung District Court of Taiwan (the Court) directed against All Ring Tech Co., Ltd. (All Ring) of Taiwan. We alleged that All Ring’s Capacitor Tester Model RK-T6600 (the Capacitor Tester) infringes our Taiwan Patent No. 207469, entitled “Circuit Component Handler” (the 207469 patent). This patent corresponds to our U.S. Patent No. 5,842,579. The patented technology is used in the Model 3340 Multifunction MLCC Tester. The Court issued a Provisional Attachment Order (PAO) in August 2005 and All Ring filed a bond with the Court to obtain relief from the attachment of its assets. In July 2007, pursuant to our application, the Court issued a second PAO and approximately US$6.0 million was restricted in All Ring’s accounts. All Ring appealed the second PAO to the High Court in August 2007 and the High Court revoked the second PAO in September 2007. We appealed the High Court’s decision to the Supreme Court. The Supreme Court granted our appeal in January 2008 and revoked the High Court’s decision. The second PAO remains in effect and cannot be revoked.

Pursuant to the Court’s orders, in October 2005 we were required to post a Taiwan dollar security bond with the Court. An additional bond amount of US$2.1 million was posted in June 2007 related to the second Provisional Attachment Order. The total security bond is valued at approximately US$9.1 million and is included in other assets on our consolidated condensed balance sheets at December 29, 2007.

In November 2007, All Ring filed with the Hsinchu District Court an application for a reverse Preliminary Injunction Order to allow All Ring to continue to manufacture, produce, sell, display, import, or export the Capacitor Tester, and we submitted a defense brief in December 2007. All Ring’s application has not yet been ruled upon.

In October 2005, we filed a formal patent infringement action against All Ring in the Court. In May 2006, after all parties filed briefs on the topic, the Court appointed an expert to conduct a patent infringement assessment. The Court-appointed expert has completed the assessment of the Capacitor Tester and concluded that it infringes every claim of the 207469 patent. The Court-appointed expert subsequently concluded that All Ring’s RK-T2000 also infringes on every claim of the 207469 patent and that All Ring’s RK-L50 infringes on a number of the claims as well.

In November 2005, All Ring filed a cancellation action against our 207469 patent in the Taiwan Intellectual Property Office (the IPO). On July 5, 2007, the IPO issued a notice requiring us to cancel two of the claims in the 207469 patent. No other claims of the patent have been rejected. We filed a response canceling the two claims and amending the remaining claims accordingly in August 2007. An interview with the Examiner is set for January 28, 2008. We intend to vigorously pursue our patent infringement claims against All Ring and defend against the cancellation action.

Item 1A.

Risk Factors

Factors That May Affect Future Results

The statements contained in this report that are not statements of historical fact, including without limitation statements containing the words “believes,” “expects” and similar words, constitute forward-looking statements that are subject to a number of risks and uncertainties. From time to time we may make other forward-looking statements. Investors are cautioned that such forward-looking statements are subject to an inherent risk that actual results may materially differ. The following information highlights some of the factors that could cause actual results to differ materially from the results expressed or implied by our forward-looking statements. Forward-looking statements should be considered in light of these factors. Factors that may result in such variances include, but are not limited to, the following:

The industries that comprise our primary markets are volatile and unpredictable.

Our business depends upon the capital expenditures of manufacturers of components and circuitry used in wireless communications, computers and other electronic products. In the past, the markets for electronic devices have experienced sharp downturns. During these downturns, electronics manufacturers, including our customers, have delayed or canceled capital expenditures, which has had a negative impact on our financial results. In the event of a downturn, we will not be able to assure you when demand for our products will increase or that demand will not decrease. Even if demand for our products does increase, there may be significant fluctuations in our profitability and net sales.

During any downturn, it will be difficult for us to maintain our sales levels. As a consequence, to maintain profitability we will need to reduce our operating expenses. Our ability to quickly reduce operating expenses is dependent upon the nature of the actions we take to reduce expense and our subsequent ability to implement those actions and realize expected cost savings. Additionally, we may be unable to defer capital expenditures and we will need to continue to invest in certain areas such as research and development. An economic downturn may also cause us to incur charges related to impairment of assets and inventory write-offs and we may also experience delays in payments from our customers, which would have a negative effect on our financial results.

In addition, because we derive a substantial portion of our revenue from the sale of a relatively small number of products, the timing of, or changes to, orders by our customers may also cause our order levels and results of operations to fluctuate between periods, perhaps significantly. For example, in the second quarter of fiscal 2007, a customer requested that the Company convert part of a previous order for UV-based semiconductor systems to IR-based systems and to postpone shipment of additional UV-based systems, which resulted in approximately $18 million being removed from backlog. Accordingly, order levels or results of operations for a given period may not be indicative of order levels or results of operations for following periods.

Delays in manufacturing, shipment or customer acceptance of our products could substantially decrease our sales for a period.

We depend on manufacturing flexibility to meet the changing demands of our customers. Any significant delay or interruption in receiving raw materials or in our manufacturing operations as a result of software deficiencies, natural disasters, or other causes could result in reduced manufacturing capabilities or delayed product deliveries, any or all of which could materially and adversely affect our results of operations.

We also have an arrangement with a contract manufacturer in Singapore to complete the manufacture of certain of our products. Any significant interruption in this contract manufacturer’s ability to provide manufacturing services to us as a result of contractual disputes with us or another party, labor disruptions, natural disasters, delay or interruption in the receipt of inventory or other causes could result in reduced manufacturing capabilities or delayed deliveries for certain of our products, any or all of which could materially and adversely affect our results of operations

In addition, we derive a substantial portion of our revenue from the sale of a relatively small number of products. Consequently, shipment and/or customer acceptance delays, including acceptance delays related to new product introductions or customizations, could significantly impact recognition of revenue and could be further magnified by announcements from us or our competitors of new products and technologies, which announcements could cause our customers to defer purchases of our systems, change existing orders or purchase products from our competitors. Any of these delays could result in a material adverse change in our results of operations for any particular period.

Failure of critical suppliers of parts, components and manufacturing equipment to deliver sufficient quantities to us in a timely and cost-effective manner could negatively affect our business.

We use a wide range of materials in the production of our products, including custom electronic and mechanical components, and we use numerous suppliers for those materials. We generally do not have guaranteed supply arrangements with our suppliers. We seek to reduce the risk of production and service interruptions and shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, some key parts are available only from a single supplier or a limited group of suppliers in the short term. Operations at our suppliers’ facilities are subject to disruption for a variety of reasons, including changes in business relationships, competitive factors, work stoppages, and fire, earthquake, flooding or other natural disasters. Such disruption could interrupt our manufacturing. Our business may be harmed if we do not receive sufficient parts to meet our production requirements in a timely and cost-effective manner.

We depend on a few significant customers and we do not have long-term contracts with any of our customers.

Our top ten customers for fiscal 2007 accounted for approximately 62% of total net sales in fiscal 2007, with two customers each accounting for more than 10% of total net sales in fiscal 2007. In addition, none of our customers has any long-term obligation to continue to buy our products or services, and any customer could delay, reduce or cease ordering our products or services at any time.

Our markets are subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance.

The markets for our products are characterized by rapid technological change and innovation, frequent new product introductions, changes in customer requirements and evolving industry standards. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes as well as current and potential customer requirements. The introduction by us or by our competitors of new and enhanced products may cause our customers to defer, change or cancel orders for our existing products, which may harm our operating results. In the past we have also experienced delays in new product development. Similar delays may occur in the future. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements or, where necessary, to license these technologies from others.

Product development delays may result from numerous factors, including:

•

Changing product specifications and customer requirements;

•

Difficulties in hiring and retaining necessary technical personnel;

•

Difficulties in reallocating engineering resources and overcoming resource limitations;

•

Difficulties with contract manufacturers;

•

Changing market or competitive product requirements; and

•

Unanticipated engineering complexities.

The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological change that may render our current products or technologies obsolete could significantly harm our business.

We acquire inventory based upon projected demand. If these projections are incorrect we may carry inventory that cannot be used, which may result in significant charges for excess and obsolete inventory.

Our business is highly competitive and one factor on which we compete is the ability to ship products on the schedule required by customers. In order to facilitate timely shipping, management forecasts demand, both in type and amount of products, and these forecasts are used to determine our inventory to be purchased. Certain types of inventory, including lasers and optical equipment, are particularly expensive and can only be used in the production of a single type of product. If actual demand is lower than forecast with respect to the type or amount of products actually ordered, or both, our inventory levels may increase. As a result, there is a risk that we may have to incur material accounting charges for excess and obsolete inventory if inventory cannot be used, which could negatively affect our financial results.

Our ability to reduce costs is limited by our need to invest in research and development.

Our industry is characterized by the need for continued investment in research and development. Because of intense competition in the industries in which we compete, if we were to fail to invest sufficiently in research and development, our products could become less attractive to potential customers, and our business and financial condition could be materially and adversely affected. As a result of our need to maintain our spending levels in this area, our operating results could be materially harmed if our net sales fall below expectations. In addition, as a result of our emphasis on research and development and technological innovation, our operating costs may increase in the future, and research and development expenses may increase as a percentage of total operating expenses and as a percentage of net sales.

We are exposed to the risks that others may violate our proprietary rights, and our intellectual property rights may not be well protected in foreign countries.

Our success is dependent upon the protection of our proprietary rights. In the high technology industry, intellectual property is an important asset that is always at risk of infringement. We incur substantial costs to obtain and maintain patents and defend our intellectual property. For example, we have initiated litigation alleging that certain parties have violated various patents of ours, such as the action we initiated in Taiwan against All Ring Tech Co., Ltd. in August 2005. We rely upon the laws of the United States and of foreign countries in which we develop, manufacture or sell our products to protect our proprietary rights. However, these proprietary rights may not provide the competitive advantages that we expect or other parties may challenge, invalidate or circumvent these rights.

Further, our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States. Many U.S. companies have encountered substantial problems in protecting their proprietary rights against infringement in foreign countries. If we fail to adequately protect our intellectual property in these countries, it could be easier for our competitors to sell competing products in foreign countries, which could result in reduced sales and gross margins.

We may be subject to claims of intellectual property infringement.

Several of our competitors hold patents covering a variety of technologies, applications and methods of use similar to some of those used in our products. From time to time, we and our customers have received correspondence from our competitors claiming that some of our products, as used by our customers, may be infringing one or more of these patents. Competitors or others have in the past and may in the future assert infringement claims against our customers or us with respect to current or future products or uses, and these assertions may result in costly litigation or require us to obtain a license to use intellectual property rights of others. If claims of infringement are asserted against our customers, those customers may seek indemnification from us for damages or expenses they incur.

If we become subject to infringement claims, we will evaluate our position and consider the available alternatives, which may include seeking licenses to use the technology in question or defending our position. These licenses, however, may not be available on satisfactory terms or at all. If we are not able to negotiate the necessary licenses on commercially reasonable terms or successfully defend our position, our financial condition and results of operations could be materially and adversely affected.

Our business is highly competitive, and if we fail to compete effectively, our business will be harmed.

The industries in which we operate are highly competitive. We face substantial competition from established competitors, some of which have greater financial, engineering, manufacturing and marketing resources than we do. If we are unable to compete effectively with these companies, our market share may decline and our business could be harmed. Our competitors can be expected to continue to improve the design and performance of their products and to introduce new products. New companies may enter the markets in which we compete, or industry consolidation may occur, further increasing competition in those markets. Furthermore, our technological advantages may be reduced or lost as a result of technological advances by our competitors.

Our competitors’ greater resources in the areas described above may enable them to:

•

Better withstand periodic downturns;

•

Compete more effectively on the basis of price and technology; and

•

More quickly develop enhancements to and new generations of products.

We believe that our ability to compete successfully depends on a number of factors, including:

•

Performance of our products;

•

Quality of our products;

•

Reliability of our products;

•

Cost of using our products;

•

The ability to upgrade our products;

•

Consistent availability of critical components;

•

Our ability to ship products on the schedule required;

•

Quality of the technical service we provide;

•

Timeliness of the services we provide;

•

Our success in developing new products and enhancements;

•

Our understanding of the needs of our customers;

•

Existing market and economic conditions; and

•

Price of our products as compared to our competitors’ products.

We may not be able to compete successfully in the future, and increased competition may result in price reductions, reduced profit margins and loss of market share.

The loss of key personnel or our inability to attract, retain and assimilate sufficient numbers of managerial, financial, engineering and other technical personnel could have a material effect upon our results of operations.

Our continued success depends, in part, upon key managerial, financial, engineering and technical personnel as well as our ability to continue to attract, retain and assimilate additional personnel. The loss of key personnel could have a material adverse effect on our business or results of operations. We may not be able to retain our key managerial, financial, engineering and technical employees. Attracting qualified personnel may be difficult and our efforts to attract and retain these personnel may not be successful. In addition, we may not be able to assimilate qualified personnel, including any new members of senior management, which could disrupt our operations.

Our worldwide direct sales and service operations and our overseas research and development facility expose us to employer-related risks in foreign countries.

We have established direct sales and service organizations throughout the world. We have also established a research and development facility in China. Having overseas employees involves certain risks. We are subject to compliance with the labor laws and other laws governing employers in the countries where our operations are located and as a result we may incur additional costs to comply with these local regulations. Additionally, we may encounter labor shortages or disputes that could inhibit our ability to effectively sell, market and service our products. If we cannot effectively manage the risks related to employing persons in foreign countries, our operating results could be adversely affected.

We recently completed an acquisition and may make acquisitions in the future, and these acquisitions may subject us to risks associated with integrating these businesses into our current business.

We recently completed the acquisition of New Wave Research, Incorporated (NWR) and in the future we may make acquisitions of, or significant investments in, other businesses with complementary products, services or technologies.

Acquisitions, including the acquisition of NWR, involve numerous risks, many of which are unpredictable and beyond our control, including:

•

Difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of acquired companies;

•

Diversion of management’s attention from other operational matters;

•

The potential loss of key employees of acquired companies;

•

Lack of synergy, or inability to realize expected synergies, resulting from the acquisition;

•

Acquired assets becoming impaired as a result of technological advancements or worse-than-expected performance by the acquired company;

•

Difficulties establishing satisfactory internal controls at acquired companies; and

•

Incurring liabilities for which we may not be indemnified in full or at all.

Our inability to effectively manage these acquisition risks could materially and adversely affect our business, financial condition and results of operations and could cause us not to realize the anticipated benefits of an acquisition on a timely basis or at all. In addition, if we issue equity securities to pay for an acquisition the ownership percentage of our existing shareholders would be reduced and the value of the shares held by our existing shareholders could be diluted. If we use cash to pay for an acquisition the payment could significantly reduce the cash that would be available to fund our operations or to use for other purposes. In addition, the accounting for acquisitions, including the NWR acquisition, could result in significant charges resulting from amortization of intangible assets related to such acquisitions. We have made, and in the future may make, strategic investments in development stage companies, which investments are subject to a high degree of risk, and therefore it is possible that we could lose our entire investment.

We are exposed to the risks of operating a global business, including risks associated with exchange rate fluctuations, legal and regulatory changes and the impact of regional and global economic disruptions.

International shipments accounted for 84% of net sales in fiscal 2007, with 75% of our net sales to customers in Asia. We expect that international shipments will continue to represent a significant percentage of net sales in the future. We also have an arrangement with a contract manufacturer in Singapore to complete the manufacture of certain of our products. Our non-U.S. sales, purchases and operations, including contract manufacturing, are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:

•

Periodic local or geographic economic downturns and unstable political conditions;

•

Price and currency exchange controls;

•

Fluctuation in the relative values of currencies;

•

Difficulties protecting intellectual property;

•

Local labor disputes;

•

Shipping delays and disruptions;

•

Increases in shipping costs, caused by increased fuel costs or otherwise, which we may not be able to pass on to our customers;

•

Unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and

•

Difficulties in managing a global enterprise, including staffing, collecting accounts receivable, managing suppliers, distributors and representatives, and repatriation of earnings.

Our business and operating results are subject to uncertainties arising out of the possibility of regional or global economic disruptions (including those resulting from natural disasters and outbreaks of infectious disease), the economic consequences of military action or terrorist activities and associated political instability, and the impact of heightened security concerns on domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:

•

The risk that future tightening of immigration controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities or our ability to hire new non-U.S. employees in such facilities;

•

The risk of more frequent instances of shipping delays; and

•

The risk that demand for our products may not increase or may decrease.

We reported a material weakness in our internal control over financial reporting in a prior fiscal year and if additional material weaknesses are discovered in the future, our internal controls over financial reporting could be adversely affected.

In connection with our management’s assessment of the effectiveness of our internal control over financial reporting at the end of the third quarter of fiscal 2007, we concluded that, as of March 3, 2007, our disclosure controls and procedures were not effective in ensuring accurate reporting of financial information due to a material weakness in our processes, procedures and controls related to the review and analysis of inventory cost variances resulting from certain inventory transactions. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements would not be prevented or detected.

We have taken the steps necessary to remediate the previously identified material weakness. However, the identification of one or more additional material weaknesses in the future could result in material misstatements in our financial reports and could lead us or our auditors to conclude that we do not have effective controls over financial reporting as required under Section 404 of the Sarbanes-Oxley Act. This may negatively impact the market’s view of our control environment and, potentially, our stock price.

No market currently exists for auction rate securities we hold and as a result we may not be able to liquidate them for par value, if at all. In addition, if the credit quality of the issuers or their guarantors declines we may have to recognize an impairment with respect to those securities.

As of December 29, 2007, the Company had a total of $19.6 million invested in auction rate securities. These securities historically provided short-term liquidity through a Dutch auction process that reset the applicable interest rate at pre-determined calendar intervals, generally every 28 to 35 days. This mechanism allows existing investors to either retain their holdings or liquidate their holdings by selling such securities at par. The recent uncertainties in the credit markets have reduced the liquidity of these securities as recent auctions have not been completed. In the second quarter of fiscal 2008, we reclassified these securities, which were previously included in current assets, as long-term marketable securities on our consolidated condensed balance sheet. We believe that these securities will ultimately be liquidated in orderly transactions at an amount equal to the cost of the assets. However, if we need to liquidate the securities in the near future or if no orderly liquidation occurs, we may not be able liquidate these securities at par or at all, which could impair our liquidity. In addition, while these investments continue to be of high credit quality and the respective credit ratings of the securities issuers also remain high, if their credit quality decreases or such credit ratings decline we may have to recognize an impairment to the value of the securities, which could harm our financial results. It is possible that continued uncertainty in the credit markets could also impact the liquidity of our other investments and cash equivalents, which could impair our liquidity or require us to recognize an impairment to the value of those investments, which could harm our business.

Our tax rates are subject to fluctuation, which could impact our financial position, and our estimates of tax liabilities may be subject to audit, which could result in additional assessments.

Our effective tax rates are subject to fluctuation as the income tax rates for each year are a function of: (a) taxable income levels and the effects of a mix of profits (losses) earned by ESI and our subsidiaries in numerous tax jurisdictions with a broad range of income tax rates, (b) our ability to utilize recorded deferred tax assets, (c) taxes, interest or penalties resulting from tax audits, (d) the magnitude of various credits and deductions as a percentage of total taxable income and (e) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rates to fluctuate between periods, which could have a material adverse effect on our financial position.

We are subject to income taxes in both the United States and numerous foreign jurisdictions. During the ordinary course of business there are transactions and calculations for which the ultimate tax determination is uncertain. Significant judgment is exercised in determining our world wide provisions for income taxes. Furthermore, we are occasionally under audit by tax authorities. Although we believe our tax estimates are reasonable, the final outcome of tax audits and examinations and the impact of changes in tax laws or the interpretation of tax laws could result in material differences from what is reflected in historical income tax accruals. For example, we recorded an additional $1.0 million of income taxes payable in the fourth quarter of fiscal 2007 due to new technical guidance from the Internal Revenue Service regarding foreign sales and leasing income. If additional taxes are assessed as a result of an examination, a material effect on our financial results, tax positions or cash flows could occur in the period or periods in which the determination is made.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

On April 10, 2007, we announced that on March 9, 2007, the Board of Directors authorized the repurchase of up to $50 million in shares of our outstanding common stock over a nine-month period beginning April 17, 2007 through transactions in the open market or in negotiated transactions with brokers or shareholders. The following table sets forth information about the share repurchase transactions in accordance with SEC Regulation S-K, Item 703:

Period

(a) Total
Number of Shares
(or Units) Purchased

(b) Average Price
Paid per Share

(or Unit)

(d) Maximum Number

(or Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased
Under the Plans or
Programs

9/30/07 to 10/09/07

72,000

$24.87

72,000

$12,656,167

On October 9, 2007, the Company suspended purchase transactions under the above share repurchase program. In total, the Company repurchased approximately 1.7 million shares for $37.3 million between April 17, 2007 and October 9, 2007.

On January 22, 2008, our Board of Directors voted to resume the previous $50 million share repurchase program. Accordingly, the Board of Directors has authorized the repurchase of up to $12.7 million in shares of our outstanding common stock over a six-month period beginning January 29, 2008 through transactions in the open market or in negotiated transactions with brokers or shareholders.

Item 4.

Submission of Matters to a Vote of Security Holders

The 2007 Annual Meeting of Shareholders of the Company was held pursuant to notice at 2:00 p.m. Pacific time on October 25, 2007 at the Company’s offices in Portland, Oregon to consider and vote upon the following proposals.


Proposal 1		To elect three directors for a term of three years.

Proposal 2		To approve an amendment to our 2004 Stock Incentive Plan to permit grants to non-employee service providers, implement a “claw-back” provision and make other changes described in the proxy statement.

Proposal 3		To ratify the appointment of KPMG LLP as the Company’s independent registered public accounting firm for the ten-month period ending March 29, 2008

The results of the voting on these proposals were as follows:

Proposal 1

Election of Directors

For

Withheld

Frederick A. Ball

Nicholas Konidaris

Jon D. Tompkins

25,374,679

25,050,031

25,395,857

255,204

579,852

234,026


	For	Against	Abstentions	Broker Non-Votes
Proposal 2	13,653,409	8,505,468	447,376	3,023,630


	For	Against	Abstentions
Proposal 3	25,112,731	438,878	78,274

Item 6.

Exhibits

This list is intended to constitute the exhibit index.



3.1		Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-A of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1991.

3.2		Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3-B of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1999.

3.3		Articles of Amendment of Third Restated Articles of Incorporation. Incorporated by reference to Exhibit 3 of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended December 2, 2000.

3.4		2004 Restated Bylaws, as amended. Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on October 21, 2004.

4.1		Amended and Restated Rights Agreement, dated as of March 1, 2001, between the Company and Mellon Investor Services, relating to rights issued to all holders of Company common stock. Incorporated by reference to Exhibit 4-A of the Company’s Annual Report on Form 10-K for the fiscal year ended June 2, 2001.

10.1		Employment offer letter, dated November 26, 2007, between the Company and Paul Oldham. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on December 3, 2007.

10.2		2004 Stock Incentive Plan, as amended. Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 29, 2007.

31.1		Certification of the Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.

31.2		Certification of the Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Dated: January 25, 2008	ELECTRO SCIENTIFIC INDUSTRIES, INC.

	By	/s/ Nicholas Konidaris
		Nicholas Konidaris
		President and Chief Executive Officer (Principal Executive Officer)

	By	/s/ Paul Oldham
		Paul Oldham
		Vice President of Administration, Chief Financial Officer and Corporate Secretary (Principal Financial Officer)

	By	/s/ Kerry Mustoe
		Kerry Mustoe
		Vice President, Corporate Controller and Chief Accounting Officer (Principal Accounting Officer)